Ord Minnett has taken a more bullish view on wholesale salmon pricing for the second half of FY17 and in FY18 following discussions with all three market participants – Tassal, Huon Aquaculture and the unlisted Petuna – with wholesale salmon prices expected to remain elevated.
Fueled by continuing demand growth, reduced competition, and the option to export to prevent oversupply (drivers which we discuss in detail below) we factor in higher wholesale salmon prices for Australia into our models. This has the result of increasing our estimates for Huon Aquaculture’s operating earnings by 11% and 13% for FY17 and FY18, respectively, while we raise our operating earnings estimates for Tassal in FY17 and FY18 by 3% and 9%, respectively. We are at the top of FY18 consensus estimates for both Huon Aquaculture and Tassal by 19% and 11%, respectively.
Both companies are trading on undemanding metrics – Huon Aquaculture with an FY18E price-earnings multiple of 9.3, while Tassal is trading on a multiple of 12.0. Our upbeat outlook leads us to raise our recommendation on Huon Aquaculture to Buy from Accumulate and our target price to $$5.86 from $5.31. We also make the stock our preferred pick in the salmon sector, with greater upside potential than Tassal thanks to its higher leverage to wholesale prices and a stronger argument for falling production costs. We maintain our Buy recommendation on Tassal but trim our target price to $5.23 from $5.33.
We had previously assumed that the substantial volumes coming on stream in FY18 and FY19 would significantly depress wholesale pricing but we no longer think this is likely.
This is because, firstly, the third player, Petuna, is out of the wholesale market, having been locked into retail agreements for some years. This cuts competition in the wholesale channel from three players to two. Petuna also operates mostly out of Macquarie Harbour, which may have afforded it a cost advantage over Tassal and Huon Aquaculture previously. Huon Aquaculture currently has the highest proportion of its business in wholesale, giving it the most immediate upside in this area, but Tassal has been making good progress.
Secondly, Australian salmon demand is growing, we believe, at a rate of high single digits per annum. We forecast volume growth ahead of this for the next two years and project overall Tasmanian salmon volumes to grow at a compound annual growth rate of 12% over FY17–19. However, we believe the popularity of salmon will minimise the negative effect of the extra product on prices, even though we now forecast supply growth to outpace demand growth for two years.
Thirdly, there is the ability to avoid domestic oversupply through exporting. After falling from January highs, international prices have recovered. A buoyant export market enables the Tasmanian salmon produced to avoid oversupply in domestic markets. Interestingly, the two times that Tassal grew pricing while significantly growing volumes were both times when export pricing rose.
In terms of costs, it was a poor growing season in 2016, with costs rising in FY16 and in the first half of FY17. We expect costs to fall for both companies, but we believe the advantage is with Huon Aquaculture as Tassal has offsetting factors. These offsetting factors include migrating volumes away from Macquarie Harbour, more start-up losses on new projects, and increased freight costs as it increases its export sales.
The main risk to our bullish forecasts is our assumption that wholesale prices remain elevated. However, given the attractive valuation multiples our forecasts imply, we see a strong risk/reward opportunity on offer with both Tassal and Huon Aquaculture.