Continued weakness in Nufarm (ASX:NUF) shares since the release of interim results in May have placed the shares in value territory. With earnings set to recover in FY25, do current levels present an entry opportunity?

About Nufarm

Nufarm is a leading crop protection and seed technologies company. NUF develops, manufactures, and distributes a range of herbicides, insecticides and fungicides. These products are used by growers to protect their crops against weeds, pests, and diseases. In Crop Protection, NUF primarily operates in the off-patent segment of the market.

The 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).

Key Fundamental Drivers

Divisional Results Remain Mixed

NUF’s results for the six months to 31 March 2024 (1H24) highlighted weakness in the Crop Protection segment and a better-than-expected performance for Seed Technologies. This is consistent with the trend of NUF’s recent financial performance.

The weakness in Crop Protection was due to high channel inventories and industry-wide destocking. This occurred due to distributors and retailers reducing inventories in response to the pressure to lower working capital. Active ingredient prices fell materially during the period, with pricing gaps of ~20% between current levels and recent historical averages across herbicides, insecticides and pesticides. As a result, margin pressure was evident given that NUF sold high-priced inventory procured at much higher prices.

While each of NUF’s Crop Protection markets reported weaker earnings, the Seed Technologies division reported stronger-than-expected EBITDA growth (+23% on 1H23). However, the Seed Technologies is not yet a major contributor to the group results.

Is the FY26 Revenue Target for Crop Protection Attainable?

The Company has previously outlined a growth strategy where it is targeting revenue of $4.4b – $4.6b by FY26, off a sales base of $3.2b in FY21. Out of this amount, NUF is seeking to deliver $600-700m of revenue from Seed Technologies (mainly Omega-3 and Carinata). The remainder is from Crop Protection (i.e. $3.9-4b).

To meet the FY26 sales target, NUF is aiming to deliver $300m of organic growth (via market share gains and maintaining pricing discipline) in crop protection products. As well, it has a its pipeline of new product introductions will deliver around $500-600m. In Crop Protection, NUF has a strong pipeline of products, with the Company’s top 22 projects having an addressable market of over US$6.65b.

The Company has, on several occasions indicated that it is on track to deliver its group revenue growth aspiration. A key assumption here is a significant recovery in active ingredient prices of 20% by FY26. Pricing improvement is important in NUF achieving its $3.8-3.9b revenue target by FY26 for the Crop Protection segment. This is because additional contribution to revenue from new product introductions is likely to be lower than the $250-300m flagged by NUF.

Given the delay in pricing improvement, consensus estimates for group revenue in FY26 are well below NUF’s target, implying that revenue growth over the next two years would have to be well above trend (i.e. >30%) in order for the Company to hit the midpoint of its FY26 revenue target.

The expectation for an improvement in active ingredient pricing is based on pricing power shifting towards manufacturers (such as Nufarm) once excess inventory with distributors are depleted. However, while prices are expected to eventually recover, recent expansion in manufacturing capacity in China present a downside risk to NUF’s expectation for a 20% recovery in prices. In particular, the expanded manufacturing capacity in China is likely to result in increased supply and could see prices remain suppressed for longer.

Elevated Gearing Expected to Reverse

NUF reported a large operating cash outflow due to a build-up in net working capital. This factor, coupled with weaker earnings resulted in gearing (on a net debt to EBITDA basis) increasing to 3.6x as at 31 March 2024. This is well above the gearing level in recent periods as well as the 1.5-2.0x target gearing range.

For the Company, the 1st half of the financial year carries a higher working capital burden and is typically followed by stronger cashflow in the 2nd half as working capital unwinds. The latter is expected to occur mainly through a reduction in receivables and an incremental normalisation of inventory and payables. As such, gearing is expected to fall towards the top end of the target range by the end of FY24. Having said that, we consider that there is a risk that gearing by the end of FY24 finishes above the target range should the delay in the above-mentioned pricing recovery continues to impact EBITDA.

It is also worth noting that the elevated gearing position is not an immediate concern, given that NUF has minimal debt covenants and has no near-term refinancing requirements

Fundamental View

We remain cautious on NUF’s fundamentals. Firstly, there is elevated risk as to whether the Company can achieve its FY26 sales target. In addition, earnings risk is heightened due to i) The increasing reliance on outperforming earnings growth from the Seeds Technologies segment to achieve short-term earnings guidance and FY26 targets and ii) A lack of transparency in the trajectory for earnings recovery in the Crop Protection segment.

Charting View

Since peaking in 2022, the shares have been trending lower. There have been some large rallies along the way, but the overall trend is still to the downside. There is some short-term support at current levels, but the next support down from here is in the low $4’s.

 

Michael Gable is managing director of Fairmont Equities.

 

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