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Morningstar | It Doesn’t Look Pretty, But There Are Seldom Buying Opportunities When Situations Are Pretty.

Shares in Nufarm have continued to slide. Our recent notes have covered off on all pertinent drivers. It is more than well documented the company is working its way through drought in Australia and supply interruptions in its European business at a time when debt levels are elevated. The borrowings reflect acquisition of those same European businesses, and substantially increased working capital. The stress is heightened by Nufarm’s notoriously seasonal cash flows which leave less room for error. But without uncertainty there is seldom opportunity. When else can you buy a premier China-leveraged stock at the right price than when under stress?

We anticipate negatives will unwind. The $64,000 question is: Will this be before any need for permanently dilutive rectifying measures? At the Macquarie Australia Conference just one month ago, Nufarm said it is “managing its working capital very closely and is on track to meet targets set for year-end.” Further with respect to quarterly testing of banking covenants “our April leverage levels present no issue in relation to the ongoing availability of our banking facilities.” Also pertinent, Nufarm said “the fourth quarter is our biggest quarter for the year, and there is no change to the guidance we provided in March.” That guidance was for fiscal 2019 EBITDA of between AUD 440 and 470 million versus our AUD 457 million estimate.

We still think the perfect storm conspiring against Nufarm’s near-term operating cash flows represents opportunity rather than disaster. But the more the weather conspires against, the greater the risk in holding to the view, particularly while working capital/debt levels are extremely elevated. The latest news reports have Nufarm sounding-out market interest in a capital raising; and this at a time when sentiment is being further hammered by glyphosate litigation in the U.S., and while Nufarm is one of the most shorted stocks on the ASX. Timing for a raising would be far from ideal.

We don’t know how true the rumours are but where there’s smoke there’s often fire. This wouldn’t necessarily be dilutionary, even for nonparticipants, if the issue was renounceable. Otherwise a nonrenounceable AUD 500 million capital raising, undertaken at a 30% discount to the current AUD 3.75 share price, might be 10% share price-dilutive and 20% fair value-dilutive. It would, however, bring net debt back by a third to less than AUD 1.0 billion, and average fiscal 2019 net debt/EBITDA back to 2.3 from nearly 3.0.

Then there is also the glyphosate litigation in the U.S. to consider. The angst around this is such that Nufarm has provided a separate update. It says the corporate risk relating to glyphosate has increased, despite no lawsuits against it in any of the jurisdictions in which it operates. Further, it remains satisfied glyphosate is safe to use, as per advice from a number of independent regulatory agencies around the world. Were glyphosate to be completely pulled from sale, it would represent around 12% of Nufarm’s revenue, but a far smaller share of earnings as glyphosate sales are low margin--less than 5% of earnings and our fair value estimate. And that’s before the potential to swap out some sales for alternative molecules.

However, this doesn’t capture potential for glyphosate litigation where unfortunately it’s a situation almost impossible to quantify. On a pure guess, AUD 200 million would be worth negative AUD 0.47 to Nufarm, but there is no science behind that figure and we make no allowance for litigation in our fair value estimate, save for the high fair value uncertainty. As we say, no one has come forward with an issue as yet, and Nufarm’s situation differs greatly to Monsanto’s. Nufarm supplies to far fewer but larger agricultural-based customers where labelling is dictated by regulatory agencies for whom no causal cancer link to glyphosate is recognised, based on overwhelming scientific evidence.