Disruptions from the pandemic seem to be more manageable for Ingham’s Group ((ING)). First half gross margins improved by 65 basis points, despite the need to clear inventory and unfavourable trends in feed costs.
Morgans suggests the benefits of strategic initiatives taken by the company are starting to emerge and a strong earnings recovery should occur over FY21 and FY22. Underlying operating earnings growth was 9.8% and net profit 10.7% in the first half.
The business benefited from a recovery in food services and wholesale channels as restrictions related to the pandemic were eased. Underscoring this, Morgans points out excess frozen inventory has materially reduced, with just $5m worth to be cleared in the second half.
There are some headwinds in the export channel because of the closure of certain poultry markets. Volumes in the first half were affected by the outbreak of avian flu in Victoria albeit not at the company’s farms. Ingham’s expects markets will be back and fully open by March.
Earnings Split
Ingham’s has reiterated a typical half-year ratio of 52:48 for operating earnings although provided no formal guidance. Citi notes earnings volatility over the last two years has made it difficult to gauge the split on half-year earnings.
The broker calculates 52% of earnings occurring in the first half compares with a five-year average of 51.4%. The pandemic has distorted earnings and previously there was a problem with processed product. Citi forecasts second half earnings growth of 6%.
Macquarie expects normal seasonal influences should prevail and expects a 50:50 split for earnings, given the recovery in higher-margin channels in the second half compared with a pandemic-impacted first half, along with more moderate feed costs.
The broker notes the strength in demand across most channels amid the return of overall trading volumes to pre-pandemic levels. The company’s goal is to return to historical operating earnings (EBITDA) margins, although this is not expected to happen in the short term in the current feed price environment.
Bell Potter notes operating cash realisation of 71% revealed the strongest performance in three years, as the first half is typically the peak of working capital. The broker believes the business will be the beneficiary of the unwinding of provisions taken in the second half of FY20.
Although hard to quantify, Credit Suisse asserts operating efficiencies are at least part of the expanded margin and should be sustainable. The broker upgrades FY21 estimates by around 7% but reduces FY22-23 by -2-3%, mainly because of lower assumptions regarding the benefits from the costs versus prior estimates.
Goldman Sachs has become more confident regarding the profit cycle into the second half. The main risk for the short term is a supply contract with Woolworths ((WOW)), due to expire in August 2021.
Goldman Sachs estimates this contract accounts for around 50% of the Australian poultry volumes. Retaining this contract, under similar terms and conditions, remains key to the production of profit stability over the medium term for Ingham’s. The broker emphasises no view is taken regarding the outcome of any negotiations.
Morgans believes Ingham’s, a market leader with an integrated network, will benefit from attractive fundamentals as well as the significant upside stemming from the business transformation. Cash flow is strong and there is an attractive fully franked dividend yield. A key drag is a resumption of normal executive compensation after a drop in the second half of FY20.
The company has outlined a new capital management framework and will invest in specific growth projects that meet its return hurdles. Additional capital will be considered for return when the balance sheet position is supportive.
Feed Prices
Ingham’s has also indicated higher soybean meal costs, around 20% of feed requirements, and resilient wheat prices mean the market should not get too carried away by the outlook for FY22.
Macquarie points out feed prices have pulled back from historical highs but have not reached anticipated lows because of strong international demand. US soy meal prices are up 25-30% and demand from China has been high while South American supply is low, which should mean higher prices persist for another six months.
Bell Potter notes domestic wheat prices are down on average -16% and a compression in wheat costs is somewhat offset by the upward movement for other feed grains such as corn and soybean meal. Despite this the broker expects a moderation of the costs and some benefits to flow in the second half, as does Credit Suisse.
Citi points out conditions are more favourable in terms of supply/demand and the affordability of chicken relative to other animal protein. The broker believes there is opportunity for margin expansion but positive signs of cost savings, assessing the poultry market has remained rational, likely reflecting this improved affordability.
Bell Potter, not one of the seven stockbrokers monitored daily on the FNArena database, has a Buy rating and $4.30 target, principally driven by the leverage there is to cost deflation in FY22 at a time when the pandemic disruptions are also likely to be easing.
Goldman Sachs, also not one of the seven, has a $4.25 target with a Buy rating while the database has four Buy ratings and two Hold. The consensus target is $3.92, signalling 7.3% upside to the last share price the dividend yield on FY21 and FY22 forecasts is 4.1% and 4.7%, respectively.
