Warrnambool battle could end in a stalemate

To many investors, the stories of an Asia-led Australian agriculture boom are as ancient as our wide brown land. The relatively low valuations of ASX-listed agribusinesses compared with their international peers suggest Australian investors remain cautious about this long-promised bonanza.

However, attraction to Australian listed agribusinesses, particularly those with exposure to Asian markets, remains strong in certain quarters. Warrnambool Cheese & Butter finds itself as the fair maiden, with multiple suitors asking it to the dance. Who's involved?

ASX-listed Bega Cheese owns 17.9 per cent of WCB. In mid-September Bega offered 1.2 of its shares and $2 cash per WCB share. Based on Bega's opening price on Friday of $4.49, this values WCB at $7.74 a share (a material increase from the implied $5.89 when its bid was launched as Bega's shares have been caught up in the frenzy).

Murray Goulburn, a farmer co-op and Australia's largest dairy processor, owns 16.8 per cent of WCB. Murray Goulburn offered $7.50 a share in mid-October.

Saputo, a Canadian-based dairy major that enjoys the support of WCB's board, bid $7 a share in early October and raised this to $8 a share on October 25 following Murray Goulburn's offer. Saputo had no interest in WCB as of that date.

Lion Dairy & Drinks - owned by Kirin Holdings of Japan - has this week reportedly paid $9.25 a share for a 9.99 per cent stake in WCB. Lion has stated that it does not intend to make an offer for WCB, but it does have a manufacturing arrangement with the company to produce Coon and Cracker Barrel brands up for renewal in 2015.

These key players collectively hold 44.7 per cent of WCB's scrip.

Before the Bega bid, WCB's shares closed at $4.51. The stock closed at $8.30 on October 31 for a market capitalisation of $465 million.

In a new twist Fonterra, New Zealand's big dairy co-op, snapped up a 6 per cent stake in Bega and was reportedly hunting around for stock to take a 10 per cent holding in Bega Cheese - the largest position a single shareholder can own in Bega under its constitution. Fonterra holds the rights to market Bega Cheese in Australia.

What are the bidders paying for?

WCB's underlying earnings before interest, tax, depreciation and amortisation has averaged $27 million in the six years to fiscal 2013. This includes a 2008 peak of $48 million and the fiscal 2009 trough of a loss of $6 million.

WCB management has forecast a fiscal 2014 earnings range of $47 million to $52 million, on par with its best year at least since listing. The forecast result is achievable as was demonstrated in 2008. The fiscal 2014 result will be supported by the impact of droughts in key supplier regions including North America and New Zealand over the past 12 months along with a weaker Australian dollar than in fiscal 2013.

Bloomberg consensus analyst earnings before interest, tax, depreciation and amortisation forecasts for fiscal 2014 are sitting at $43.3 million, approximately 60 per cent above the average since 2008.

Consensus forecasts appear to suggest this strong rebound in earnings represents a new base going forward.

History tends to suggest that the earnings of agribusinesses will revert to the mean over the medium term.

Using an $8.30 share price and even using consensus forecasts for robust fiscal 2014 earnings per share of 36.1 ¢, on a price to earnings per share basis WCB is now trading at 23 times forward earnings. This is materially higher than the 12.6 times price to earnings it has averaged over a full commodity price cycle since 2008.

WCB's dance is in full swing, but the greater risk is that with several interested parties holding blocking stakes a successful bidder won't emerge in the foreseeable future, causing a stalemate.

While it is possible that a new, potentially $9-plus bid may emerge, it is also possible that a stalemate could see WCB's share price begin to sag. In the three years before Bega launched its September bid, WCB's shares averaged $3.65. WCB shares have enjoyed a 127 per cent share price gain in the 12 months to October 31.