We revisit Tassal Group (ASX:TGR), with a view to tracking the progress on its prawn strategy (following a recent acquisition) and to assess the earnings outlook for the salmon business, which accounts for ~85% of group sales across three channels: Domestic Wholesale, Domestic Retail and Export. We also have a look at how it is trading and what the charts are telling us.
About Tassal Group
Tassal Group is Australia’s largest vertically integrated salmon grower. The Company produces, processes and markets premium salmon, prawn and seafood products for both the Australian domestic (retail and wholesale channels) and export markets (Asia). TGR’s salmon operations are concentrated in Tasmania, where it operates across five salmon farms, four processing facilities and two hatcheries.
The Company has recently expanded into the seafood category (via the acquisition of Sydney-based De Costi Seafoods) and into the prawn category with the acquisition of the Fortune Group in FY18, which added three prawn farms in Mission Beach, Proserpine and Yamba. TGR sells both branded and private label products. Key brands are Tassal, Superior Gold, Tasmanian Smokehouse and De Costi Seafoods.
Earnings Expectations for Salmon Business
After reporting a 21.7% increase in harvest volumes in 1H19, Company commentary at the 1H19 results release indicated a slower rate of volume growth for the full year (~12%), reflecting the seasonality of salmon harvesting, where volumes are typically weighted ~60% in the first half and 40% in the second half.
As well, TGR flagged the likelihood of lower rate of harvest volumes in FY20. While part of this is natural off a strong base, jellyfish and algal events across the industry in December 2018 have impacted volumes. Accordingly, we expect a flat volume growth profile in FY20, although favourable growing conditions in early 2H19 (i.e. colder water temperatures) offer potential upside to volume growth in FY20.
As a result of declining volume expectations, the earnings growth profile for salmon is expected to be flat in FY20. While slightly higher average salmon prices expected, this is likely to be offset by higher costs stemming from leases and the Company’s strategy to increase the average fish size to 5kg hog (currently 4.7kk hog).
So, the key question now is the extent to which the prawn business can underpin a significant portion of TGR’s future earnings growth.
Prawn Business has Aggressive Targets
TGR first entered the prawn farming market in mid-2018 via the acquisition of three prawn farms. At the time that the acquisition was announced, the Company had planned to grow production from the three farms from 450tpa to over 3,000tpa over 3-5 years, Accordingly, the uplift in production was expected to result in EBITDA growth from ~$2-3m annualised at present to $15-25m within five years (i.e. FY23).
However, at the 1H19 results release, the Company revealed more aggressive targets – it is now targeting ~$25m EBITDA from FY21 (compared to the prior target of $15-25m in FY23). The expected annual EBITDA contribution of ~$2-3m is still anticipated within the first 12 months of ownership, with earnings expected to commence in 2H19.
The earnings growth potential from prawns is underpinned by the fact that prawns can improve overall cashflow (prawns have a 1-year working capital cycle compared to three years for salmon) and generate higher margins (~2.5x salmon) as prawns have a materially higher selling price per kg relative to salmon.
…… But Appears Higher-Risk
While we consider that prawns are a good strategic fit, we hold some reservations:
i. Forecast risk for the prawn business is inherently higher than salmon, given the relative immaturity of the business. In particular, the more aggressive EBITDA target relies heavily on production ramping up in line with projections.
ii. There is downside to the margin for the prawn business, which currently is elevated, as a result of pricing being more volatile, due to around 90% of prawn consumption in Australia sourced from imports (compared to salmon, where ~90% is produced locally) and hence production is more reliant on foreign growing conditions.
Fundamental View of Tassal Group
With the shares currently trading on a 1-year forward P/E multiple of ~14x, we consider that the risk/reward profile is unappealing in light of the flattening earnings growth profile for salmon placing greater reliance on the higher-risk prawn category to generate group earnings growth.
Charting View of TGR
For the last 3 years, TGR had been trading in a range between about $3.60 and $4.60. It then broke higher in mid-February. Since then it has been able to hold on to these higher levels, which is a positive sign. Short term weakness back towards the $4.60 level would be a buying opportunity from a technical point of view. However, we don’t want to see it trade back into the old range which means investors should then ensure they have stops nearby. A breach under $4.60 would see if fall even further and provide investors with much cheaper levels.
Michael Gable is managing director of Fairmont Equities.
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