Tassal Group

We have mixed feelings about Tasmanian salmon farmer Tassal Group. On one hand, the stock trades well below replacement value (it currently trades at a 20% discount to net tangible assets) and well below the $1.80-$1.90 offered by a private equity firm in 2010, it’s owned by numerous value investors we admire—including Allan Gray (formerly Orbis) and Maple-Brown Abbott—and it operates as the dominant domestic producer in a business heavily protected against imports. It’s one of only a few food suppliers that hold genuine bargaining power against Coles and Woolies.

On the other hand, there are concerns. The great bulk of its profits to date have come from appreciation of the value of its ‘livestock’—SGARA markups (an accounting policy the company must implement) that don't generate an immediate tax payment. So while the profit and loss statement shows tax payments each year, the company hasn’t actually paid meaningful amounts of tax to date—which explains why all of its dividends have been unfranked. At a minimum, the payment of unfranked dividends, especially when combined with a dividend reinvestment plan, is poor capital management. But it is also a potential red flag that reported profits overstate economic reality.

The group has been a bit of a capital hog in recent years, as Tassal has invested heavily to grow its processing and production facilities. Management claim that this investment has now mostly been made, and the cash should come gushing in soon (along with the real tax bills). The results to 30 June 2012 support the theory, with operating cash flow up 21% to $50.4m and capital expenditure down to $29.6m (from $39.4m the prior year). Further improvement seems likely.

So while it hasn’t been a good ride in recent years—this stock peaked at $4 in 2007—the business seems to be at an inflection point. We aren’t confident enough to place a positive recommendation on the stock, but are commencing coverage with a HOLD and will keep an eye on developments.