By Leo Sek, Clime Asset Management
Nufarm Limited (ASX:NUF) is a manufacturer and distributor of generic and off patent crop protection chemicals. It manufactures in 14 countries, has marketing operations in 20 countries and product sales in more than 100 countries (see image below).
Herbicide has been and is expected to be the largest product category for NUF.
Global planting drives demand
Over the long term, a growing world population and the corresponding increase in demand for food underpins NUF’s revenue growth. On an annual basis, the key revenue driver for NUF is the volume of global plantings.
As more crops are planted, the greater the demand for herbicides to protect these crops; the volume of global planting is in turn dependent on weather conditions and the profitability of farmers.
The profitability of farmers is impacted by global soft commodity prices and input costs such as the price of fertilisers. While the key revenue drivers are therefore beyond the control of NUF management, global population growth should continue with long term revenue growth sustainable.
Key operating costs
In examining the key operating costs, it is useful to first look at NUF’s major products by sales revenue. These are glyphosates (e.g. Roundup) and phenoxy (e.g. 2,4-D).
The major ingredient into making glyphosate is glyphosate tech/acid. Major sources of glyphosate tech globally are Monsanto and a number (less than 20) of Chinese manufacturers. Up until 2007, NUF purchased all glyphosate tech from Monsanto under an exclusivity agreement that lasts until 2013. Since then, NUF has sourced additional glyphosate acid from Chinese producers. NUF now sources circa 50% of glyphosate acid requirements from Chinese producers.
NUF manufactures phenoxy using phenol sourced from Japan, cost is driven by oil and benzine prices; electricity and salt with costs under contract. Transport, labour and packaging are other the major input costs.
Source: Nufarm Ltd
NUF has a three pronged growth strategy of geographic expansion, product expansion and seeds business.
Geographic expansion is largely in place as the proporation of sales to the Australian market has reduced from 80% of total sales in FY 1995 to 29% in FY 2008. This reduces NUF’s exposure to Australian climatic and economic conditions.
Product expansion is driven by:
• products coming off patent
• new formulations and mixtures
• improved delivery systems
• co marketing agreements with external companies
• corporate acquisitions
The number of product registrations increased from 1,377 in FY 2002 to 2,787 in FY 2008. Future initiatives include increasing sales of higher margin insecticide and fungicide and extending insecticide products into higher margin horticulture, turf and ornamentals market segments.
NUF is extending into the seed and seeds treatment business that distributes genetically modified (GM) seeds throughout Australia. This business also treats seeds with chemicals to protect them prior to germination e.g. launching Roundup ready canola in Australia. A reason for establishing this business is because GM crops are being bred to be resistant to certain type of herbicides. If NUF doesn’t breed seeds that are resistant to its own herbicides, it may be locked out of the crop protection market.
Return on equity (ROE) at was 19% between FY 2006 and FY 2008. However, ROE more than halved to 7.2% in FY 2009 due to a combination of $216 million of new equity raised in FY 2008 and the poor return on incremental equity as reflected in the dramatic drop in profit.
The halving of profit in FY 2009 is symptomatic of the volatile nature of the agriculture industry. The year was affected by the global financial crisis reducing credit availability to farmers, low demand seasons in Australia and US and higher than normal glyphosate stocks at farmers. These factors led to a halving of glyphosate prices and reduced selling opportunities. A lack of demand led to reduced volumes and lower prices.
Franking levels reduced from 100% historically to 66% in FY 2009 as NUF diversified their revenue offshore.
Gearing is moderate with net debt per equity of 67.8% as at 31 July 2009. Interest cover during the difficult FY09 year came in at 1.5 times. This will be important as interest rates increase with a gradual economic recovery. However, NUF has a high level of intangibles with $3.89 of intangibles per share versus equity per share of $6.35. The risk is of a write down in goodwill if the purchased businesses perform less than expected.
Over the long term, the fundamentals for the agriculture industry look positive with population growth and decline in available arable land. However, in the short to medium term, we expect profit to be affected by constrained availability of credit, volatile weather conditions and the carrying of high cost fertiliser and herbicides by farmers and distributors.
NUF raised $300 million in May 2009 to repay debt, producing a low return on incremental equity. In addition, NUF’s managing director sold down 6.8% of his shareholding in the company.
Given these factors and Stockval’s valuation of NUF at $6.62 per share, Sinochem is currently offering $13.00 per share and we believe this looks attractive.
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