Bega Cheese (BGA) | Challenges remain in 2H20, but conditions likely to improve in FY21
- In a nutshell: Bega (BGA) provided its last update on trading and its FY20 outlook with the release of its 1H20 results. At the time, the company reaffirmed earnings guidance for FY20 of an EBITDA in the range of $95m- $105m. Since then, the company has experienced some improvement in trading conditions. Bega Foods is likely to have been a clear beneficiary from a spike in demand in its grocery lines, although somewhat offset by weaker food-service demand. While dairy earnings are likely to remain under pressure in 2H20, the outlook for FY21 appears brighter. While uncertainty of sales and earnings remain for most companies, Bega’s future earnings profile appears more certain than it has done in the more recent past.
- Dairy outlook set to improve: The Australian dairy industry has been impacted by a prolonged period of challenging conditions. The flow-on impact of a constrained supply of milk, drought conditions in most regions, higher feed costs and higher water costs have presented significant challenges. This has resulted in pressure on industry earnings and operating margins. However, more favourable weather conditions across many dairy regions, has resulted in the “first year-on-year increase in Australia’s milk production in 18 months” (Source: Dairy Australia – Dairy situation and outlook 2020). While Bega’s dairy businesses will continue to experience relatively difficult conditions in 2H20, conditions should improve in FY21. Domestic demand remains robust across most dairy categories. In addition, more favourable weather conditions along with a lower impact from prior pricing strategies (Bega Supply Premium) should boost FY21 earnings. The Koroit Lactoferrin facility’s recent commissioning should also benefit FY21.
- Bega Foods a beneficiary of strong demand amidst COVID-19: We expect Bega Foods to benefit from strong revenue growth across its key products in 2H20. Sales growth in the grocery category started to increase in late February, impacted by customer stock piling given concerns relating to COVID-19. This continued through March and early April. Although the rate of growth is likely to have moderated of late, we expect sales remain at elevated levels. We expect Bega’s 2H20 earnings to benefit from the surge in demand.
- Exports benefiting from strong demand from China and favourable currency: In addition, Bega’s export operations, which currently represent just under one-third of sales, should benefit from the following: 1) demand from China remains robust, particularly in the infant formula market which has been disrupted and challenged sporadically by a changing regulatory environment; and 2) exports should benefit by the depreciation of the Australian dollar versus the US dollar.
- Financial position: Bega’s net debt position remains eleveated. It had net debt of $303.4m as at 1H20, an increase of $16.1m compared with FY19. The debt figure represented a decrease of $164.7m from 1H19, largely due to a trade receivables facility and a return to normal inventory levels following the acquisition of Koroit. The covenants on its debt facilities have increased from a leverage ratio of 3.0x to 3.75x to September 2020. The covenant reduces to 3.5x as at 30 December 2020 and back to 3.0x from March 2021. We have forecast leverage ratios of 3.04 as at FY20, 2.2x as at FY21 and 1.5x as at FY22. This is an aggressive de-gearing which is reliant on a significant rebound in earnings and capital expenditure of 30-$35m over the next two years.
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