Anthony Clark: Hatching poultry deals

Quantum and Astral are not now market favourites, but could form a future business opportunity

Ihave covered poultry stock Astral Foods since its unbundling from Tiger Brands in 2001, and also Quantum Foods, the specialist animal nutrition and egg business, since 2014, when it was unbundled from Pioneer Foods. At the time of writing their market capitalisations were R8.9bn and R884m respectively — Quantum is about a tenth of Astral’s size.

By the time this magazine is on the shelf, Astral Foods will have published clucking good results. Its trading update has indicated that headline earnings per share would rise by between 90% to 100%.

Towards the end of November Quantum Foods’ results will be published. In its recent trading update it said its forecast yearon-year headline earnings rise was a cracking 224% to 244%.

This places Astral Foods on a prospective average earnings multiple of 5.6 and Quantum on 2.6. Both of them are prodigious cash generators, have an aversion to debt and are expected to pay fat dividends.

But the market gives them a low rating. From their 2018 share price highs, Astral has fallen 38% and Quantum 22%. This hardly seems logical; but is there more at play? The answer is a resounding yes, which is why I’ve been cautious on both stocks since July.

Much of Astral’s and Quantum’s surge in 2018 earnings has been from judicious and well-timed management of both company’s main input cost, maize — which is a key cost in rearing hens for meat and egg laying. Both stocks benefited from the bumper maize harvest of 2017 and the subsequent collapse in the maize price.

Astral, which buys more than 800,000t of maize a year, hedged most of its 2018 procurement at excellent, low prices. Similarly, Quantum, mostly a coastal operator, hedged much of its needs and benefited from some low-cost imports of maize. That maize cost benefit, with some excellent operational leverage, led to the bumper earnings that both Astral and Quantum expect to report in late-November. But tougher times are ahead; the maize price has increased by more than 30%.

This is the reason why the market has de-rated the earnings multiples of both stocks. Also, consumers, especially those in the lower income brackets, can’t deal with the price rises needed to sustain profits from higher input costs. So one expects the companies to succumb to margin pressure and record lower volumes, or do both. These factors harm earnings prospects.

Another matter at play is that in the egg market Quantum, which is a leading player through its Nulaid brand, experienced price surges in the past year due to avian flu causing a shortage of eggs. As flocks have been repopulated and eggs hit the market again, prices have fallen, leading to a margin decline.

Egg profitability has been the main driver to Quantum in 2018. This will sharply reverse in 2019.

So both counters have challenges ahead in 2019. But both also hold potential, and I see a combination of them as an eventual business opportunity. They have experience in poultry and various parts of the value chain. Further, both counters have excellent, profitable but fairly noncompeting animal nutritional businesses.

Quantum has an expanding network of egg businesses in Africa which would augment the (to date) patchy performance of Astral’s small interests in poultry on the continent. Add in Quantum’s business to Astral and there are cost synergies, crossmarketing benefits, access to new products and markets, and a management infusion.

Any deal would be dependent on Zeder, Quantum’s largest shareholder, tipping a wink, though its Quantum stake is small change in Zeder’s bigger portfolio. I’m not saying it’s going to happen, but an Astral-and-Quantum permutation — at current ratings and valuations — looks appealing. The market might well “flock” to the idea.

As flocks have been re-populated and eggs hit the market again, prices have fallen, leading to a margin decline