For anyone interested, I've dug a little deeper into my thesis that the recent wonderful performance of FRM is largely attributable to current low grain feed prices. Yes, I fully accept that management have done a wonderful job repairing the balance sheet, and that they have demonstrated prudence etc. Be that as it may, I believe they have benefited from what is likely to be temporary beneficial pricing of their key input, and that if (when) this tide turns, they will have to perform miracles to prevent a severe reversal in profitability.
To start, below I am listing their recent revenue and cost performance:
|
Column 1 |
Column 2 |
Column 3 |
Column 4 |
Column 5 |
Column 6 |
Column 7 |
| 1 |
FY
|
A
sales rev
($m)
|
B
sales costs [#]
($m)
|
C
flock addition costs [@]
($m)
|
D
normal indirect costs
($m)
|
(A-B-C-D)
implied EBITD [&]
($m)
|
|
| 2 |
2009 |
95.48 |
65.20 |
10.18 |
17.76 |
2.33 |
|
| 3 |
2010 |
95.79 |
64.60 |
8.86 |
17.56 |
4.78 |
|
| 4 |
2011 |
91.67 |
58.54 |
10.58 |
18.36 |
4.19 |
|
| 5 |
2012 |
93.44 |
60.50 |
9.71 |
19.35 |
3.87 |
|
| 6 |
2013 |
100.98 |
67.34
|
8.96 |
20.06 |
4.62 |
|
| 7 |
2014 |
96.42 |
59.87 |
10.24 |
19.30 |
7.01 |
|
| 8 |
2015 |
91.20 |
50.37 |
9.69 |
18.85 |
12.29 |
|
| 9 |
2016 |
93.62 |
50.54 |
10.03 |
17.75 |
15.30 |
|
[#]: I am here subtracting the flock amortisation charge, which I firmly believe is charged to cost of sales. Some have expressed reservations about this. I am willing to expand on my rationale if anyone desires.
[@]: These are the flock "additions", which I firmly believe are real cash charges. Once again, I can provide my rationale if anyone desires.
[&]: This is equal to EBITDA, but I thought I would leave out the "A", less it be confused with the flock amortisation charges. There are no amortisation charges, apart from the flock amortisation. So if we accept that that "flock additions" are a real cash expense which comes of the op cashflow line (which I'm pretty certain they are), then this number will compare well with the operating cashflows (once adjustments are made for changes in provisions & working capital).
It is fairly clear that whilst some gains have been made in reducing indirect costs in the last four years, the big gains have come from reductions in sales costs, especially in the last 2 years.
It is more instructive if we repeat the same exercise, this time with the numbers as a ratio of the sales revenue. This is given below:
|
Column 1 |
Column 2 |
Column 3 |
Column 4 |
Column 5 |
| 1 |
FY
|
sales cost
margin
[#]
|
flock addition cost
margin
|
normal indirect cost
margin
|
implied EBITD
margin
|
| 2 |
2009 |
68% |
11% |
19% |
2% |
| 3 |
2010 |
67% |
9% |
18% |
5% |
| 4 |
2011 |
64% |
12% |
20% |
5% |
| 5 |
2012 |
65% |
10% |
21% |
4% |
| 6 |
2013 |
67% |
9% |
20% |
5% |
| 7 |
2014 |
62% |
11% |
20% |
7% |
| 8 |
2015 |
55% |
11% |
21% |
13% |
| 9 |
2016 |
54% |
11% |
19% |
16% |
[#]: The same as 1-GM.
There can be no question, from these numbers, that the heavy lifting in cost reduction, raising the operating margin in the last two FY's, has come from the direct costs of sales (after subtracting the flock replacement costs). Prior to FY 2013, these costs were running at about 65% of revenues (ie, the gross margin was running at about 35%). If the GM in FY's 2015 and 2016 had been at those levels, then the resulting EBITD margins, instead of being respectively 13% and 16%, would have been more like 3% and 5% (!). If the GM ere to revert to those levels, then that would be quite a crunch to earnings, and in fact would leave very little to cover depreciation (or maintenance capex, if you prefer). Thankfully, the business is now net cash, so it won't have an interest bill to contend with.
It is further instructive to compare the direct costs (again, after subtracting flock amortisation) against the number of birds owned:
|
Column 1 |
Column 2 |
Column 3 |
Column 4 |
Column 5 |
| 1 |
FY
|
average no. of birds owned
(m)
|
sales costs
($m)
|
sales costs per bird
per year
($)
|
sales costs per bird
per week
(c)
|
| 2 |
2009 |
1.537 |
65.20 |
42.4 |
82 |
| 3 |
2010 |
1.529 |
64.60 |
41.3 |
79 |
| 4 |
2011 |
1.362 |
58.54 |
40.5 |
78 |
| 5 |
2012 |
1.402 |
60.50 |
43.8 |
84 |
| 6 |
2013 |
1.246 |
67.34 |
50.9 |
98 |
| 7 |
2014 |
1.249 |
59.87 |
48.0 |
92 |
| 8 |
2015 |
1.293 |
50.37 |
39.6 |
76 |
| 9 |
2016 |
1.493 |
50.54 |
36.3
|
70 |
So clearly, the huge gains in the last two FY's have been that the birds have only required a direct expense each, of substantially below 80c per week. Now I'm no chicken expert, but a quick sniff around the internet indicates that the bulk of this costs will be in the feed. And frankly, when you are getting close to 5 eggs per bird, per week, (below 16c per egg), it does not seem unreasonable to me. So as commendably as management have reduced costs and repaired their balance sheet, I doubt they have much control over grain feed prices. So short of starving their birds (which probably won't be good for egg production), I am doubtful that a sustainable cost advantage, here, can be relied on going forward.
I would struggle to believe that FRM can obtain substantially more competitive pricing on feed grain, than anyone else (so yes, unfortunately, it is not a price maker on its key input, and nor is it with its product).
And another quick look on the internet indicates that grain feed is currently in global oversupply (thanks largely to a slow down in Chinese imports). See her for example:
http://www.weeklytimesnow.com.au/ag...y/news-story/fdfadbc1eaaf1b9a42c824a4bb39ed0d
https://www.rabobank.com.au/-/media/rabobank-au/files/pdf/agribusiness monthly/2016/pdf_agri-monthly-outlookau-2016.pdf?la=en
So I can't help but feel that at some point soon, if not next year then perhaps the year after, FRM's margins are going to get crunched. If this happens, you would have to guess that the share price is likely to be tested (hammered). If this happens (
when it happens?), and if the management continue on their prudent path of repairing the balance sheet, and even better if they win market share, there may be an attractive opportunity to acquire the business at substantially below book value.
So at that point I might be back, but for now it's likely to be
sayonara from me.
(20min delay)