Nufarm shares shoot up on China bid

Nufarm – the Australian herbicide maker that grew out of former New Zealand fertiliser group Fernz Corp – was last week handed a “get out of jail” card.

It needed it badly.

Nufarm’s benefactor was China’s Sinochem, which is considering a takeover. Nothing new there since it is the latest in a string of approaches by state-owned Chinese entities for Australian firms.

What marked this approach out is that it came as Nufarm management warned that profits would be 10-15% below its earlier guidance of July-full year profit of $A187 million.

Profit warnings are never happy affairs for management nor shareholders, but this one – the second in as many months – was about as bad as it gets.

Profit picking off

In May Nufarm reaffirmed its July year guidance of $A220 million as it launched an $A300 million institutional capital raising, a share purchase plan and a secondary offering of a portion of managing director Doug Rathbone’s shares.

A month later it was forced to extend the capital raising for a week as it warned it would deliver just $A187 million for the July year.

Then it capped all of this with last week’s earnings downgrades, in stark contrast to the traditional practice for companies under takeover offer to suddenly find they had low-balled profit guidance.

Certainly sales of its key herbicide glyphosate – generic Roundup to you and me –in May and the first half of June are tracking significantly below budget in North America and Australia.

This comes thanks to a combination of later-than-normal buying decisions, seasonal effects and lower application rates and a late planting season in North America. (A late plant US corn crop will tend to grow quickly and crowd out weeds, which means less glyphosate sprays).

Finally, distributors, in an effort to minimise working capital have also run down inventories in an attempt to reduce working capital and their reliance on banks.
US chemical firm Monsanto and Canada’s Agrium had also warned on profits in May, reflecting similar trends.

However, two poor forecasts in the space of two months is at the very least bad form, especially during a capital raising when institutions are right to expect conservatism from management.

If it were not for the prospect of the takeover Nufarm’s shares would have slumped. Instead they surged 24% and are now trading north of $A11.
It is, however, worth asking where the shares would have been had Nufarm’s profit forecasts been a little more accurate?

Bid estimates

Shareholders, who include this country’s wealthy Goodfellow family, are now turning their attention to a potential takeout price and indications are that it could be north of the present value.

In late 2007 a consortium led by ChemChina and two private equity firms bid the equivalent of 17.55Ac a share. This represented a 25% premium to three-month average share price and was recommended by the NUF board. However, it failed to get traction because of the credit crisis.

Applying a similar premium to the average share price of the last three months would imply a takeout of around $A14.00 share price.

Nufarm would represent an attractive bolt-on acquisition for Sinochem, expanding its global presence and helping to secure critical supplies for China, now the world’s largest and fastest growing consumer of grains.

Its agricultural operations include the largest fertiliser supplier and distributor in China and one of the strongest pesticide and herbicide distributors.

It also has interests in oil and gas, financial services and property and has global sales amounting to US$45 billion. Included in is stable are three listed companies: Sinochem International, SinoFert and Franshion Properties.

A good buy

Sinochem may also get the business at a trough in earnings.

As confidence returns, the current practice of de-stocking will run its course. Distributors will in turn be forced to re-build inventory, while farmers will resume spending on farms inputs as grain prices recover along with the recovery in other commodity markets.

These are exactly the trends that have driven surges in other commodity markets and are ones becoming evident in other agricultural commodities such as fertiliser.
Shares in Aussie fertiliser giant Incitec Pivot, for example, surged 16% in the last week alone as its global peers Mosaic and Potash presented upbeat assessments of their prospects.

Nufarm shareholders will be hoping such developments will generate a get out of jail card for them as well.

Richard Inder is an investment adviser at Macquarie Private Wealth. His disclosure statement is free and is available on request. Clients may hold shares in the firms mentioned. Comments, think differently? Write to richard.inder@macquarie.com