Tassal (TGR:xasx), is a class one stock and the company has a competitive edge, high barriers to entry and is a leader in the aquaculture (fisheries) industry. It delivers above average returns in a low growth global macro environment. We regard it as a hidden gem, waiting to be found with an opportunity of a 75% return in three years.
Background
Tassal (TGR) is Australia’s largest salmon producer which listed on the Australian stock exchange in 2003. Tassal Group was born from the collapse of Tassal Limited, following a restructure from the receivers, KordaMentha. After a number of successful strategic takeovers, TGR operations have grown to include hatching, farming, processing and selling Atlantic salmon.
The recent acquisition of De Costa has now expanded their market to include the seafood industry. The company share price has been growing in strength from 2012 once finishing significant capital expansion. Tassal now holds a competitive edge through economies of scale and brand recognition. At the age of 34, CEO Mark Ryan, a specialist in restructuring, corporate recovery and turnaround management, came from KordaMentha in 2003 to lead TGR. Since then, he has generated a compound share price return for shareholders of 16% + dividends per annum. With revenue and a market capitalisation over twice that of its nearest competitor, TGR is in a class of its own in the Australian market.
Industry Overview
Globally, more than 2 million tonnes of salmon are farmed annually. The industry worldwide has experienced strong growth in the last decade with CAGR of 6% from 2004–2013, while Australia at the same time grew at 10% CAGR. Norway and Chile are the world’s two largest producers, accounting for 56% and 38% of the world’s production respectively, where Australia contributes just 2%. There are three main reasons for the rise in demand for salmon in Australia. The first is increased awareness of healthy eating, the second is convenience and a preference for food that is faster and simpler to cook, and finally, the influence of Asian cuisine on Australian dining. Over the past seven years salmon consumption has almost doubled in Australia with a third of all consumers buying it weekly.
Australian salmon may look like a small fish in a big pond when compared to international producers. And it is. But it is in no way under threat from a larger player of losing market share. Australia, known for its wildlife diversity, fiercely protects its boarders from pests and disease. Quarantine and biodiversity laws do not allow the importation of live brood stock, live eggs or salmon milt. This makes competing in the fresh HOG space very restrictive and costly for international competitors.
Locally, Tasmania is the only state that is suitable for farming salmon as other state waters are too warm. Marine leases and hatchery licences are issued to industry incumbents by the state government. So not only is it financially costly to compete in the Australian salmon territory, but the high barriers to entry makes it very difficult to start a new enterprise. In such an environment, an intending player would find it easier to enter the market via a merger or acquisition than by attempting to start from scratch.
Competetive Strategy
Of the 55,000 tonnes of salmon farmed in Australia, Tassel accounts for 49% of the volume. The other major competitors being Huon (38%) and Petuna (13%). Tassal’s capital investment at the turn of the decade focused on three key areas: First was infrastructure of farming waters and in bio-assets; the second avenue has come through developing their product range to include fresh, frozen, canned and packaged salmon and; lastly the distribution network. The outcome of this investment resulted in a slew of awards being won for innovation, employer of choice and lastly, most remarkably, being named # 1 seafood provider in an international report on the world’s top 100 companies for sustainability, transparency and social responsibility. This adds to brand awareness and trust.
As the largest farmer of Atlantic salmon in Australia Tassal has economy of scale but still chooses to be selective in who it does business with. As recently as last month, the company chose to walk away from a distribution contract with Australia’s second largest supermarket chain, Coles, citing, inter alia, a need to ensure the sustainability of its stock in the long term.
Importantly, we see this move as strategic in allowing the company to not be reliant on a few large buyers . Any fish not sold can easily be exported and absorbed by the export market, admittedly at a higher cost. Supply shortages are expected in the international market over the next two years, driving prices higher. Developing a new supply chain into Asian emerging markets is a focus and growth opportunity as well.
The acquisition of De Costa Seafood has opened the company’s total target market from $700 million in salmon to now include $4.3 billion in seafood. This led to a rise in revenue of 50% in the second half of 2015. Leveraging existing operations and channels as well as stripping costs from the business, TGR is looking to increase margins on De Costa's current thinner margins. Synergies have already been recognised and we expect there are more to come as the business integration gains more traction. The company also continually invests in maximising salmon growth efficiencies, utilising selective breeding for size and reducing feed conversion ratios and bathing.
Current Situation
Tassal sold off ahead of its first half reporting on a "buy the rumour, sell the fact", following its recent acquisition. We believe the market was shortsighted in expecting business operations and synergies to be integrated within six months. We anticipate second half results to show margin improvement with further economies of scale and efficiencies to continue through to 2017. We believe management's track record of adding shareholder value affords them the trust to make good on the De Costa Seafood takeover. A discount needs to be recognised for the risks unique to farming.
TGR currently has a market capitalisation of $620m with a P/E of 11.11 and a P/B of 1.53. Its debt structure is conservative at 14% and gross dividend yield of 4.40%. According to these figures TGR is being priced as a value stock following its 2015 financial report that showed figures more closely related to a growth company:
Revenue up 50% to $226.8m
Operational EBITA up 11.2% to $41.3m
Operating cashflow up 34.9% to $25.5m
Operational NPAT up 4.7% to $19.3
Interim Dividend up 7.1% to 7.5%
Valuation
TGR will have plenty of cash to pay out to shareholders in the next few years. In addition it is key to capture the pricing of growth opportunities the company offers. Therefore we feel pricing TGR using a dividend discount model would be most appropriate.
Dividend growth in the past 3 years has been: 19%, 21% and 21%. This may very well continue at this trajectory given the protected market it operates in and the above average growth within the industry. But let’s clip the fins a little to offer room for accommodative pricing.
Anticipated dividends we’ve put forward in 2016 – 2018 are: $0.16, $0.18, and $0.20. From there an expected growth will flatten out to 5%. Given a required return of 8% the discounted cash flow model gives us a price of $7.46 in three years.
On a relative basis TGR is looking well priced. Its P/E is trading above that of other industry players. This higher P/E we believe is on a lower forecasted EPS and not over pricing the stock. We believe the market is underestimating the takeover of De Costa and that EPS will beat expectations. In addition, TGR's protected market place and growth opportunities warrants a higher P/E. Australian produce is highly regarded by our Australasia neighbours and it should not be overlooked at a large player looking to strategically partner up or buy into this world leader.
Tassal Financials
Key Risks
Tassal is an agricultural company and bears the risks of environmental conditions. The risk of disease also exists although Australia’s isolation and industry standards is relatively less risky . TGR as a hidden gem bears the risk of not being "discovered" by the market in a reasonable time frame. The ASX at the moment is one of the more heated markets at present and Tassal would not be immune to a selloff.
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