|Shares Out. (in M):||203||P/E||0||0|
|Market Cap (in $M):||8,575||P/FCF||0||0|
|Net Debt (in $M):||0||EBIT||0||0|
Austevoll is a Norwegian aquaculture and fisheries business. It's main asset is a 63% stake in Leroy Seafood which is the world's second largest salmon farmer after the Fredriksen owned Marine Harvest. Leroy Seafood is also publicy listed. 75% of the SOTP valuation for Austevoll comprises of the stake in Leroy and basically Austevoll is a cheaper way to buy Leroy than to buy Leroy shares directly as its other businesses are undervalued. There is no near-term catalyst to resolve the valuation discrepancy.
Leroy is the world's 2nd biggest Salmon farmer. Salmon is a commodity and there's effectively no difference between salmon farmed by any of the salmon farmers or salmon caught in the wild. Hence to understand why Leroy is attractive, you have to understand the salmon market.
Aquaculture is a very small part of the entire fish market globally. Most of the fish eaten globally is still caught at sea. And it is an even smaller part of the overall protein market globally. Needless to say there are some very large mega-trends at work which have been delivering very robust GDP+ demand growth for aquaculture and salmon in particular. There are
1. Demand for proteins has been steadily increasing at above global GDP levels as poorer countries in Asia and Africa are increasing their per capita protein consumption as they get richer.
2. Healthy living trends have been increasing the demand for fish at the expense of beef, pork and chicken, and demand for fish has been increasing faster then the demand for other proteins.
3. Demand for Aquaculture is increasing faster than demand for fish as aquaculture is sustainable while a lot of fish stocks in the wild are getting depleted from overfishing and quotas and monitoring of fish caught in the wild are increasing to make wild fishing more sustainable.
4. Demand for salmon within Aquaculture has been very healthy because of its very prominent use in sushi, and french and other cuisines, which are increasingly becoming more popular globally with a long runway still to go.
All these factors have conspired to result in salmon demand growth of about 7% globally very consistently for decades now and likely to continue for the foreseeable future.
In light of this reliable and steady demand growth, the commodity has consistently seen price cycles for decades now because of supply fluctuations. It takes 3 years to grow salmon to adult harvestable age. New capacity can be added fairly rapidly if space/location is available with logistical network in place and this supply will hit the market in 3 years as the fish gets older. This is the classic hog cycle from Economics 101 which is also prevalent in the salmon industry (you can refer to the discussion for Pilgrim's Pride idea). The difference this time for salmon, after many decades of these cycles (the last downcycle was 2012), is that we are running out of places to farm salmon.
Salmon requires temperature in the water to be fairly cold all year round. This eliminates pretty much any place close-ish to the equator. It also requires water temperature to remain in a tight range all year. In the wild the fish just migrate to different areas of the oceans as temperatures vary. For farming you need the temperature to remain in a steady cold range. This eliminates any location that e.g. freezes over or gets too cold. In the the only locations left are Norway, Scotland, Chile, Kamchatka and eastern Russia, Eastern and Western Canada, Tasmania (a small island south of Australia). Of these Eastern Russia and Eastern Canada have no existing infrastructure or locations in play. Western Canada entered the market but has pretty much reached its limits due to First Nations issues. Scotland has been maxed out for a long time. Chile entered the market strongly but is now running into problems. And Norway is by far the world's biggest producer (Fish is norway's biggest export after oil and gas). And even Norway is now struggling to produce more.
The reason for the problems is that there's a biological limit to how much fish you can farm in a given area before running into evolution fighting back. At some point some form of disease (lice or others) breaks out and spreads rapidly across the entire population and decimates the stocks. Hence smaller groups are strictly controlled and maintained with some distance from each other with no intermingling. Heavy use of antibiotics or other treatments leads to resistances developed that are passed down the generations etc. The Norwegian govt hands out licenses and quotas and very zealously monitors these for fear of future outbreaks. The solution for a long time was to open more areas for salmon farming and slowly increase the quotes. But it's been known for a long-time that we're approaching the limit for what Norway can produce and the recent white paper (a govt study) on this matter effectively shut the door on any major quota increases. Chile, which was the last major location that was viable, entered the market and rapidly increasd share about a 5-10 years ago and has since run into consistent problems with lice and disease and even logistics and has failed to increase production last few years despite best efforts.
Meanwhile due to the collapse of Oil and Copper respectively, Norwegian Krona and Chilean Peso have collapsed leading to a lowering of the cost curve globally and also of salmon price in USD. Salmon is quoted in Norway and prices appear very robust but in USD they are closer to the lows of 2012. Hence demand remains very robust for salmon.
The biggest component for cost (half of total cost) is feed. Feed is constructed from a combination of fish oil and other ingredients. Fish oil is processed from fish caught in the wild. Most of the fish oil is produced from Pelagic fish caught in Peru (mostly) and some other places. Fish oil has recently seen an alternative demand from Omega-3 pills which are increasing in popularity and hence fish oil prices have been trending up over last decade. There is also concern that the recent oncoming El-Nino will depress pelagic catch in Peru and cause a spike in fish oil prices.
Despite the good run over last few years, there are a number of reasons the salmon stocks remain cheap. One is the perpetual fear that the one way or another the hog cycle will hold and somehow, from somewhere, more salmon will come to the market and that this time is not different either. I respect that argument but the data increasingly supports that we've hit the biological limit in existing locations. For more salmon to be farmed, the options are basically onshore salmon (in massive drums), offshore salmon (way off from the shore), or new locations like Eastern Canada or Eastern Russia. All of these options are uncompetitive currently, although I expect a combination of all of these to happen eventually as salmon price keeps going higher. As we exhaust current sources of supply, and demand remains resilient, then prices will trend up to the point that more expensive and alternative sources are put in play.
Another reason stocks have been somewhat depressed is that we just had 2 relatively warm winters in Norway and even though quotas are monitored, there's some natural variation on how much the fish grow and they grow a bit bigger over 3 years if the winters (when they grow the slowest) are warmer than usual. This led to a robust harvest of salmon in May and hence prices were a bit weak as they fell from 42-43 NOK to 35 NOK but they have since recovered. I expect prices to further strengthen from here as prices are already fairly depressed in international currencies and demand should be robust.
And a final reason is the expectation that costs will continue to trend up. Fish oil and hence feed, is priced in USD, and it has gone up in NOK for farmers accordingly. But also fish oil has gone up due to alternative uses. The coming El-Nino has also raised concerns about causing disruption in fish oil feedstock and hence cause a spike in fish oil prices or shortage of fish oil. Since part of the thesis is that supply is limited, I don't expect there to be a pressure on fish oil demand. Any spike from El-Nino has historically been short lived. And we still face the prospect of a potential "veggie fish" although the ultimate effect of that is unpredictable. Fish don't naturally have much Omega-3. They must eat other fish to produce it. Hence the need for fish oil in their feed. But the fish can also be given feed from veggie oils and they taste perfectly fine, they just don't have as much Omega-3. I can attest first hand the two types of salmon are indistinguishable. Since Omega-3 has been such a marketing tool for creating demand, salmon farmers have been so far reluctant to switch to the far cheaper veggie oil based feed. If fish oil prices go beserk, they are likely to switch.
There's another recent that feed costs might actually fall. Marine Harvest is the world's largest salmon farmer. Once it ran out of expansion opportunities due to hitting the biological limit, and refusing to do M&A to grow (not the Fredriksen way, and trading prices for licenses in Norway are nosebleed high as they should be), it decided to grow via investing in vertical integration. Marine Harvest invested heavily in a very large feed facility which is just now coming online and which has significantly added to global feed capacity and which will run at full capacity. The top 3 feed producers Skretting, Ewos and BioMar account for 88% of fish feed and have seen their large customer take significant demand internal. Overall capacity utilization at these facilities will likely fall and could pressure their margins and lower feed prices. Marine Harvest can do a 2nd facility as well in a JV with another Norwegian player (it can't consume all the volume of another facility internally).
Leroy has recently completed some substantial investments over the last bit of increased quotas allowed. It also has improved operations with greater use of cleaner fish so it doesn't have to halt operations as often for medical treatments. This will lead to improved costs over next few years. Keep in mind, these effects aren't major relative to items like feed costs or costs of medicine. Leroy also steadily improved the revenues generated from Value added Processing to almost 11 NOK per kg and it's still slightly trending up. Leroy will likely maintain the 30 NOK per kg in added revenue generated (on top of raw fish prices) for Sales and Processing. The operating costs have jumped up recently as fish oil prices in NOK have gone up and also as medicines costs went up slightly. Both of these will likely flatten or decline slightly going forward.
I use a range of 40, 45, 50 for salmon price sensitivity for Bear, Base, Bull scenarios and a range of FCF yield valuations 2 years out as well as EV/EBITDA multiples and averaged them. The bear scenario is close to current trading price so effectively market is pricing in my bear scenarios of 40 NOK and low end of FCF Yield or EV/EBITDA. I think salmon prices are likely to be mid 40s if not higher in 2 years and as the thesis firms up, the valuations will strengthen.
|Volumes (000 tones)||2015||2016||2017|
|Leroy Share Price||281|
|Leroy Shares outstanding||54.247|
|Leroy Market Cap||15243|
|Value added processing||506||605||624||864||1236||1610||1827||1923||2025|
|VAP / kg||4.7||5.2||4.6||5.6||8.5||10.2||11.0||11.3||11.6|
|Sales & Processing||7361||8670||9020||9049||10257||11964||11904||12538||13211|
|Internal sale / elimination||-3617||-4498||-5059||-5187||-6051||-7119||-6810.1||-7318.6||-7857|
|Sales and Processing only (excl eliminations)||3744||4172||3961||3862||4206||4845||5094||5219||5354|
|Sales and Processing only (excl eliminations) / Kg||34.5||35.7||29.0||25.2||29.0||30.6||30.7||30.7||30.7|
|Operating cost / kg||-58.2||-60.6||-56.2||-54.2||-61.7||-67.3||-69.0||-68.0||-67.0|
|Effective tax rate||26.0%||26.3%||29.2%||27.1%||24.0%||23.0%||25.9%||25.9%||25.9%|
|Change in WC||-150||-150||-150|
|Free Cash Flows||1012||1489||1986|
|Free Cash Flow Yield||6.6%||9.8%||13.0%|
|FCF Yield||Salmon Price||2017 FCFs||Valuation||+2YR FCFs||Per share|
|Leroy target share price in 2 years||Bull||6.0%||50||2633||43883||5005||901|
|Alternatively||Multiple||Salmon Price||2017 EBITDA||EV||ND 2017||Eqtuiy||Per share|
|Average Target Price||Buill||887|
Excluding Leroy, Austevoll's main assets including fishing assets in Peru. It controls 7% of the anchovies quota in Peru. The company also has onshore fishmeal and fish oil production facilities. Austevoll also has 9% of the jack mackerel market in Chile and canning and frozen fish processing facilities. It also owns 49.9% of Birkeland which is accounted as associated income, which is another salmon farmer in Norway. It also the largest processor of Pelagic fish in North Atlantic via a 50% stakje in Pelagia. All these assets are currently being valued at an implicit value of 1.3b NOK at current trading value of Leroy and for negative value in my base target price for Leroy in 2 years.
The El Nino event in 2H 15 could affect volumes in Peru, which is likely the reason Austevoll has underperformed Leroy recently. These assets are priced even cheaper today. Once quotas normalize, and forecasting a normalized earnings / EBITDA going forward. Most of the inflection in EBITDA of consolidated assets is the increased in EBITDA from Austral in Peru as volumes from quotas normalize. At the moment this business has fallen to almost breakeven levels due to under-utilization and significant fixed costs, while it generated closer to 300m NOK EBITDA couple of years ago.
|Revenue of Austevoll ex-Leroy (fully owned)||3851||3857||2852||2530||1840||1646|
|EBITDA of Austevoll ex-Leroy||768||637||526||536||442||355||409||525||650|
|EBITDA margins of Austevoll ex-Leroy (fully owned)||19.9%||16.5%||18.4%||21.2%||24.0%||21.6%|
|Equity accounted associated assets income||80||192||46||29||194||217||210||265||276|
|Attributable to Austevoll (50% stake in Birkeland and Pelagia)||50%||40||96||23||15||97||109||105||133||138|
|Valuation of Equity accounted assets on earnings multiple||Multiple||2017 Earnings||Valuation|
|Valuation of fully owned assets Austvoll ex-Leroy||Multiple||2017 EBITDA||Valuation|
|Total Valuation of Austevoll ex-Leroy||Bull||6856|
Austevoll is cheap. So is Leroy. I suppose buying just Leroy is the cleaner thesis to the trade and provides significant upside and will obviously have no "holding company discount". I am recommending Austevoll since the non-Leroy assets are currently being valued implicitly at 1.3b NOK and I believe they are worth significantly more than that and the earnings power of those assets will become clearer. Also Leroy will likely keep increasing dividends closer to earniings/FCF levels so any holding company discount will further shrink/disappear. Plus Austevoll has added catalyst of being able to divest some/any assets to realize some of the discount gap. Plus Austevoll is naturally hedged against some of the bear thesis around fish oil prices spiking as it has significant upstream operations.
I believe both Leroy and Austevoll are excellent investments on my base case I see about 100% upside in Leroy in 2 years and 150% upside in Austevoll in 2 years.
|Austevoll SOTP||Target in 2 years|
|Leroy share price||281||901||557||320|
|Austevoll shares (m)||34.1||34.1||34.1||34.1|
|Current Net Debt at Austevoll (ex debt of Leroy)||-2263||-2263||-2263|
|Net Debt at end of 2017|
|Equity value of Austevoll||35324||22008||12338|
|Value per share||174.3||108.6||60.9|
|Current share price||43.2||43.2||43.2|
|Upside to current share price||303%||151%||41%|
|Subject||Question about farming margins and costs|
|Entry||08/03/2015 03:10 AM|
Thanks for a good write-up. I've been following this sector for some time, also Austevoll which I wrote up (long) on Sumzero in 2011 (turned out well).
I tend to agree with you on several points, especially w/ regard to the demand side. I think it will be more stable and stronger than it has been in the past. The development of new salmon products will increase consumption. I think this is an important and lasting change in the way salmon is being consumed. Chinese and brazilian demand looks weaker than it has done over the last few years, but I don't expect a huge impact from this. So basically I think 40 NOK/kg sounds reasonable as an estimate for 2015 and 2016 salmon prices on average.
On the supply side of things, I agree with you that new supply will most likely be limited over the next few years. I do however, worry more about chilean production over the longer term. They could get their act together and bring quite a bit on stream given time. In which case the market may be surprised. But that's not my main concern - it takes a long time to bring new supply of any consequence to market, and biolgy may very well supress chilean production as it has in the past.
I think your assumptions w/ regard to cost inflation are a bit too optimistic though. The reasons are feed costs (which you talk about) and increasing biolgical costs.
Since 2000, cost pr kg is up over 50% (from 19 NOK/kg to something like 31 NOK pr kg i 2015). Feed cost is now almost 50% of this. while Austevoll would also benefit from higher fish meal / fish oil prices, the sector in general will not be protected from the cost inflation (and Lerøy won't either). With the strengthening of the dollar vs the nok, rising fish meal/oil prices could rise even more. (I don't usually have strong macro views, but the US near a beginning of a tightening cycle and Norway near another rate cut or two as oil prices drop, a further dollar strengthening is likely IMO). It is certainly a risk that should be considered. I'm not sure I would be so confident that feed prices will fall because of the new feed capacity from MHG etc. I would certainly want to see that materialize to some degree before assuming that.There's also the issue of biological costs rising. Because even as salmon prices now benefit from Chile having biological issues and high costs which reduces supply, we are seeing cost pressures rising in Norway too with more biological problems. This could also eat into farming margins.
With oil prices falling and oil investments coming down, there's also the possibility of more farming licenses being issued ("what are we supposed to make money on when we can't make money on oil?" is the question being asked in norwegian newspapers these days. Many talk about fish farming as a continued growth industry).
If I'm right and cost stay > 31 NOK pr kg, then farming margins will be about (40-31) = 9 NOK/kg, which is still very good and much stronger than the historical average, but lower than consensus implies (about 11-12 NOK/kg for the next couple of years). Which makes it likely that the market is being too optimistic currently.
Of course, I may be wrong. But in any case: I think you should at least consider a bear scenario more in line with historical farming margin averages. I guess where we mainly differ is that I think the range of outcomes is wider than you think. Over the last five years leading up to the stellar 2014, farming EBIT margins were about 7 NOK on average - markedly lower than today's long term consensus. Go further back, and they're even lower.
I personally don't see any margin of safety in fish farrming stocks these days and will wait for a better entry - which may never come :)) But if it does Austevoll will probably be one of the stocks I buy along with Salmar, Bakkafrost and MHG. I know it sounds ridiculous now with the stock at 101 NOK, but I wouldn't buy MHG above 60...
Anyway. Just my 2c.
|Subject||Re: Question about farming margins and costs|
|Entry||08/03/2015 06:43 AM|
(I should note that feed prices are now down over 25% in dollar terms from the peak -in my comments above it seems like I'm saying they have been rising in a straight line - they have not). So my point is that I worry about them rising again AND the impact of a stronger dollar simultaneously.
|Subject||Re: Re: Re: Question about farming margins and costs|
|Entry||08/03/2015 10:03 AM|
Ha ha. You never know...
|Subject||Note by Nordea june 16th|
|Entry||08/04/2015 09:13 AM|
Came across an interesting sector update by Nordea today (with a bearish bias) dated june 16th.
The analyst (K. Giskeoedegaard) lists a few reasons why consensus is too high for 2015 and why he believes EBIT/kg will come down to 8-10 pr kg:
1. Increasing Chile supply from 2016 (H1), as the smolt release in H2 2014 was very high. Consensus is ignoring this risk.
2. Also says El Nino is very likely and could have very dramatic effects, and refers to the 97-98 El Nino which halted fisheries for 2 seasons and led to increasing oil and meal prices on the order of 60-70%.
3. Increased use of larger post-smolt "could increase production from existing norwegian licenses by 25-50% as it shortens the on-growing phase in the sea and increases the turnover of the biomass." He says he expects this to mean 5% supply growth on a global basis from post smolt alone. Pretty significant if he's right.
4. Signs of dropping demand over the last 4 quarters bc of dropping demand from price-sensitive buyers in HoReCa and soft Russian markets.
Anyway, I don't know if he's right or not but thought you might find this interesting.
|Subject||Re: Note by Nordea june 16th|
|Entry||08/04/2015 09:22 AM|
I should also say for the record that this guy was wildly bullish on salmon stocks for years, so it's not some guy who's been wrong all along and unable to change his mind talking here.
|Subject||Re: Re: Note by Nordea june 16th|
|Entry||08/06/2015 02:57 AM|
Hi Biffins. Thanks for your detailed answers, this is very helpful.
|Subject||Lice problem declining|
|Entry||08/07/2015 04:33 AM|
Article out today saying 2015 will be a record low year in terms of lice issues. Which is good news for the rapidly rising costs over the past few years w/ reg to tackling the problem.
Low lice levels also allow for greater biomass growth. The deadline to apply for 5% growth is in September.
|Subject||Re: Nordea upgrade|
|Entry||10/06/2015 01:08 AM|
Good call Mr Biffins. I stand corrected (so far anyway).