Scale the Name of the Game for Aquaculture

by Max Andrews – Business Developer / Analyst

Aquaculture companies underperformed on the ASX compared to the consumer staples index (-10%), until Cooke Aquaculture proposed a bid to TGR. They have now overperformed (13%). The prior underperformance was probably largely due to operational issues, impacts on demand from Covid and large capital raises. It appears there are signs of the sector turning around with high fish pricing, favourable FX rates, and merger & acquisition activity. Like mining, aquaculture is cyclical and leveraged to prices and is best to be investing when the cycle turns.

Fisheries and aquaculture production value is poised to increase by 10% in FY22F (ABARES). The increased value is supported by higher prices for salmon, prawns and oysters. Demand for these products is also supported by improved domestic and international market conditions post lockdowns. Aquaculture companies were impacted hard by Covid due to a large portion of their products being sold into restaurants channels.

In our view, aquaculture companies are probably one of the toughest sectors to manage, with small margin of error due to the following reasons:

• Working capital life cycle from hatchery to harvest can be up to three years;
• Capex heavy industry with continuous maintenance capex; and
• Farms are prone to disease which can cause high mortality

For these reasons, to sustainably scale production takes years and typically capital injections along the way. In our view, reaching scale for a range of channels and strong brands are the deciding factors to generate meaningful free cash-flow.

In our view, Tassal (ASX:TGR) is well positioned as it has completed its scaling phase of its salmon segment into domestic and export markets with its strong retail brands, and now using free cash flow to scale its prawn operations. During the writing of this report Cooke Aquaculture (Cooke) lodged a non-binding indicative proposal for 100% of TGR shares for $4.85 per share in cash consideration. TGR declined the proposal from Cooke, we believe this was theright move as they are trading at a discount 28% to international peers on a FY23 EV/EBITDA basis.

The other listed companies we focus on in this report are in the process of scaling their operations. In our view, Clean Seas Seafood (ASX:CSS) is probably the best positioned if it can reduce its cost base similar to pre-Covid levels, and can generate cash flow. We like Murray Cod Australia (ASX:MCA) due to its strong brand, genetics’ position, balance sheet and growth, however, appears expensive compared to peers. It appears early for New Zealand King Salmon (NZK) as they have a history of high mortalities rates with its salmon, which has probably stagnated any scaling opportunities. East 33 (E33) has been able to grow its oyster production, however it appears early, and has disappointed from its Prospectus forecasts. E33 had three board members resign on the 26th of April, which was not well explained in our view. We believe TGR is the safest option and should provide strong cashflow going forward. It is limited by growth in salmon, however there is prawn and product mix growth, and it is cheap relative to peers. CSS and MCA are worth watching and both have defensive balance sheets. We did not focus on Seafarms (ASX:SFG) in this report.

In our view Yumbah Aquaculture is the leading abalone producer in Australia. We like Yumbah’s management and their diverse locations and broad range of shellfish. It has a proven track record for high quality product with low mortality rates. Rare Foods (ASX:RFA) has a low capex model, however its key catalysts of scale and a new on land aquaculture facility have been delayed due to Covid issues in Perth. We prefer Yumbah’s “on land” model compared to RFA’s sea ranching model, while it requires more capex it is more scalable and controllable.