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Morningstar | Inghams’ Shares Still Overvalued Despite Sell-Off

Despite falling by about 15% since the start of calendar 2019, shares in no-moat Inghams remain overvalued relative to our AUD 3.50 per share fair value estimate. While the company hasn’t provided any explicit earnings guidance, management recently confirmed it is comfortable with the current consensus estimates for fiscal 2019, which indicates about 3% EBITDA growth for the full year, broadly in line with our expectations.

Our long-term earnings projections are broadly unchanged, and we forecast EBITDA growth in the mid-single digits on average during the next five years. Despite the higher poultry costs (on the back of the higher grain price) the outlook for consumption remains positive. We continue to project low-single-digit volume growth on average over the long term, supported by around 1%-2% per year in population growth, and incremental increases in consumption on a per capita basis. While it is still early days, the New Zealand business is starting to improve and management expects it to have made a full recovery by the end of fiscal 2020, after EBITDA fell by 35% during the first half of fiscal 2019.

Poultry production economics remain attractive relative to alternate animal proteins and continue to improve. The feed conversion ratio for chicken has declined by around 30% during the past years and is currently about 1.75 kilograms of feed required to produce 1 kilogram of liveweight. This is a material advantage over other meats, which are currently 1.5 times higher for pork, 3 times higher for beef, and as much as 5 times higher for lamb. This reflects genetic improvements, feed and nutrition optimisation, and increasing efficiency of the supply chain. This cost advantage is reflected in the lower price of chicken relative to alternate meats and will result in chicken growing in popularity, supporting the modest increase in consumption per capita.

The wheat cost has moderated over the past few months but remains elevated by historic standards. The company will continue to pass these onto consumers where possible, currently over 60% of poultry volumes are supplied with feed pass-through mechanisms. Consistent with long-term history, we expect poultry prices to continue moving in the same direction as the wheat price, limiting the effect on the firm’s EBITDA margins.

We continue to forecast EBITDA margins to expand by almost 100 basis points from current levels to just under 10% by fiscal 2022, reflecting the ongoing ‘project accelerate’ cost-cutting initiatives. This strategy is unchanged and tracking in line with our expectations, already adding 150 basis points to EBITDA margins since fiscal 2016. The core focus is on increasing utilisation of assets and reducing unit costs through network rationalisation, automation, and procurement initiatives. We believe the firm lacks an economic moat, and we believe any margin expansion beyond 10% will be competed away or retained by supermarket customers.