Buttered up – our agribusiness takeover targets

Australia’s agribusiness sector has proved its value with the spectacular takeover of Warrnambool Cheese & Butter…who’s next? Here are our top targets.

Summary: Acquisitions activity is picking up across Australia, with agribusiness the hot topic, despite the impact of the drought and the expansion of relief programs. We identify three companies which stand out as potential targets, and explain why.
Key take-out:  Despite the government knocking back ADM’s bid for Graincorp, the company remains a potential target for another, possibly  joint-venture takeover bid. Bega, Nufarm and Australian Agricultural Co may also attract attention.
Key beneficiaries: General investors. Category: Mergers and acquisitions.

Recommendations: Graincorp (GNC): Outperform (under review). Bega Cheese (BGA): Outperform (under review). Nufarm (NUF): Outperform (under review). Australian Agricultural Co (AAC): Outperform (under review).

Investors could be forgiven for thinking now is not the best time to consider listed agricultural stocks, given parts of Australia are experiencing extremely dry conditions and the Federal Government is under pressure to expand its drought relief programs.

Nothing, however, could be further from the truth. The remarkable takeover saga surrounding Warrnambool Cheese & Butter (WCB) late last year has set the eyes of the world on our superbly located agricultural sector. Moreover, momentum in the mergers and acquisition space is at last gathering pace across all areas in the Australian economy, including agriculture. After sinking to depressed levels over the past few years, the first quarter of 2014 is shaping up to have the highest volume of deals in Australia since 2010.

With a month left in the quarter, $12.5 billion worth of merger and acquisition deals have already taken place – just shy of 2010’s $12.6 billion and well above levels in 2011 and 2012.

Australian companies are finally wakening to the scope of takeover opportunities available as overseas corporations launch some of the biggest takeovers on record, such as the $45 billion merger between Comcast and Timewarner cable and Facebook’s $19 billion acquisition of WhatsApp.

You just have to look at the scale of local deals in the past six months:

  • The three-way takeover war for WCB that saw its market cap more than double to $530 million.

For the record, in Eureka Report last September I named WCB as a potential target very shortly before the takeover battle began and the stock was trading at $4.51 (10 stocks in the takeover spotlight). After the Saputo bid set the stock alight, I further noted on October 23 that the market could expect at least two more bids…and they duly came. The final  acquisition price of WCB was $9.40 more than double the price level at which I first named the stock as a target.

  • A $2.6 billion proposed acquisition of Aurora Oil & Gas by Canadian energy corporation Baytex.
  • Westpac’s $1.2 billion acquisition of Lloyds’ Australian assets.
  • The $3.4 billion proposed takeover of GrainCorp. Though it was rejected because of political reasons, Archer Daniels Midland was intent on completing it.

Within this environment, Australian agriculture is ripe for mergers and acquisition activity. In fact takeover activity is the prospect in this area:  More generally many investors have struggled to make decent money in the agricultural sector in recent years. (To read more on this issue see Doug Turek’s Growing Wealth)

What’s more, several giants of the agricultural sector have recently fallen into foreign hands. As well as Warrnambool, notable former targets include AWB (AWB) and ABB Grain (ABB).  As these low hanging fruit have gradually been picked off, it has become harder, but not impossible, to identify new targets such as these:

Graincorp (GNC)

Although Treasurer Hockey recently knocked back a $13.20ps bid by US-based Archer Daniels Midland (ADM), the American company hasn’t pack its bags and gone home. Archer Daniels Midland retains a 19.9% stake in GNC, and was granted the right by Mr Hockey to raise this to 24.9%.

Clearly ADM cannot just relaunch its original offer, as this would most likely result in another knockback. But the bidder could offer to engage in a joint venture with a local group to appease the ‘fear of foreigners’ suffered by many politicians in the National Party. In addition, ADM’s offer (during its failed bid) to invest between $200m and $250m in infrastructure upgrades for GNC may soon look attractive as the target company struggles to attract fresh capital.

Graincorp

2013-14

2014-15

Earnings/share (adj)

51.5c

63.7c

Dividend/share

32.4c

37.5c

EPS growth (adj)

-32.9%

23.75%

DPS growth

-19.06%

15.92%

Price/Earnings (adj)

15.51 times

12.54 times

Dividend Yield

4.06%

4.69%

Source: Bloomberg


Graph for Buttered up – our agribusiness takeover targets

Bega Cheese (BGA)

BGA was one of the big winners from the protracted takeover for WCB. After selling its stake to successful bidder Saputo for almost $100m, BGA is now well and truly cashed up. It also has a great brand name in Australia, and with its WCB-generated riches is well placed to expand further into Asia to satisfy the growing demand by middle class people there for more dairy products.

Bega Cheese

2013-14

2014-15

Earnings/share (adj)

20.8c

23.6c

Dividend/share

8.8c

10.3c

EPS growth (adj)

20.98%

13.47%

DPS growth

17%

17.52%

Price/Earnings (adj)

25.87 times

22.8 times

Dividend Yield

1.64%

1.91%

Source: Bloomberg


Graph for Buttered up – our agribusiness takeover targets

Nufarm (NUF)

At their current price of around $4.00, NUF shares are not far from their all -time low point over the past 20 years. Like industry giant Monsanto, NUF manufactures herbicides, fertilizers and seed products (think genetically modified organisms, or GMOs) for farmers around the world. These businesses are absolutely essential for the 21st century world to feed itself, yet in recent times NUF has struggled to make consistent profits due in part to intense competition.

Despite NUF’s inconsistent earnings profile, at current prices the company is a takeover target. This is because several years ago, Japan’s Sumitomo Corporation bought a 23% stake in NUF at prices way above today’s levels. Like many Japanese companies, Sumitomo is a patient investor that has consistently worked with the NUF Board to improve its return on investment.

Eventually, I think Sumitomo will look to acquire the 77% of NUF it doesn’t presently own. The only issue for investors is when – and unfortunately, Japanese companies often work on a much longer timescale than shorter-term share traders might prefer. As a result of this, NUF is a takeover target for the longer-term.

Nufarm

2013-14

2014-15

Earnings/share (adj)

35.4c

42c

Dividend/share

11c

14.3c

EPS growth (adj)

34.01%

18.85%

DPS growth

37.93%

29.2%

Price/Earnings (adj)

11.03 times

9.3 times

Dividend Yield

2.82%

3.66%

Source: Bloomberg


Graph for Buttered up – our agribusiness takeover targets

Australian Agricultural Co (AAC)

AAC has a number of very positive attributes: it directly owns about 1.3% of mainland Australia’s landmass; it has a huge herd of cattle at a time when global demand for beef is growing; and Dubai-based IFFCO Poultry owns a 9.9% position on its share register (possibly in conjunction with a Malaysian Government entity called Felda).

To me these factors would normally scream ‘takeover target’. Unfortunately, however, AAC is not without some considerable negatives. For a start, it last paid a dividend in 2008, which suggests that genuine cash earnings have not been strong over the past five years. Indeed in many ways AAC is a lot like a giant farm….and in this respect it has many of the problems that can beset Australian farmland with great land value but poor cash flows.In addition, continual Australian Government interference in the live cattle export trade makes any future earnings subject to considerable sovereign risk.

Because of these latter two factors, AAC is a takeover target but as an operational business it continues to struggle to get its fundamental business model working.

Australian Agricultural Co.

2013-14

2014-15

Earnings/share (adj)

1.7c

5.4c

EPS growth (adj)

-109.18%

221.07%

Price/Earnings (adj)

-

23.43 times

Source: Bloomberg


Graph for Buttered up – our agribusiness takeover targets

Conclusion

Because of factors like the variability of both weather and government regulation, agribusiness often provides investors with a bumpy ride (just ask any farmer). Yet as the recent bids for GNC and WCB demonstrated, at the right time shares in agricultural companies can generate stellar returns. The trick, as always, is to buy such stocks when they’re generally out of favour with the market. Now appears to be one of those times.

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