Inghams Group (ASX:ING) shares have struggled to gain traction over the last 18 months. Cost pressures, declining poultry volumes and increased capital requirements have been the key factors impacting sentiment. Based on recent trends, is the worst over for ING? We recently researched the Company in The Dynamic Investor to find out.
About Inghams Group
Inghams Group is the largest vertically-integrated poultry producer across Australia and NZ. The Company also holds the number one and two market positions by value, respectively. The major end markets include the major retailers, Quick Service Restaurant (QSR) operators, food service distributors and wholesalers.
In terms of the earnings composition by country, around 88% of earnings are generated in Australia. The remainder of earnings are generated from New Zealand.
Key Fundamental Drivers
Gradual Recovery in Poultry Volume Growth Expected
Core poultry volumes in Australia declined by 0.3%. This was driven mainly by lower bird numbers processed as a result of a shortage of high-quality eggs. This was attributable to a small reduction in fertility levels from the performance of breeding roosters. The Company noted that excluding the impact from primary production challenges in Australia, volume growth would have been ~2.5%. This is below ING’s core poultry volume growth of 3% per annum over the last three years.
ING is addressing these supply constraints in Australia via a new NSW breeder farm in Casino (NSW). This farm is expected to increase the supply of high-quality eggs. At the time of the 1H23 results release in February, the Company commented that there had been improvements in early 2H23. Additional benefits are expected to have flowed through towards the end of 2H23.
Notwithstanding the benefits from the above initiatives, we do not expect an improvement in core poultry volumes in Australia over the short term at least. In particular, industry chicken meat production in the March 2023 quarter decreased by 3% on a year-on-year basis.
Pricing Environment Remains Favourable
ING was able to successfully implement price increases across all customers in Australia and NZ in 1H23. Average selling prices in 1H23 rose by 8.5% compared to 1H22 and were 10.7% higher than 2H22. Pricing strength gained momentum over the course of 1H23 and ING was able to implement price increases in 2H23, which are likely to offset feed cost and other inflationary pressures in the 2H23.
In 3Q23, poultry price inflation in Australia and NZ increased by 7% and 17% on a year-on-year basis, respectively. However, these figures are broadly in line the year-to-date averages in both Australia and NZ and with a moderation in broader inflation, poultry price inflation is likely to have tapered in the June 2023 quarter.
Notwithstanding inflation in poultry prices, chicken remains an attractive category as a cheap & affordable source of protein. This advantage is expected to drive ongoing growth for the chicken category. In particular, consumers have been increasingly shopping on price in light of intensifying cost-of-living pressures.
The retail channel is ING’s largest, accounting for over 60% of sales. Across the retail channel, there have been material price increases across all categories.
Expectations for Lesser Margin Recovery
Following the release of FY21 results back in August 2021, the Company indicated its intention to improve the group EBITDA margin back to the FY18 level of 8.8%. While the Company had intended to achieve this aim via its cost savings program, several factors impacted EBITDA margin for both the Australian and NZ businesses over the course of FY22.
Although EBITDA margins recovered over the course of FY23, it appears that the aim of improving the group EBITDA margin back to pre-COVID levels appears unrealistic over the medium term. The reason for this is that the Company’s focus appears to have shifted away from internal cost savings/efficiency improvement programs. Instead, the focus has likely shifted to prioritising investment on high-returning projects that will be incremental to the earnings base.
Gearing Starting to Looked Stretched
Gearing (on a net debt to EBITDA basis) increased to 2.5x as at 31 December 2022, which is above the upper end of ING’s target gearing of 1.0-2.0x. The increased gearing position resulted from depressed earnings (i.e EBITDA) in 2H22 as well as seasonal working capital. Importantly, the gearing level as at 31 December 2022 was within covenant limits and is expected to be lower as at 30 June 2023, as EBITDA improves and cycles past the 2H22 period.
While gearing is expected to decline to within the upper end of target range by FY23, it is worth noting that there is limited scope for debt reduction to lower the gearing level even further in FY24/25. This is because of several factors. Firstly, additional CAPEX is required for key projects. Secondly, the majority of free cashflow is being used to fund dividend payments (in order to maintain the stated 60-70% dividend payout ratio). Thirdly, a reduction in the gearing level relies on maintaining high levels of cash conversion. To this end, cash conversion has recently been below the long-term trend.
At current levels, we struggle to find any near-term catalysts and highlight several factors likely to temper a material re-rating in the shares:
i. ING is currently trading on a 1-year forward P/E multiple of ~13x, which is broadly in line with the 5-year average multiple of ~13.5x.
ii. Earnings tailwinds from lower feed costs are likely to be mitigated by challenges in passing on further price increases and below-trend core poultry volumes.
iii. Elevated gearing levels creates an overhang risk for the shares. As an equity raising may be required to either reduce the gearing level further, or to pursue acquisitions.
Inghams Group has been trending lower since the March peak in a fairly well defined channel. It is at the top of that channel now so unless we get an upside break, investors can expect a cooling off here and can therefore be patient for lower levels. We would expect a move back towards $2.60 and a reversal near there would be a better entry point.
Michael Gable is managing director of Fairmont Equities.
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