Bega Cheese: Where to from here?

About the author:

Author name:

By Belinda Moore

Job title:

Senior Analyst

Date posted:

29 August 2022, 7:30 AM

Sectors Covered:

Agriculture, Food & Beverage, Travel and Chemicals

• Bega Cheese's (ASX:BGA) FY22 result was in line with guidance. Earnings growth reflected the Lion Dairy & Drinks (LD&D) acquisition. Operating cashflow was the highlight.
• Its weak FY23 guidance (overpaying for milk) was reiterated. Our NPAT forecasts have increased materially due to lower D&A post finalising acquisition accounting.
• We continue to be concerned about the industry structure and the continual need to pay the farmers a higher milk price at the expense of shareholder returns. For the company to rerate, this needs to change. We maintain a Hold rating with a new price target of (login to view).

FY22 result was in line with guidance

FY22 sales rose approx. 46.1%, underlying EBITDA increased 27.1% to A$180.1m (guidance was A$175-190m) and NPAT was up 16.9% to A$46.3m. The final dividend was 5.5cps, ff.

LD&D acquisition delivers the growth; COVID/inflationary costs are material

BGA’s EBITDA was up materially on the pcp given it included LD&D and the associated synergy benefits. However, its EBITDA margin was weak at 6.0% (6.9% in FY21), reflecting approx.

A$50m of COVID costs, supply chain disruption from the floods, rising input costs due to inflation and the China lockdowns. NPAT growth was materially lower than EBITDA growth due to increased D&A and interest expense. However the tax rate was lower than expected at 27.7% (34.1% in FY21).

The strong uplift from in the Branded result reflected the addition of LD&D and price rises, with revenue +63.2% and EBITDA +37.2%. EBITDA margin was weak at only 5.4% given LD&D is a lower margin business and it incurred rising input cost pressures.

Branded sales are now over 82% of group sales (1H22 was 83% and FY21 was 73%). Bulk sales fell 16.8% and EBITDA was -3.5% on the pcp due to lower milk supply, additional COVID and supply chain related costs and lower nutritional sales. However, the Bulk EBITDA margin improved to 8.3% from 7.8% due to product mix (lactoferrin).

Operating cashflow was strong at A$158.2m vs A$111.4m in the pcp, assisted by an inflow of A$41.6m from the termination of the Reckitt contract and other one-off benefits. Cashflow conversion in FY23 is expected to fall vs FY22.

Gearing was also better than expected with ND/EBITDA at 1.5x. Based on our forecasts, gearing will likely rise in FY23. However, BGA is trying to sell its Port of Melbourne property (sale and leaseback), which if achieved, would strengthen its balance sheet.

FY23 guidance is reiterated

BGA reiterated its FY23 EBITDA guidance of A$160m-190m which at the midpoint is 2.8% below FY22 EBITDA (which was affected by a number of issues). FY23 is impacted by BGA paying materially more for milk supply (its key COGS).

Due to fierce competition among dairy processors for milk supply (the worst we have seen), BGA has increased it farmgate milk price (key COGS) three times since its opening offer.

Its FY23 southern farmgate milk price is ~A$9.55/kgms (FY22 was ~A$7.40/kgms). Given some processors are paying a higher farmgate milk price than BGA, further increases in FY23 can’t be ruled out.

While BGA is looking to recover the increased costs by pushing through higher prices (with a lag impact) in both the retail and food service channels, they won’t be anywhere near the quantum of the increase in its FY23 milk procurement cost.

We materially upgrade our NPAT forecasts for lower D&A

We have left our FY23/24/25 EBITDA forecasts unchanged. Our FY23 EBITDA forecast of A$175m is at the midpoint of BGA’s guidance.

However, post BGA finalising its acquisition accounting, reduced D&A has seen our FY23/24/25 NPAT forecasts increase 20.8%/12.2%/9.6%.

Investment view – Hold rating

Following forecast changes (lower D&A and net debt) our blended valuation has increased to (login to view) previously.

Until Australian processing capacity rationalises further or the Australian milk pool materially grows, the competitive environment will likely remain fierce and dairy processors will overpay for milk. This means that BGA will not generate an acceptable return and the dairy farmers will win out at the expense of shareholders.

For this reason, BGA deserves to trade at a material discount to its FMCG peers.

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