The covid pandemic arguably brought mixed blessings for poultry processor Inghams Group ((ING)). While extra demand for its chicken, turkey and plant-based protein products came from people hoarding food, it was offset by restaurant restrictions and closures. As a result, management made no apologies in explaining that steering the company through a year of fickle and unpredictable demand has been tricky.
Following an improvement in trading conditions, as the impact of covid restrictions ease and operating efficiencies increase group margins, this week’s maiden FY21 earnings guidance was ahead of consensus expectations. As a result, brokers believe Inghams’ fundamentals are attractive, and have upgraded their forecasts to reflect strong earnings recovery.
While uncertainty around the current Victoria lockdown is not reflected in management’s update, guidance suggests underlying earnings are expected to be $203-$213m, and underlying net profit is expected to be $96-103m.
While Inghams is broadening its customer relationships in wholesale, which accounts for 8% of revenue, management identified reduced international tourism as a lingering headwind. However Inghams also expects export volumes to grow slowly as overseas markets reopen.
Inghams had not previously provided FY21 guidance, but highlighted its typical earnings fist half/second half skew of 52/48%. The stronger relative first half reflects robust demand for poultry over the summer period, while turkey demand is skewed to the Christmas period.
Operational efficiencies
Macquarie believes Inghams’ better guidance update reflects both the benefits derived from operational efficiencies implemented throughout the year, and improved general trading conditions as the impact of covid restrictions progressively decrease.
In early May Inghams noted that third quarter 2021 core poultry volumes were slightly lower versus the previous period due to cycling a period that benefitted from covid pantry filling. Management also noted slightly lower third quarter volumes had been offset by operational efficiencies and net feed cost improvement, which are positive for earnings margins.
Based on Inghams’ guidance around efficiencies implemented throughout the year, Credit Suisse suspects they have not only driven further margin improvement, but are the main contributor to FY21 guidance that was ahead of consensus.
Due to increasing evidence of delivery on planned margin expansion, Credit Suisse believes demand trends remain positive, with input feed costs likely to provide a relative tailwind in FY22.
In Macquarie’s view, higher-margin channels are improving as covid restrictions ease. The broker notes average chicken pricing across the products track increased 12% in the second half of 2021 to date versus the previous period and up 5% sequentially versus first half 2021. Overall, Macquarie is forecasting FY21 net profit 5% up on the broker’s prior forecast.
Morgans also expects fourth quarter 2021 to have benefited from lower grain costs. The broker notes, the company has previously stated that FY22 will benefit from both a full year of lower grain prices and further efficiency benefits from recent growth initiatives, including new Victoria and WA hatcheries.
Inghams has previously highlighted how its continuous improvement program is securing cost savings with minimal capital required, and over 250 improvement opportunities have been identified.
Over time, the company is expected to expand its product offering to include higher margin products. With beef prices remaining at record highs, Morgans expect solid volume growth given that chicken is the affordable protein.
Resumption of normal trading & tax credits
While the impacts from international tourism restrictions in A&NZ were still being felt when Inghams last updated in May, management’s guidance suggests volume across the food service channel, which accounts for 8% of revenue, has now largely returned to pre-covid levels.
Two standouts were chicken nuggets and value enhanced products up 29% and 18% respectively on average in the second half of 2021 to date yer on year. While local lockdowns have had minimal impact on the retail channel, which accounts for 53% of revenue, Macquarie notes that consumer shopping behaviour continues to normalise.
Future earnings will also be aided by the expected receipt of an R&D tax credit and while this will lower Inghams’ tax rate, it is yet to be qualified.
Macquarie assumes it will be more material in FY21 given the need for management to disclose it in the company’s update. Macquarie reduces effective tax rate assumptions to 27.6% in FY21 from prior 29.1%.
While the R&D tax credit has typically been $0.3-0.6m annually between FY17 and FY20, Morgans views the maximum benefit as being $8.5m.
Credit Suisse, Morgans, Macquarie and Cit — four of the six brokers on the FNArena to cover the company — all have Buy (or equivalent) recommendations on Inghams.
Post forecast changes, Morgans blended valuation has risen to $4.27 from $4.10. The broker expects key catalysts for the stock to include the FY21 result, further weakness in grain prices and resigning the Woolworths contracts (the company’s largest customer) with no adverse impacts.
By comparison, Credit Suisse and Macquarie have a target price of $4.10 and $3.98 respectively.
Credit Suisse remains of the view that Inghams offers a positive growth trajectory against an undemanding valuation. Macquarie also notes, based on 13x FY21 earnings, Inghams trades at an attractive -27% discount to its peers.
The consensus target on Inghams is $3.97 which suggests 13.2% upside to the current price.
