EUR 850.00 For Business Accounts Only

Morningstar | Validity of Revenue Growth Projections for No-Moat Nufarm Explored. FVE Upgraded to AUD 7.00. See Updated Analyst Note from 11 Dec 2018

We upgrade our Nufarm fair value estimate to AUD 7.00 per share from AUD 6.85, equivalent to the time value of money. This assumes little-changed five-year revenue CAGR of 4.8% to AUD 4.2 billion by fiscal 2023, and a midcycle EBITDA margin of 14.5%. The margin assumption betters the five-year historical average of 11.4%, crediting favourable growth prospects, recent accretive European acquisitions and cost-outs. EBITDA margin was 13.4% in second-half fiscal 2018 despite severe Australian drought. At AUD 5.75, Nufarm shares trade at a material discount to fair value. Normalisation away from current drought conditions could be a key catalyst for share price rerate to fair value. We think Omega-3 canola essentially comes as a free option at the current share price. That’s despite it having the potential to dwarf Nufarm’s existing seed technologies business, already comprising 10.5% of our fair value estimate, though we don’t ascribe specific value to it.

Given the sharp share price retrace, it’s timely to test the plausibility of our revenue growth assumptions. While growth in key drivers continues to structurally slow, we think in combination they comfortably support our forecast revenue growth. More than half the growth estimate simply reflects our standard 2.25% inflation outlook.

Nufarm is now a global firm and impacted by global macroeconomic trends. Our fair value estimate is geographically diversified and comprises 42% for Europe, 16% for North America, 15% for South America, 10.5% for Australia/New Zealand, 6% for Asia and 10.5% for Seeds. The key demand drivers for Nufarm’s core pesticide products--insecticides, herbicides and fungicides--include population growth and rising per capita calorie intake as global living standards rise. More importantly, as per capita incomes rise, the make-up of calories consumed shifts towards a higher protein intake and more fruit and vegetables. These are more taxing on inputs than for example, staple grains and corn.

Partial offsets include improving crop yields per hectare requiring less land, although with a material portion of yield gains reflecting use of pesticides, in addition to fertilisers and use of disease and pest-resistant crops and higher yielding crops via genetic modification.
Taking on an assumed 1.0% population growth rate, IMF’s 4% per capita GDP growth to 2023--driving a 0.5% annual increase in per capita calorie intake, in addition to a further 1.0% indirectly for consumption mix shift to meat and so on--facilitates 2.5% (real) growth in market. Overlaying our 2.25% inflation assumption gets the nominal growth potential to 4.8%, in line with our revenue growth rate for Nufarm. This of course for now ignores particular nuances in Nufarm’s business model, including focus on some niche elements of the market, and potential to take market share in areas like proprietary Omega-3 canola, for example.

Global population expands inexorably though at a declining pace. Growth of just over 1.1% per year for the last 20 years is down considerably on levels nearer 1.75% in the 1980s and 2.0% in the 1960s. Population will not be as big a driver of pesticide growth going forward, and we assume an average annual 1.0% population growth rate for the forecast period.
But rising living standards will be an ongoing source of demand growth, though once again at a declining rate. The impact is two-fold, coming via rising calorie intake, but mostly via mix-shift towards more input-expensive calories.

Per capita calorie intake rises as a function of average per capita income, a positive for demand for crop protection products. But most of the gain comes at low per capita GDP levels and we expect rising living standards to generate only modest per capita calorie increase from here, around 0.5% annually. Constant per capita global GDP grew at around 7.5% annually from the 1960s to the mid-1990s, before a hiatus to the early 2000s. China’s rise reinvigorated per capita global GDP growth to an average 5.7% in the 2000s, before another post-boom hiatus. The IMF now projects average 4% per capita GDP growth from 2017 to 2023, notable contributors including China and India.

However, there is also a shift in the consumption of foodstuffs regardless of limited change in the overall calorie supply. This primarily from carbohydrate-rich staples (cereals, roots and tubers) to animal products (meat and dairy), vegetable oils, and sugar. Income growth in low- and middle-income countries drives this dietary transition, adding pressure on natural resources. For example, we estimated it takes about 7 kilograms of grain per kilogram of steak on the plate. This trend is more powerful than simple calorific increase and drives 1.0% annual demand growth in our crop protection market model.