Argentina Drags

Nufarm recently reported an FY17 underlying net profit of $136 million, up 25% on FY16, including $23 million of one-off restructuring and rationalisation costs. Group revenues of $3.1 billion represented a 12% increase on the previous year, with strong revenue gains in Australia, North America and Asia tempered by the Argentinian operations, which were weaker due to market liberalisation and increased supply.

 

The result was driven largely by earnings before interest and tax (EBIT) growth of 5%, reduced interest charges and lower currency losses.

 

We note the following highlights from the announcement:

  • The performance improvement program (PIP) drove EBIT growth, with a net incremental benefit of $26 million in FY17. The company guided for more than $15 million in net incremental benefits in FY18.
  • A final (unfranked) dividend of 8cps was declared, up 18% on FY16, and took the full-year dividend to 13cps.
  • Returns on funds employed (ROFE) increased, with guidance for a medium-term target of 16% and more than $15 million in net incremental benefits from the PIP in FY18. We forecast ROFE of 14.2% in FY18.
  • The average net working capital to sales ratio improved to 36.8%, with supply chain investment benefits to be realised from FY18.
  • Organic growth was achieved at above-market rates in core geographies.
  • Divisional margin trends were largely mixed, with the global crop protection market forecast to remain flat in 2017.
  • M&A activity was of interest and management raised the possibility of an equity raising to fund potential deals.
  • Strong seasonal conditions in Australia for canola resulted in market growth and share gains, with canola volumes up about 50%, although market conditions were challenging for US sorghum. Omega-3 canola registrations are on track and first revenues are expected in FY18–19, leading to a positive EBIT contribution from FY20–21.

In our view, execution of the PIP has seen a higher focus on margin improvement and Nufarm has enjoyed strong sales in various geographies despite slow market growth. However, in the absence of M&A, challenges remain in the crop protection industry in the form of soft commodity prices, volatile seasonal conditions, pricing competition and regulatory risk all weighing on the share price.

 

We also note a lack of valuation support, with our discounted cash flow valuation at $8.52, and have lowered our target price to $9.00 from $9.75. We maintain our Hold recommendation.

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