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Morningstar | Corporate Action: Take Up Entitlements Issue Given the Discount to Fair Value. FVE Down to AUD 6.85. See Updated Analyst Note from 26 Sep 2018

We marginally lower our fair value estimate for no-moat-rated crop protection company Nufarm to AUD 6.85 per share from AUD 7.00 prior. The decline is equivalent to the bonus element in a new AUD 303 million entitlement issue, so no decline in real terms. Fiscal 2018 earnings marginally disappointed but not to the detriment of our longer-term outlook. Including foreign exchange expense, underlying NPAT fell 28% to AUD 98 million, 7.5% below our AUD 106 million forecast, with depreciation up a higher than anticipated 37% to AUD 121 million. Depreciation in the Europe segment nearly doubled to AUD 63.4 million following recent acquisitions.

Net debt more than doubled AUD 1.37 billion factoring those European acquisitions, in addition to higher drought-related working capital. Net debt/EBITDA is consequently elevated at 3.8 but was likely to fall to levels approaching 1.5 within three years. Despite this, Nufarm is undertaking an AUD 303 million entitlement issue to secure against short-term risks. Recent drought has no doubt frayed nerves. A fully underwritten 3-for-19 offer is set at an ex-dividend price of AUD 5.85, a 12% discount to the AUD 6.64 dividend-adjusted preceding close and 16% below our prior AUD 7.00 fair value estimate. We consequently recommend participation, though a book-build for the institutional portion and entitlements trading for the retail portion creditably dull the absolute urgency to participate, as does regardless only limited potential dilution.

Our fair value estimate equates to a fiscal 2023 EV/EBITDA of 7.0, and P/E and dividend yield of 14.7 and 1.8%, respectively, all discounted for WACC. We assume annual average 4.7% compound growth in revenue to AUD 4.2 billion by fiscal 2023, at a 14.5% midcycle EBITDA margin. This betters the five-year historical average margin of 11.4%, including fiscal 2017’s improved 12.1%, crediting favourable growth prospects, recent accretive acquisitions and cost-outs.

Nufarm anticipates strong earnings growth in fiscal 2019 due to partial recovery in the Australian business and a full year’s contribution from recent acquisitions. Underlying EBITDA is expected to improve by 40%-50% to AUD 500-530 million. This is despite an expectation for commodity prices to remain low, with conditions competitive. We forecast a bottom of the range AUD 490 million, preferring evidence of drought resolution.

First-half EBITDA is expected to be unchanged on first-half fiscal 2018’s approximately AUD 110 million performance given ongoing Australian drought and planned plant shut-downs for Europe. But second-half earnings are expected to recover strongly. Nufarm continues with its cost savings and performance improvement program and an improvement in the working capital position is also anticipated.

The full-year dividend of AUD 0.11 per share was essentially in line with our expectations, on a slightly higher than anticipated second-half payout of 24%. Our underlying fiscal 2019 NPAT forecast declines by 14% to AUD 173.5 million or AUD 0.42 per share, following adjustments for a weaker first half and more conservative recovery rates from drought. We’ve similarly lowered our DPS forecast to AUD 0.15 from AUD 0.16. At the current AUD 6.70 share price, our fiscal 2019 dividend forecast equates to a lacklustre sub-2.2% yield. We are forecasting 21% five-year cumulative annual average EPS growth to AUD 0.71 by fiscal 2023; which on 30% payout would see the dividend at AUD 0.21. The implied 3.1% unfranked yield by fiscal 2023 remains mediocre.

With respect to fiscal 2018, a 12.3% decline in underlying EBIT to AUD 265.1 million was near the mid-point of most recent company guidance of AUD 255–270 million. That despite the company reporting revenue growth in all regions bar Australia. European acquisitions largely offset the severe Australian drought impact from a revenue perspective. Nufarm acquired FMC Corp and Adama and Syngenta crop protection portfolios for a combined USD 575 million, delivering additional sales of AUD 69 million in fiscal 2018. Group revenue overall grew 6.3% to AUD 3.3 billion.

Net operating cash out-flow of AUD 88 million disappointed with higher net working capital balances at period-end driven by late seasonal conditions in Europe and very dry Australian conditions. Underlying EBITDA margin deteriorated to 10.8% from 12.1% in fiscal 2017, and the five-year average to fiscal 2017 of 11.3%.

The retail offer opens on Oct. 4 and closes on Oct. 17, with entitlements to trade from Oct. 1 to Oct. 10. Following receipt of funds, net debt/EBITDA will fall to a safer 2.4 and we project levels near 1.0 by as soon as 2020.