why is Tassal so cheap? what am I missing?, page-4

My bullish sentiment is well documented - salmon margin growth, salmon volume growth, salmon export prices having bottomed in 1H21, prawn volume growth, CAPEX reducing, and FCF increasing. Sum that up and you see 1) in the short term we should revert back to our pre-Covid mean, 2) in the medium term hoping that we see some growth driven by prawns, and 3) in long term we should have some decent shareholder returns from the FCF. Really, three separate timeframes and investment thesis rolled into one stock.

But what's worthwhile delving in to is the bear argument. They're important to know, even if you think they are outweighed by the bull arguments.

1. Debt levels. I think this is valid that high levels of debt creates risk to a company. Essentially, they maxed their borrowings for the prawn growth, and if maintenance and growth CAPEX continue to be high, there could even be the risk of more capital raisings. Note that Tassals already did approach the capital markets - debt and capital raisings, so shareholders from pre-2019 have definitely been diluted.

2. Absence of FCF. This is a bit more tricky because it depends on where you draw the lines. Though essentially, all operating FCF has been eaten by investing FCF. If you zoom out only the past 2-3 years, it's been hugely negative, around $130m in total. But if you exclude the prawn costs and zoom back a decade of salmon only, you see that once the CAPEX is expended the FCF is positive. Still, future FCF is unknown and a large chunk needs to be allocated to paying back the aforementioned debt.



3. Low ROE and ROIC. This has been declining from around 11-12% to as low as 8% in FY20. And indeed even management incentives have been reduced to match current levels of ROE. Is this because of more competition? Poor capital allocation decisions by management (e.g. De Costi acquisition)? Lower actual returns than expected on investment decisions? There are some valid points here, and if ROIC doesn't go back above 10% then a long term shareholder should worry. With CAPEX reducing and future earnings from prawns increasing, one should see this bounce at least some way.

4. Lack of insider holding. Management and management incentives aren't necessarily well aligned with shareholder value. The reality is that management short-term and long-term incentives are a relatively low bar, and that salaries are a much greater portion of take home pay than performance payments. Conversely, look back at shareholder return since IPO in 2004, and if you include dividends being reinvested, you get something like 10-11% CAGR which about matches their ROE, and I reckon is pretty decent of management.

5. Operational challenges. This is the sort of 'tip of the iceberg' thinking of prawns aren't going to grow, salmon is a commodity, etc. There are always going to be operational challenges, and even as recent as FY20 they pushed back their prawn growth strategy due to financing availability. I reckon this is really hard to judge. Typically TGR beats market expectations on this front, but that's been in salmon and not prawns.

6. Marketing and distribution challenges. One could argue that people simply won't eat 20,000t of black tiger prawns, and there isn't a market for it. Distributing that much is going to eat into margins to compete with low cost Asian imports. They're going to have to grow the market along with their production, and even if they succeed it could be costly.

7. Environmental, Social and Governance (ESG) concerns. In particular, that salmon production in the clean cold waters of Tasmania is fraught with dangers, and should be abolished. That salmon aquaculture is a blight on the landscape, and the political parties of Tasmania are in cahoots with the business sector. A change in politics could change the licensing arrangements, or that consumers may turn away from it.

8. Salmon production methods. Perhaps linked to #5 and #7, that salmon farming may shift to on-land or pens in the ocean. And I suppose that linked to this argument, one would also need to believe that Tassal's can't or doesn't adapt, or that there are significant sunk costs in adapting to alternative production methods.

I won't counter each of these arguments, except to say, I maintain my sentiment as a 'buy' in the short, medium and long term.