Chicken Sh** (ASX:ING)

Inghams Group (ING) – a 100-year-old ASX listed supplier and producer of poultry and livestock feed.

Notably, the company holds the no.1 market position in Australia for chicken production with an estimated 40% market share and the no.2 market position in New Zealand with a 34% estimated market share.

The groups core business – poultry production reportedly experienced a volume increase of +3.2% over the FY18 – 17 period as mentioned in the 2018 Annual Report. However, revenue was flat at $2,373m due to a decline in volumes for the livestock business. The Feed business makes up 10% of revenues; the decline was attributed to the closure of Red Lea Chickens (competitor), a free kick for Ingham’s core poultry business.

The FY18 total Poultry Volume was 505.3kt (+2%) for ANZ. The Australian segment volume increase was +1.6% & New Zealand 4.5%.

The below was reported in the presentations (note, kt is a symbol for 1000 metric ton).

  • The 2017 investor presentation highlighted “Poultry Volume” of 495.3kt (+11%)
  • The 2018 investor presentation highlighted “Core Poultry Volume” of 397.7kt (+3.2%)

At first read of the Annual Report it seems that volume increased in 2018 by 3.2%. However, the total volume growth was 2% and a marginal 1.6% in Australia. The volume and revenue numbers reported suggests a slowdown which hasn’t been reflected in the recent share price gains.

Maybe its this fuzzy reporting on volumes and possible slowdown that has lead Ingham to be the 4th most shorted stock on the ASX with a short interest of 13.17% (see www.shortman.com.au).

I’m havent read other short-thesis’s out there, however it’s not hard to make a short case. And with the share price at 52-week highs, maybe a bearish view makes most sense. Some points worth mentioning;

1st point – Profitability – Notwithstanding its dominant market position in the industry, the groups’ revenue is heavily concentrated with 60% of revenues from top 5 customers. See below:

  • 53% of revenues are from Major Retailers in Australia (i.e. Woolworths & Coles etc.)
  • 17% of revenues are from Quick Service Restaurant (KFC etc.)

The above concentration erodes its ability to raise prices, and even the demand for its products, which is subject to the selling campaigns, and product positioning of the major retailers. Revenue is broadly at the mercy of the major retailers and key customers.

The top line pressure is also compounded by the rising input costs and not being able to pass on the full feed costs to its customers (All those chickens need to eat something! And it’s wheat). And on that, Wheat prices have continued to rise, with continuing poor weather in Australia and across the globe. Wheat futures prices could continue to lift. Australian wheat prices have lifted to their highest level in seven years.

The group reported a strong Ebitda result of $212m (+$51m from FY17). The improvement in Ebitda YOY is for the most part a result of the net gain from the sale of an asset for $19.4m in FY18, and a one-off cost in FY17 relating to the IPO of $39m. This makes YOY comparisons sexier than the reality.

To go further, the operating profit in FY17 was $117m; if we add back $39m (IPO costs) it becomes $156m. Now compare this to FY18 that was $166m, and now less gains from the sale of an asset of $19m, operating profit was $146m. After adjustments operating profit fell over FY17 to FY18 period.

Despite the average profitability, the share price has been well supported by is its $273m cash balance ($150m left over from the IPO) that has enabled a share buy back & a return of capital to shareholders.

2nd point – TPG Capital (private equity); its dirty past, the company was floated in November 2016 from the suspect hands of private equity (TPG Capital) at a price of $3.15 with the indicative price hoped for at the time was $3.57 to $4.14. Nonetheless, TPG took what cash they could with the sale and lease back of 51 facilities generating $188m in sales as per the Adjusted Statutory Historical Results in the prospectus.

And, unfortunately, TPG sill has a 32% ownership since the IPO that they are currently looking to offload.  The shares were in escrow since August 2017 – and are still not sold, with TPG sourcing strategic partners or institutional investors. If the IPO is an indication of future sales, will the sale be at a discount?

3rd reason why you should own – Cash flow: The group had recently announced a share buy-back of 5% from the sale of the Mitavite Feed Business sale for $52m which was finalized in October 2018. A temporary boost to the share price, noting future buy backs are unlikely. Current capital decisions are short term and well-timed.

In addition to the above, ING announced a Return of Capital to shareholders of $125m from funds leftover at the time of the IPO. Maybe the capital return was more a gift for TPG who will receive 30%. I’m sure there could have been other uses for the cash.

These shareholder gifts want continue. The groups operating cash flow for FY18 was $238m (FY17: $149) which looks great on the surface, however accounts payables increased $40m, collection of receivables was $21m, and the other change was provision of income taxes $13m.

After adjusting for the previous items, net operating cash flow was in line with FY17 at $165m. Now, see the below.

  • Adj Operating Cash flow: $165m
  • Capital Expenditure: $62m
  • Free Cash Flow: $100m
  • Dividends Paid $70m.

Not much wiggle room with the $70m dividend.

It’s worth noting that accounts payable has increased for two consecutive years and is now at $313m. The two-year increase in payables of $70m has done the group justice in funding its working capital while the cash at bank is left to accumulate to $273m.

Furthermore, the strong cash has so far ensured a low net debt ratio as headlined in the 2018 Annual Report but this due to an artificially high cash balance that is masking its $420m debt load now representing a third of its market cap at $1.5b. And this doesn’t iclude the $1b in leases reported off the balance sheet.

The Enterprise value excluding cash is close to $2b with profit after tax of $115m (17x P/E) a premium for company with slowing revenues and margin pressure.

Catalyst

The upcoming TPG sale has an element of uncertainty; it will be either sold to a strategic investor at a premium or to institutions at a discount. The latter seems more likely. The second case for a reprice is change in the dividend policy.

 

 

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