Shares in Nufarm (ASX:NUF) have de-rated since the Company’s results release for the first half of financial year 2022 (1H22) in May. The de-rating was a function of market concerns that FY22 is a peak earnings year and the removal of a takeover premium that has been ascribed to the shares following the sale of Sumitomo Chemical Company’s 15.8% shareholding in NUF.
Accordingly, we recently researched Nufarm (NUF) in The Dynamic Investor, as the shares appeared to have been oversold. The shares have since recovered from its recent lows and in this note, we outline several fundamental reasons why there is potential for the recovery to continue.
Nufarm is a leading crop protection and seed technologies company. NUF develops, manufactures, and distributes a range of herbicides, insecticides and fungicides. These are used by growers to protect their crops against weeds, pests, and diseases. In crop protection, it primarily operates in the off-patent segment of the market.
Its seeds business uses proprietary technology and NUF is developing its seed treatment capabilities. The crop protection business is focused on major agricultural markets in Europe, North America, and Asia Pacific (APAC).
NUF has formulation and manufacturing facilities in nine countries, marketing operations in over 30 countries and distributes its products in ~100 countries across Australia & NZ, Asia, North America and Europe. The Company previously held a strategic alliance with Sumitomo Chemical Company. They were NUF’s largest shareholder until it sold its 15.8% interest in NUF on 23 May 2022.
Key Fundamental Drivers
Industry Trends Suggest Buoyant Trading Conditions
Recent June 2022 quarterly earnings results for NUF’s key global crop protection peers (including BASF, Bayer, FMC, Corteva, UPL and Adama) showed strong earnings growth and margin expansion. The strong results from the crop protection industry alongside positive outlook commentary are supportive factors for NUF shares.
On average, the peer group reported: i) Organic sales growth of 22% compared to the June 2021 quarter. This was achieved via a combination of volume (+7%) and pricing growth (+15%) and ii) EBITDA growth of 40%, which equated to EBITDA margin expansion of over 200 basis points.
The strong results reflect the fact that over the past 18 months, crop protection companies have benefited from tightening soft commodity inventories. This had the effect of pushing prices higher and incentivising farmers to use more crop protection products in order to lift production and maximise yield. Given that it will likely take several years for soft commodity inventories to be restored from decade lows to more normalised levels, soft commodity prices are likely to remain at elevated levels over the short-to-medium term.
Macro Conditions Remain Favourable
Over the short-to-medium term, agricultural demand is expected to remain strong (driven by elevated soft commodity prices as a result of the Russia/Ukraine conflict, strong farmer Profit & Loss/cash position), which, in turn, is supportive of crop protection demand & pricing. Supply is likely to remain relatively tight amid ongoing supply chain/logistics challenges. NUF has also been prudent in relation to its inventory sourcing and as such, has a good degree of protection in event of falling prices. Further, trade flows of agricultural chemicals into major NUF markets have remained at historically high levels.
Long-Term Revenue Targets Remain Unchanged
At the 1H22 results release, the Company re-affirmed its strategy and aspirational targets to 2026, which were initially detailed in a trading update in February 2022.
NUF has an overall ambition to achieve annual revenue >$4b by 2026. This equates to revenue growth of >4.5% on a CAGR basis from FY21-26 and assuming an FY21 revenue base of $3.2b. While there are a number of facets to the growth targets, it is clear that two of the key pillars will be the existing Seeds business (i.e. Omega 3/Carinata), as both present clear market opportunities. More specifically, the revenue growth is expected to be derived from three areas:
i. $300m from growth from the existing Crop Protection business;
ii. $500-600m of additional upside within the Crop Protection business from the new product pipeline, and
iii. $400-500m from additional Seed Technologies platform growth.
Balance Sheet Metrics Continue to Strengthen
Gearing (on a net debt to EBITDA basis) as at 31 March 2022 was 1.1x and remains below the Company’s target gearing range of 1.5x-2.0x. Given that NUF’s cashflows are skewed towards the 2nd half of the financial year, gearing is expected to decline further by the end of FY22. To this end, the Company expect gearing to be below 1.0x for as at 30 September 2022.
Importantly, NUF retains a strong liquidity position in excess of $1b ($553m of undrawn facilities and $461m in cash) as at 31 March 2022. Accordingly, the Company remains well positioned to pursue growth opportunities (growth projects and/or small bolt-on acquisitions) in order to support its aspirational targets and/or return capital to shareholders (including special dividends and/or share buybacks).
Notwithstanding the re-rating in the shares since our recent report, NUF shares are still trading on a 1-year forward P/E multiple (~16x) that is well below the 5-year average of ~20x.
NUF’s investment case remains compelling given the clear (and achievable) outline of the long-term revenue growth path, continued favourable trading conditions across all markets, as well as the significant progress made to date with regard to the Omega-3 and Carinata seeds platforms and strong balance sheet position.
After falling sharply during May – June, Nufarm then went on to trade sideways. There appears to be a clear range now between about $4.80 and $5.60. Like the rest of the market, NUF has bounced off the bottom of the range. Current levels could be a buying opportunity for those willing to run a tight stop at the June low. A higher probability entry point would be to wait for it to clear resistance near $5.60.
Michael Gable is managing director of Fairmont Equities.
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