Competitive pressure was enhanced for Bega Cheese ((BGA)) in the first half as direct milk intake was reduced and difficult conditions prevailed for nutritionals demand in China.
Net profit was down -21%, as a better result at Bega Foods was insufficient to mitigate weakness at Tatura Milk, which was particularly affected by lower intake in northern Victoria. Bell Potter points out, in the last two years, the company’s milk collections in south-east Australia have contracted -8% compared with the sector contraction of -2%.
The company has initiated cost reductions to address a $200m compressible cost base, which Bell Potter expects will materially benefit the business from FY21-22. There was a material improvement in operating cash flow in the half, the broker notes, reflecting the benefit of utilising receivable securitisation.
FY20 operating earnings (EBITDA) guidance has been retained at $95-105m. Morgans envisages downside risk to guidance in the event the company increases farm-gate milk prices further in the fourth quarter, or as supply drops again. Dairy Australia is forecasting a -3-5% reduction in Australia’s 2019/20 milk production.
The Tatura business suffered the largest comparable decline in earnings in the half year, as milk collections fell. Processed milk volumes also fell -5%, with the majority of the reductions in volume being experienced by the Koroit facility. Moreover, demand for infant formula into China has been soft.
Focus On Brands
UBS found the results compositionally different to what had been anticipated but assesses Koroit and the core export branded/manufacturing business are the source of upside. This stems from favourable commodity pricing for Koroit, new toll processing contracts and rises in retail prices.
Underlying operating earnings in the core brands increased 40%, as the increased cost of milk paid to suppliers was offset by a full six-month contribution from Koroit, growth in international branded & consumer packaged business, the closure of Coburg and new customers.
The company also pointed out that Vegemite delivered a small amount of revenue growth, Bega peanut butter won market share and consumers are enjoying Bega Simply Nuts. Vegemite with -40% less salt will be launched in the second half.
The company intends to continue to diversify its branded business, targeting branded sales by 2023 at 70% of group sales. Morgans points out the focus on higher margin, value-added product should reduce some of the volatility in earnings.
The lactoferrin facility is on track for commissioning in April 2020 and will add 35 tonnes of additional capacity, supported by a long-term supply arrangement with an international customer.
Conditions may be challenging but the company is controlling what it can by reducing costs and working capital requirements. Still, the balance sheet is stretched and Morgans does not rule out an equity raising, retaining a Hold rating and $4.17 target.
Net debt is expected to reduce in the second half as inventory is sold. Bell Potter maintains a favourable view on the stock, with a Hold rating and $4.25 target, believing in the success of the integration of the Mondelez assets and the potential to expand the brand portfolio over time.
Supply growth from major dairy exporters globally has been lagging demand because of unfavourable seasonal conditions and environmental controls. This did underpin prices until the potential for a coronavirus pandemic weakened global dairy prices in recent weeks. At this stage, coronavirus impact is not considered material and the company has noted its supply chain and customer shipments have not been affected.
Bega Cheese intends to further rationalise its supply chain and manufacturing footprint, simplifying processes. However no specific targets were provided. Morgans highlights that poor segment disclosure has made it difficult to ascertain just how the individual businesses are performing, so forecasting accuracy is low.
UBS assesses the balance sheet is now more stable and there is less earnings risk from Tatura as commodity prices for the near term are largely locked in and there is contracted lactoferrin offtake from FY21. UBS has a Buy rating and $5 target and re-bases expectations for Tatura to reflect the likely optimisation of the facility to take sustained lower milk volumes from northern Victoria.