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Morningstar | No-Moat Nufarm Represents Rare Value, and Seeds (Omega-3) Could Surprise. See Updated Analyst Note from 12 Apr 2019

At AUD 5.00, Nufarm Limited shares screen as materially undervalued. Australian drought and teething issues with recent AUD 575 million European acquisitions fuel fears of an equity raising. Lawsuits against glyphosate manufacturer Bayer haven't helped sentiment. But we think working capital fears are overdone and expect issues to substantially unwind in second-half fiscal 2019 in the main planting season. Our AUD 7.00 fair value estimate posits Nufarm eking out respectable 4.7% five-year revenue CAGR to fiscal 2023, and that's despite the best growth years for the industry likely being behind.

We project only inflation-like 2.5% revenue CAGR going forward, with the benefit of population growth and rising income levels to be substantially offset by technological innovation continuing to drive real crop protection pricing lower. But we think Nufarm can continue to achieve considerably better, including from its seeds business with innovative omega-3 canola, in addition to capturing first real revenue accretion from fortuitous European acquisitions. The market is underestimating the top-line growth rate of Nufarm, providing an opportunity to invest in a cyclical but solid business at a margin of safety. Nufarm's primary competitive strengths are marketing scale, dominant position in the Australian market, formulation expertise, and skills in marketing post-patent crop-protection product.

Our unchanged AUD 7.00 per share Nufarm fair value estimate equates to a fiscal 2023 EV/EBITDA of 6.7, and P/E and dividend yield of 13.3 and 2.1%, respectively, all discounted for the weighted average cost of capital, or WACC. In nominal terms, the P/E and yield improve to 8.3 and 3.4%, respectively. The comparatively modest yield forecast assumes retention of at 30% payout ratio, in line with the five-year average to fiscal 2018. Nufarm dividends are typically unfranked given the high proportion of offshore earnings.

Crop protection comprises the lion's 80% share of our fair value estimate, with the balance from seeds. This assumes 8.6% 5-year EBITDA CAGR to AUD 600 million for crop protection, and higher 16.4% 5-year EBITDA CAGR to AUD 93 million for seeds, including omega-3 canola. Discounting omega-3 canola from proceeding in any meaningful sense would reduce our Nufarm fair value estimate overall by 4.2% or AUD 0.30 to AUD 6.70. Our base case assumes Nufarm's omega-3 market share grows to 10% by fiscal 2027. But the company will be first to market with its product in a field with limited potential players. If it were instead to achieve a higher 50% market share, our fair value estimate would increase by 8.5% or AUD 0.60 to AUD 7.60.

Nufarm does not possess an economic moat. Sub-9% returns on invested capital including goodwill have historically failed to meet the weighted average cost of capital WACC as a result of the competitive nature of markets, lack of pricing power, and exposure to cyclical agricultural demand. Nufarm operates primarily in the off-patent segment of the global crop-protection market, an industry subject to intense price competition. The company does have patents over a small number of active ingredients and some proprietary formulations, but these are not sufficient to drive any material competitive advantages.

Our fair value breakdown includes 9% for Australia and New Zealand, or ANZ; 39% for Europe; 14% for North America; 14% for South America; 5% for Asia; and 20% for seed technologies. Of these major segments, only ROIC from Europe and seed technologies are expected to meaningfully exceed the 10% weighted average cost of capital, with EBITDA margins in excess of 25%. For the balance, we project ROICs of 5% to 10% and EBITDA margins from 12% to 18%. Nufarm is not expected to be particularly capital-intensive going forward, but the company did in the past spend on manufacturing facilities globally, a number of which have since been closed. On balance, our projected midcycle group EBITDA margin is 14.6%, ahead of the 11.4% five-year average to fiscal 2017 due to fiscal 2018's purchase of a high-margin European crop protection portfolio from ChemChina, and due to omega-3 canola.