Inghams Group (ING.ASX)
In an investment world that seemingly cares little about cash flow generation and debt, Inghams came across our radar as a business that generates great FCF, continues to reduce debt and operating leverage as well as sits in a reasonably defensive industry with good tailwinds. For those of you less familiar with the business, Inghams is one of the largest producers and suppliers of poultry and feed in the country. They count chains like McDonalds and KFC as customers as well as supermarkets like Woolworths. Going to the tailwinds, chicken meat consumption and demand continues to grow at a reasonable pace over red meat as the market continues to be more health conscious.As can be imagined, the business was in the front lines during the Covid-related sell-off and, although the recovery has taken place, the market continues to significantly discount the business based on the prospects of continued lockdowns. Especially given a significant portion of her revenues come from the food service and QSRs (Quick Service Restaurants). However, management has been gaining momentum in inventory reductions and further streamlining of the business.
Author: Sid Ruttala
In terms of catalysts for the future, the business is focusing on specific niches including the premium market as well as private label product innovation. ING’s divestment of non-core assets, most recently its dairy feed supply business, is a good move in our opinion. The most important metric in our view are the margins, which have continued to increase with gross margins at 23.4% (compared to 19.6% in 2020). With that, let’s get to the numbers.
Revenue was up 5.5% to $2.3bn, EBITDA up 15.8% to $208m, NPAT up 26.9% to $100m AUD (this takes into account the change in accounting regulations, i.e. pre-AASB 16). Arriving at the juicy and all important part, cash flow conversion continues to be a stellar 102%. What is also pleasing to see is the 3-9 month forward cover when it comes to feed, with the likely continued volatility in both soy and wheat prices as well as the recent gyrations of the AUD.
So, why does it make sense?
Firstly, management has continued to maintain discipline in its balance sheet management. This business has deleveraged to around 1.2x from 1.8x and, with the business churning out great cash flows, we should continue to see reasonable dividends and dividend growth in future. ING’s agreement with WOW looks set to be renewed though we would like to see the finer details before making further comment.
Returning to our thesis around inflation, Inghams could also be seen as a hedge given its strategy to optimise the core and cost-outs (i.e. higher margins).
Red Flags & Risks: The biggest risk continues to be further disruption as a result of Covid, not only to the domestic market but also broader supply chain and export markets. Higher feed costs and biosecurity issues could potentially have disproportionate long-term impacts.
Dividend Yield: At current prices, ~4% with expectations of high single digit growth on an annualised basis.
Monadelphous Group (MND.ASX)
For those of you that have been tuning in recently, it may be obvious that we’re onto a thematic here. That is, businesses and industries in defensive sectors and/or those that are likely to be solid inflation hedges. Having acknowledged that, let’s get to another business that should see substantial tailwinds despite what the recent price action in the spot market may suggest. To summarise MND very quickly, they operate across two verticals: engineering construction and maintenance/industrial services within the resources and energy sectors. Yes, the business has started to diversify revenue streams into water, power and marine infrastructure to deal with the cyclical nature of the mining industry but as it currently stands over 73% of revenues are tied to the fortunes of the iron ore industry.
This is one business that has never quite recovered from the Covid related sell off – not yet recovering to the $16+ mark it was trading at in February 2020 – despite the recovery in spot prices and we feel that the market has overlooked the potential for continued growth. Before proceeding further a disclaimer that, despite the sell-off in ore prices from a peak of $222 USD/T to $156 USD/T at the time of writing, we remain long-term bulls when it comes to the price given the infrastructure pipeline globally as governments continue to spend in order to resuscitate nascent aggregate demand. It must also be remembered that even at these prices, it still remains a viable proposition for businesses to place additional capex (which is arguably what matters for MND). If anything, the tight labor market and wage inflation across the resources sector broadly is an indication that the sector continues to expand. Combined with our thesis around an oil price recovery to approximately $80 USD/barrel given supply constraints in US shale production, we believe that any turbulence in MND’s revenue streams should be compensated by continued recovery in the business’ energy sector exposure.
Before proceeding further, the numbers. Revenue up 18% to $1.953bn. Of this, the outperformer (as one could guess) was the engineering and construction division with a stellar 51% increase on pcp. Basis. EBITDA was up 18% to $108m and the all important NPAT was up 29% to $47.1m AUD. Of concern was the decline in maintenance and industrial services revenue by 7%. Nevertheless, going forward the company has secured a pipeline of $470m in renewals and extensions as well as a significant $100m in new contracts in oil and gas. As that particular market recovers we should see momentum building.
So, why does it make sense?
Despite the jitters caused by the sell-off in ore prices, it must be remembered that the business is not as directly impacted given the contracted nature of the revenues and, with a continued recovery in crude, we should see substantial tailwinds feed on through for the business. MND continues to be pleasingly disciplined and targeted in securing new contracts. Should we be correct in our prediction of a secular bull cycle in commodities broadly, the business should continue to benefit substantially while not being as exposed to the gyrations of the spot markets (in terms of revenue streams).
Red Flags & Risks: The biggest risks for the company are centred in project delays and continued volatility in commodity prices. The business also operates in a rather competitive backdrop and investors have to pay particular attention to contract growth and retention.
Dividend Yield: 4.3%
