Elders (ASX:ELD) delivered a solid result for the 12 months to 30 September 2023 (FY23). This was achieved via successful execution of several growth initiatives. The pleasing result was also achieved despite some challenges. These included the normalisation of agricultural chemicals/fertiliser prices, as well as lower livestock prices fell as producers destocked their herds.
However, the uplift in the share price following the release of the FY23 result has not looked as bullish as the general market. This prompted us to research the Company to assess whether the market may be undervaluing the shares.
ELD is one of Australia’s leading agribusinesses, with a national distribution network with over 450 points of presence throughout Australia. ELD’s geographic and product diversification is key strength of the business.
The Company supplies rural farm inputs (e.g. seeds, fertilisers, agricultural chemical and animal health products) and provides agency (livestock, wool and grain marketing), real estate, financial and feed and processing services. Livestock prices and volumes, as well as retail product sales are key earnings drivers and seasonal conditions play a significant role in determining the trend of these drivers.
ELD has a number of reporting segments, the main segments being Rural Products and Agency Services, which together account for over 80% of group margin. The Company’s revenue and earnings base has expanded significantly following the acquisition of 100% of the shares in Australian Independent Rural Retailers (AIRR) in July 2019.
Key Fundamental Drivers
Challenging External Conditions to Continue
The FY23 period endured the fastest revision in cattle prices this century (-64%), as measured by the Eastern Young Cattle Indicator (EYCI). The sharply lower price revision was driven by:
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i. Disruptions to the live export market, following a small number of cases of Lumpy Skin Disease in Indonesia and
ii. Increased supply with herd destocking following expectations for potential drier outlook for parts of Australia.
Challenges with respect to soft livestock prices are likely to persist, with indications of further downside risks as herd sizes for both cattle and sheep are expected to step up in the near term.
The key outlook comments made by ELD was that some of the headwinds experienced in FY23 are expected to continue into FY24.
Are There Mitigating Factors?
There are three mitigating factors to the challenging external conditions noted above:
i. Further Contribution from Bolt-On Acquisitions – With recent acquisitions in FY24, as well as FY23, ELD notes potential upside from these could be $8-10m of EBIT in FY24. To this end, it is worth noting that the gearing level remains low enough to allow ELD to continue pursuing a bolt-on acquisition growth strategy in FY24 and beyond.
ii. Advancement of the Backward Integration Strategy – The backward integration strategy across crop protection and animal health products involves the Company selling more of its own branded products at higher margins. In essence, this entails replacing 3rd party products with its own internally produced offerings across crop inputs and animal health. The Company continued to progress its backward integration strategy in FY23, with penetration in the addressable generic products within ELD’s crop protection portfolio increasing to 54% (from 45% in FY22).
ELD expects this to step up further by six percentage points to 60% in FY24, which could yield A$5-10m of EBIT upside. The Company has a long-term target of 70%.
iii. Further benefits from Cost-Out Program – Given the heightened inflationary environment, ELD is seeking to focus on its discretionary expenditure. This initiative is in addition to several efficiency improvement initiatives that the Company is already undertaking. To demonstrate ELD’s discipline in controlling discretionary spend, it is worth noting that ELD’s underlying cost base has been broadly flat in 2H23, in comparison to both the prior corresponding period (2H22) and on 1H23.
There is significant earnings uncertainty in FY24 from several factors:
i. The deterioration in input prices for crop protection and fertiliser is likely to persist in the near term as highlighted by global crop protection companies in recent months.
ii. Livestock pricing headwinds continuing into FY24, notwithstanding that the EYCI appears to have bottomed.
iii. Lower rural and wholesale product demand due to the anticipated drier weather causing reduced planting.
iv. Higher interest rates continuing to weigh on real estate earnings, albeit somewhat offset by higher property management earnings.
These headwinds are likely to be mitigated by a combination of organic volume growth as prices normalise; as well as benefits from the three mitigating factors referred to earlier. However, earnings visibility remains low. Further, at current levels, we consider that there is further downside risk to the share price, as some broker estimates for FY24 earnings factor in an increase on FY23’s earnings on the basis that the initiatives around further contribution from bolt-on acquisitions, the backward integration strategy and cost-out would more than offset (rather than mitigate) the aforementioned headwinds.
ELD shares are currently trading on a 1-year forward P/E multiple of ~12x. This is broadly in line with the 5-year average. Further, the current multiple appears unappealing in the context of downside risk to currently-modest EPS growth estimates of ~4% over FY23-26 on a CAGR basis.
The recent rally has seen Elders break the August high, which is a positive sign for the share price. It means that we are likely to see higher levels in the short-term. However, looming large is the major downtrend line that has been in place since 2022, and that could be a source of selling for ELD.
Michael Gable is managing director of Fairmont Equities.
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