Australia made a record trade surplus in December 2020 with ~$6.79 billion on a seasonally adjusted basis, according to the data by The Australian Bureau of Statistics. This was after dropping for eight straight months from April 2020. Australia continues to be a net exporter with exports accounting ~38% to China in December 2020. Despite trade disruptions, exports to China increased by ~21% over the prior month led by an increase in iron ore exports. Consumption of iron ore by China surged following government stimulus measures and construction demand. Overall exports grew by ~3% on a seasonally adjusted basis to $37.26 billion in December 2020 (on an M-o-M basis).

Figure 1. Trade Surplus Was Far Above to 2-Year Average in December 2020:

Source: Data from The Australian Bureau of Statistics, Chart Created by Kalkine Group

The favourable trade surplus was also due to a decline in imports. Being a two-way trading partner, China imports for telecommunications and sound equipment, among others, declined by ~7% in December 2020 over the prior month. However, imports from China stood higher than last year. Overall imports declined by 2.4% to $30.48 billion in December 2020 over the prior month.

China imposed restrictions on coal, lobsters, timber, red meat, and cotton exports from Australia. It had also imposed a tariff on wine and barley products. While no restrictions were placed for iron ore exports currently. The non-rural products signify ~67% of total exports, but it grew minuscule by 2.2% in December 2020 over the preceding month with positive movement in metal ores and coal. Australia is diversifying away from China with an increasing share of exports to Hong Kong, India, Japan, Switzerland, and the US, largely for rural products. Rural products outperform non-rural exports with ~18% growth in December 2020 over the prior month. Rural products accounted for 11.1% of total exports. Cereals and meat products led the category with +216% and +6% growth. This was followed by vegetables, dairy products, and wool & sheepskins.

Figure 2. Exports of Rural Goods Surged by 18% in December 2020 to $4.15 Billion:

Source: Data from The Australian Bureau of Statistics, Chart Created by Kalkine Group

Winter crop production is supported by favourable rainfall during September and October and increased soil moisture levels. But crop prospects in Western Australia and Queensland were less favourable comparatively as yield prospects deteriorated due to unfavourable seasonal conditions during the early spring. The December forecast report from the Department of Agriculture, Water and the Environment has upwardly revised the 2019-20 production estimate of winter crops driven by strong wheat and barley production. New South Wales is to show an all-time high of winter crop production as mentioned by the Director of ABARES. A spike in demand from importing markets for wheat was seen during the second half of 2020 in an attempt to secure supplies in the wake of the second outbreak in the northern hemisphere.

Figure 3. Production Trend of Winter Crops by States:

Source: Data from Department of Agriculture, Water and the Environment, Chart Created by Kalkine Group

Barley prices are expected to ease due to increased production on the east coast and declining domestic demand which may lead to a marketable surplus. Above-average summer rainfall in most parts of the continent is expected to support sorghum grain production. Australia aims to export wheat to Saudi Arabia and other Middle Eastern countries, Japan and south-east Asia. Worldwide demand for oilseeds to outpace supply and is expected to support oilseeds price. The Australian canola price is expected to return to support export parity following the year-long drought. On meat processing, herd rebuilding has increased domestic demand for cattle. Livestock prices have improved benefited from the herd and flock rebuilding and growing international demand.

Figure 4. Price Trend of Selected Agriculture Commodities:

Source: Data from Department of Agriculture, Water and the Environment, Chart Created by Kalkine Group

Key Risks:

The ongoing trade tension with China particularly impacted Australia’s exports of barley and wine, creating a marketable surplus for barley leading to price distortion. Climate change and seasonal factors have a pivotal play in agriculture output. The 3-year long drought in Australia crippled wheat exports. Similarly, the cost of fruits and vegetables is expected to increase during the summer periods. World export parity affected domestic prices like strong Chinese import demand for soybeans is likely to reduce global supply of stocks to the lowest levels. Dry climatic regions in several parts of the European Union are expected to impact canola production.

Figure 5: Key Risks in Agriculture Output and Prices: 

Source: Analysis by Kalkine Group

Outlook: Considering the above facts and trends, we have figured out 4 stocks on ASX that are set to see the momentum from the development. ABARES, the government body has upwardly revised the gross value of agricultural production to $65 billion for 2020-21, representing 7% growth over the prior year.  This was on the back of the largest winter crop production expected particularly in New South Wales and promising rainfall outlook. Barley production is expected to increase 33% to 12 million tonnes in 2020-21, led by seasonal conditions across South-eastern Australia. Wheat production is expected to double in 2020-21 to 31 million tonnes, led by above-average yields particularly in New South Wales, Victoria, and South Australia. Australia Canola export is expected to regain lost market share in Canada. Biodiesel demand in the EU market is expected to support the Australian canola market. Australia is pursuing free trade agreements with other developing and emerging markets in an effort to cut-off China ties. Like, it is expecting to strengthen trades with the UK, the EU, and India. The Indonesia-Australian partnership forged in July 2020 to significantly boost exports as Indonesia is expected to become the world’s fourth-largest economy by 2050 as mentioned by ABARES.  As per the recent press release, Australia opened up for exports of barley for nearly 30,000 tonnes to Mexico. The government will work with CBH Group to expand into Latin America.

(1) Tassal Group Limited (Recommendation: Buy, Potential Upside: Low Double-Digit)

(M-cap: A$ 703.74 Million, Annual Dividend Yield: 5.40%)

Domestic Retail Sales Provided Resilience: Tassal Group Ltd (ASX: TGR) is an Australia-based company, engaged in the farming of Atlantic salmon and tiger prawns and the processing and marketing of salmon, prawns, and other seafood. The pandemic impacted foodservice and wholesale business segment, but this was offset by a surge in in-home cooking trends and retail consumption. Export markets were strategically targeted with bigger salmons. Domestic sales volumes were up by 13.4% in Q4 FY20 (on a YoY basis). Overall sales grew by a modest 0.2% to $552.7 million in FY20. An increase in freight costs (air freight went up by 4x) to cater to the exports market pushed down EBITDA but was mitigated by favourable sales mix and pricing. EBITDA margin improved to 22.6% in FY20 as compared to 20.1% in pcp. Stock piling-up for salmon and prawn to drive through the pandemic impacted operating cash flows to reach $49.85 million in FY20, down from $89.90 million reported in pcp. TGR continues to invest in live biomass and prawn harvesting with growth capex reaching $75.7 million. The company completed fund rising in two stages upto $125.8 million which includes private placement and share purchase plan. Overall cash balance stood at $21.9 million as of June 2020 (vs. $24.6 million in pcp). With incremental debt, gearing ratio increased to 52.6% in FY20 (vs. 28.2% in FY19) post AASB 16 reporting.

In the Q1 FY20 trading update, TGR reported a 31.1% increase in revenues to $132.4 million (YoY basis), supported by the domestic retail market. Higher freight costs continue to weigh on export business. Production costs per kg improved at both salmon and prawns businesses.

Outlook: TGR completed the acquisition of Billy Creek which holds a 1,300-hectare property adjacent to TGR’s Proserpine prawn farm. The acquisition supports the expansion plans of the prawn business. The management is expecting positive consumer sentiments to show momentum in FY21 sales. It is targeting to achieve stronger operating earnings and returns particularly in the prawn business. Available committed facility extended to $509.2 million. A dividend payout policy of not less than 50% of operating net profit decided to be maintained for FY21

Valuation Methodology: EV/EBITDA Multiple Based Relative Valuation (Illustrative)

EV/EBITDA Multiple Based Relative Valuation (Source: Refinitiv, Thomson Reuters)

Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months

A-VIX vs TGR (Source: Refinitiv, Thomson Reuters)

Stock Recommendation: The stock is undergoing correction with 3-month and 6-month negative returns of ~10.03% and ~7.52%, respectively. It is currently trading below to the average of 52-week high price of $4.500 and 52-week low price of $2.770. With the acquisition of Billy Creek, the management expects to achieve stronger operating earnings and returns particularly in the prawn business. Consumer sentiments to show momentum in FY21 sales. The stock underperformed the market volatility index as lockdown restrictions impacted foodservice and wholesale business. We have valued the stock using the EV/EBITDA multiple based illustrative relative valuation method and arrived at a target price of low double-digit upside (in percentage terms). We believe that the stock might trade at a slight premium as compared to its peer average EV/EBITDA (NTM Trading multiple) given the positive impact of Billy Creek acquisition in FY21 results besides increased investment in live biomass and prawn harvesting which will support the volume growth. For this purpose, we have taken peers such as Freedom Foods Group Ltd. (ASX: FNP), Elders Ltd. (ASX: ELD), Bega Cheese Ltd. (ASX: BGA), to name a few. Considering the growth targets, adequate capitalization following fund rising, valuation and current trading levels, we give a “Buy” recommendation on the stock at the current market price of $3.320, down by 0.301% on 15^th February 2021. 

(2) The A2 Milk Company Limited (Recommendation: Buy, Potential Upside: Low Double-Digit)

(M-cap: A$ 7.39 Billion, Annual Dividend Yield: 0%)

The Infant Nutrition and Diversification Strategy Paid-Off: The A2 Milk Company Limited (ASX: A2M) produces protein-free milk and distribute it to Australia, New Zealand, China, Hong Kong, Singapore, United States, and the United Kingdom. A2M experienced strong revenue growth in the core markets – Australia & New Zealand (ANZ), China & Other Asia. Growth in infant nutrition products across channels drove the growth. The company began home deliveries and saw increased traction for online sales particularly in China. It had also begun online live streaming of in-store products. Favourable mix and pricing benefited APAC business. It had doubled Australian fresh milk growth in FY20 totalling NZD 152.5 million. US market continues to be targeted for the premium segment. It had launched products in Canada through licensing agreements. A2M deepened footprint in the US with ~20.3k stores in FY20. A slight drop in EBITDA margin to 31.9% in FY20 (vs. 32.5% in FY19) was led by  higher distribution costs related to China label and the US business and increase in business expansion related costs. Australia & New Zealand and China business contributed to EBITDA in FY20 with growth of 19.9% and 66.6%, respectively. It had closed the full year with a cash balance of NZD 854.2 million in FY20. Working capital posted an increase of NZD 33.6 million due to timing payment to suppliers.

Outlook: A2M expects multi-channel strategy and corporate daigou to drive sales growth, particularly in China and ANZ segments. The company downwardly revised its projections with group revenue to be in the range of NZD 1.40-1.55 billion in FY21. Group EBITDA margin in the range of 26%-29% for FY21. In the recent developments, A2M signed an agreement to purchase a 75% stake in Mataura Valley Milk Limited, a dairy nutrition business, located in Southland, New Zealand. The deal consideration agreed at NZD 268.5 million. The acquisition to bring geographic diversification and strengthen supplier partnerships in China. The company is expecting one-off transaction costs of NZD 10 million to incur in FY21 and about half in H1 FY21.

Valuation Methodology: EV/EBITDA Multiple Based Relative Valuation (Illustrative) 

EV/EBITDA Multiple Based Relative Valuation (Source: Refinitiv, Thomson Reuters)

Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months

A-VIX vs A2M (Source: Refinitiv, Thomson Reuters)

Stock Recommendation: The stock has witnessed correction of ~31.97% and ~48.45% in the last 3-month and 6-month, respectively. It is currently trading below to the average of 52-week high price of $20.050 and 52-week low price of $9.800. A2M is expecting its multi-channel strategy and corporate daigou channel to drive sales particularly in China market. The acquisition of 75% interest in Mataura Valley Milk Limited is likely to bring in adequate diversification and will strengthen supply-chain. The stock underperformed the market volatility index given the in-store restrictions. We have valued the stock using the EV/EBITDA multiple based illustrative relative valuation method and arrived at a target price of low double-digit upside (in percentage terms). We believe that the stock might trade at a slight discount as compared to its peer average EV/EBITDA (NTM Trading multiple) as the management downwardly revised the revenue and EBITDA projections for FY21, citing the bleak macro environment and the proposed acquisition to add-up the costs. For this purpose, we have taken peers such as Murray Cod Australia Ltd. (ASX: MCA), BWX Ltd. (ASX: BWX), Youfoodz Holdings Ltd. (ASX: YFZ), to name a few. Considering the growth in core markets and adequate geographic reach, valuation and current trading levels, we give a “Buy” recommendation on the stock at the current market price of $9.830, down by 1.306% on 15^th February 2021.

(3) GrainCorp Limited (Recommendation: Hold, Potential Upside: Low Double Digit)

(M-cap: A$ 1.06 Billion, Annual Dividend Yield: 1.49%)

Increased Canola Oil to Support Crushing Margin: GrainCorp Limited (ASX: GNC) provides a range of products and services across the food and beverage supply chain in the food and agriculture business. Excluding the demerger impact of UMG business, GNC reported an uptick in revenues in FY20. But its agribusiness continues to have a drought impact resulting in lower tonnage of crops handled. Lower woodchip demand affected bulk materials. Its feed business drove the growth. Good demand for oil and spreads lifted the processing revenues. Underlying EBITDA turned positive at its Agriculture business to $52 million and the processing segment showed improvement to $40 million in FY20 as against $16 million in pcp on the back of improved crushing margins. The company saw an increase in canola supply, while meal and oil values attracted a strong premium during COVID-19. Capex increased to $45 million owing to higher investments in Yamala and Berrybank sites. Cash flows were supported by inflows of $58 million from the crop protection contract. It had closed the full year with a cash balance of $124.7 million as of September 2020. With UMG demerger, net debt declined to $239 million as compared to $909 million as of March 2020. The company had $2.23 billion available, of which $364 million was utilized during the current fiscal year.

Outlook:  GNC is expecting full-year underlying EBITDA for FY21 in the range of $230-270 million and underlying net profit after tax of $60-85 million. This includes $70 million payable towards the crop protection contract. The management is expecting increased canola oil seeds to support strong oilseeds crushing margins despite some pressure on meal values.

Valuation Methodology: EV/Sales Multiple Based Relative Valuation (Illustrative)

EV/Sales Multiple Based Relative Valuation (Source: Refinitiv, Thomson Reuters)

Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months

A-VIX vs GNC (Source: Refinitiv, Thomson Reuters)

Stock Recommendation: The stock posted 3-month and 6-month returns of ~11.83% and ~15.31%, respectively. It is currently trading below to the average of 52-week high price of $8.920 and 52-week low price of $2.810. The pandemic saw increased consumption of canola oil seeds which had lifted the earnings of the company. Demerger of UMG business saw drop in sales but net debt improved on YoY basis. The stock performed well over the market volatility index. We have valued the stock using the EV/Sales multiple based illustrative relative valuation method and arrived at a target price of low double-digit upside (in percentage terms).  We believe that the stock might trade at a slight discount as compared to its peer median EV/Sales (NTM Trading multiple) given the company’s agri business which are susceptible to drought (exposed to climate risk) and crop yields. Decline in crop tonnage volumes pushed down overall revenues and earnings during FY20. For this purpose, we have taken peers such as Select Harvests Ltd. (ASX: SHV), Ridley Corporation Ltd. (ASX: RIC), Pental Ltd. (ASX: PTL), to name a few. Considering the financing flexibility, adequate liquidity, valuation and current trading levels, we give a “Hold” recommendation on the stock at the current market price of $4.820, up by 3.211% on 15^th February 2021.

(4) Select Harvests Limited (Recommendation: Hold, Potential Upside: Low Double Digit)

(M-cap: A$ 649.21 Million, Annual Dividend Yield: 2.40%)

A Drop in Almond Price Impacted Margin: Select Harvests Limited (ASX: SHV) is engaged in the distribution of edible nuts, dried fruits, seeds, and a range of natural health foods. During the year, SHV experienced a decline in the global price of almonds to $7.50/kg as compared to $8.60/kg in FY19. This translated to a drop in revenues by 16.8% to $248.3 million. Almond production costs increased by 13.3% to $5.36/kg in FY20. Higher water costs and decrease in hull value at Almond division impacted EBITDA margin. Further, its food division was impacted by increased competition for private labelled products from domestic retailers. Overall EBITDA margin slipped to 17.8% in FY20, down from 30.4% in pcp. Working capital requirements surged as a result of crop inventory and delayed shipments. And as a result, operating cash flows declined to $13.2 million (vs. $80.3 million in pcp). SHV agreed to acquire Piangil Almond Orchard located in north-west Victoria for consideration of $129 million. The deal will be funded through new debt of $64 million, $80 million from entitlement offer and $40 million raised through private placement. The incremental debt will be excluded from March 2021 leverage ratio covenant test. The acquisition is expected to increase fixed assets by $16.6 million. Total debt stood at $59.0 million as of September 2020 as against $3.6 million in pcp.

Outlook: Acquisition of Piangil Almond Orchard to increase tonnage volume by 20% in FY21. Total planted almond hectares are likely to increase to 4,644 post-acquisition. The acquisition is scheduled to be completed by Q1 FY21. SHV took control measures to improve irrigation and risk management strategies to drive down the cost of producing almonds. Market pricing of almonds to remain uncertain owing to uncertainties in California almond shipments and market access. The start of the 2020-21 water season has seen temporary water prices back to their historical average. Orchard age profile, risk mitigation strategies, and on-farm technologies are to provide support to crop volumes for FY21.

Valuation Methodology: EV/Sales Multiple Based Relative Valuation (Illustrative)

EV/Sales Multiple Based Relative Valuation (Source: Refinitiv, Thomson Reuters)

Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months

A-VIX vs SHV (Source: Refinitiv, Thomson Reuters)

Stock Recommendation: The stock posted 3-month and 6-month negative returns of ~10.60% and ~1.33%, respectively. However, in last one month, it had posted positive returns of +7.24%. The stock is currently trading above to the average of 52-week high price of $8.941 and 52-week low price of $4.910. SHV is expecting the acquisition of Piangil Almond Orchard to increase tonnage volume by 20% in FY21. The company took various measures to improve irrigation and risk management strategies to drive down the cost of producing almonds. The stock slightly fell lower to the market volatility index given the subdued almond prices. We have valued the stock using the EV/Sales multiple based illustrative relative valuation method and arrived at a target price of low double-digit upside (in percentage terms).  We believe that the stock might trade at a slight premium as compared to its peer average EV/Sales (NTM Trading multiple) as management projected water prices to decline supporting yield and the acquisition of Piangil Almond Orchard to improve FY21 sales with higher tonnage volumes.  For this purpose, we have taken peers such as Bubs Australia Ltd. (ASX: BUB), Australian Agricultural Company Ltd. (ASX: AAC), A2 Milk Company Ltd. (ASX: A2M). Considering the strong net profit margin vis-à-vis peers, financing flexibility, valuation and current trading levels, we give a “Hold” recommendation on the stock at the current market price of $5.480, up by 1.481% on 15^th February 2021. 

Comparative Price Chart (Source: Refinitiv, Thomson Reuters)

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