Tassal Group. Salmon and seafood growth strategy ADD

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1 Vol m Food & Beverages Australia Equity research September 14, 2015 ADD Current price: Target price: A$3.82 A$4.20 Previous target: A$ Up/downside: 9.9% Reuters: Bloomberg: Market cap: Average daily turnover: TGR.AX TGR AU US$397.4m A$562.3m US$1.64m A$2.22m Current shares o/s 147.2m Free float: 100.0% Price Close Relative to S&P/ASX 200 (RHS) Sep-14 Dec-14 Mar-15 Jun-15 Source: Bloomberg Price performance 1M 3M 12M Absolute (%) Relative (%) Belinda MOORE T (61) E belinda.moore@morgans.com.au Tassal Group Salmon and seafood growth strategy Following the attractively priced De Costi Seafoods acquisition, we think TGR is well positioned to benefit from its salmon and seafood growth strategy. The addressable market is worth A$4.3bn (salmon is A$0.7bn and seafood is A$3.6bn). We re-instate coverage of TGR with an Add recommendation and A$4.20 price target. FY15 result Solid considering We believe TGR reported a solid FY15 result (15% NPAT growth) despite challenging 2H15 market conditions. TGR was a beneficiary of its strategic decision to focus on the less volatile domestic market. The rate of TGR s earnings growth slowed in the 2H15 from the 1H15 due to lower wholesale and export prices. Consequently, margins were down on the pcp. Offsetting the negative impact from lower prices was strong volume growth (+20% on pcp) and prudent cost control despite higher feed prices. Cashflow was weaker reflecting TGR s strategic decision to invest in fish growth (both number and weight). Importantly, this investment should underpin future earnings growth. Salmon and seafood strategy underpins future growth We forecast double digit earnings growth over the next few years underpinned by rising domestic demand, increasing production volumes, efficiency benefits and the De Costi Seafoods acquisition which accelerates TGR s seafood strategy. Wholesale prices are now improving and export prices are also rising. Oversupply due to fish imports should reduce with a lower AUD as salmon products become less profitable to import. We view this acquisition of De Costi Seafoods (paid 5x EBITDA) as strategically important as it provides TGR with a presence on the east coast and allows it to sell a basket of seafood products (not just salmon) to both the retailers and food services sectors. TGR recently won a new contract to supply fresh salmon to Aldi through De Costi Seafoods in Queensland and NSW for a period of 12 months from 1 October We believe there is a significant opportunity to grow De Costi's earnings overtime with TGR's strict financial discipline and the synergies from combining the companies. Synergies will come from the group s broader sales offering, economies of scale, category management and distribution/supply chain. De Costi Seafoods should also improve TGR s cashflow conversion as it converts stock into cash more quickly than the existing salmon business. Re-instate coverage - Add rating and A$4.20 price target Our blended valuation (PE, EV/EBITDA and DCF) for TGR is A$4.20. TGR is trading at a sizeable discount to the agri/food sector (FY16F PE of 13.2x vs 20x) which is unwarranted in our view. We believe TGR is a quality business (market leader and strong brand name) with a clear growth strategy. Strong barriers to entry also exist. It is a beneficiary of healthy eating trends and the growing demand for salmon and seafood. Downside risks include acquisition risk, pricing pressure, diseases, warm water temperatures, predators, higher feed prices and regulatory risks. Financial Summary Jun-14A Jun-15A Jun-16F Jun-17F Jun-18F Revenue (A$m) Operating EBITDA (A$m) Net Profit (A$m) Normalised EPS (A$) Normalised EPS Growth 13.7% 14.6% 22.1% 8.9% 9.7% FD Normalised P/E (x) DPS (A$) Dividend Yield 3.01% 3.66% 4.17% 4.54% 4.98% EV/EBITDA (x) P/FCFE (x) Net Gearing 15.4% 17.6% 32.6% 32.0% 30.0% P/BV (x) ROE 9.3% 9.8% 11.1% 11.6% 11.9% % Change In Normalised EPS Estimates Normalised EPS/consensus EPS (x) IMPORTANT DISCLOSURES REGARDING COMPANIES THAT ARE THE SUBJECT OF THIS REPORT AND AN EXPLANATION OF RECOMMENDATIONS CAN BE FOUND AT THE END OF THIS DOCUMENT. MORGANS FINANCIAL LIMITED (ABN ) AFSL A PARTICIPANT OF ASX GROUP Powered by EFA

2 Tassal Group (TGR) Financial Summary (A$m) Income statement 2014A 2015A FY16F FY17F FY18F Enterprise value (A$m) Divisional sales EV/Sales (x) EBITDA EV/EBITDA (x) Depreciation EV/EBIT (x) EBITA PE (x) Amortisation PEG (x) EBIT Net interest expense At target price 2014A 2015A FY16F FY17F FY18F Pre-tax profit EV/EBITDA (x) Income tax expense PE (pre-goodwill) (x) Minority interests NPAT Per share data 2014A 2015A FY16F FY17F FY18F Significant items No. shares NPAT post abnormals Reported EPS (cps) EPS (normalised) (c) Income statement ratios 2014A 2015A FY16F FY17F FY18F Dividend per share (c) Sales growth -2.1% 16.8% 50.3% 7.7% 6.6% Dividend payout ratio (%) 56% 59% 55% 55% 55% Operating cost growth -4.7% 17.5% 58.7% 7.0% 5.7% Dividend yield (%) EBITDA (incl. Assoc) growth 7.2% 14.3% 23.1% 10.2% 10.1% Franking (%) 50% 50% 50% 50% 50% EBITA growth 9.9% 12.8% 25.5% 10.5% 11.1% EBIT (incl. Assoc) growth 9.9% 12.8% 25.5% 10.5% 11.1% Balance sheet 2014A 2015A FY16F FY17F FY18F NPAT growth 14.7% 14.7% 21.6% 11.1% 11.9% Cash & deposits Normalised EPS growth 13.7% 14.6% 22.1% 8.9% 9.7% Trade debtors EBITDA margin (%) 24.3% 23.8% 19.5% 19.9% 20.6% Inventory EBIT margin (%) 18.3% 17.7% 14.8% 15.2% 15.8% Biological assets Net profit margin (%) 11.7% 11.5% 9.3% 9.6% 10.1% Investments Goodwill Cash flow statement 2014A 2015A FY16F FY17F FY18F Other intangible assets Operating EBITDA Fixed assets Change in working capital Other assets Net interest (pd)/rec Total assets Taxes paid Short-term borrowings Other oper cash items Trade payables Cash flow from ops (1) Long-term borrowings Capex (2) Provisions Disposals/(acquisitions) Other liabilities Other investing cash flow Total liabilities Cash flow from invest (3) Share capital Incr/(decr) in equity Retained earnings Incr/(decr) in debt Reserves Ordinary dividend paid Total equity Preferred dividends (4) Minority interest Other financing cash flow Total shareholders' equity Cash flow from fin (5) Total liabilities & SE Forex and disc ops (6) Inc/(decr) cash ( ) Operating performance 2014A 2015A FY16F FY17F FY18F Equity FCF (1+2+4) Asset turnover (%) 12.5% 13.2% 16.9% 16.1% 16.1% Net debt (A$m) Internal liquidity 2014A 2015A FY16F FY17F FY18F Net debt/equity (%) 15.4% 17.6% 32.6% 32.0% 30.0% Current ratio (x) Net interest/ebit cover (x) Receivables turnover (x) ROIC (%) 12.1% 12.3% 13.0% 13.3% 13.8% Payables turnover (x) ROA (%) 11.7% 12.3% 11.2% 11.5% 12.0% Cashflow conversion 92.1% 72.0% 78.5% 81.0% 81.0% SOURCES: MORGANS, COMPANY REPORTS 2

3 Table 1: TGR - result summary (A$m) FY15 result We believe TGR reported a solid FY15 result (15% NPAT growth) despite the challenging 2H15 market conditions. TGR was a beneficiary of its strategic decision to focus on the less volatile domestic market. The rate of TGR s earnings growth slowed in the 2H15 from the 1H15 due to lower wholesale (A$11.55/kg vs A$13.29/kg) and export prices (A$8.77/kg vs A$10.00/kg). Consequently, margins were down on the pcp. Trading conditions were weaker than expected in the 2H15 due to a soft Easter trading period, the continued prevalence of imported Norwegian products and an oversupply of lower quality fish affected both the wholesale and export price. Importantly, from 1 May 2015, TGR increased its wholesale price by A$1/kg. Offsetting the negative impact from lower prices was strong volume growth and prudent cost control (operating costs/kg fell 5%). In FY15, TGR was more efficient across its entire supply chain growing, processing, logistics and distribution. These efficiencies more than offset higher feed prices. Volume growth for the year was 20% on pcp with the majority of volumes being sold to the domestic retail market (68%) in line with TGR s strategy of growing domestic salmon per capita consumption. During the year, TGR benefited from favourable growing conditions, improved feed conversion and fish survival. Cashflow was weaker reflecting TGR s strategic decision to invest in fish growth (both number and weight). Importantly, this investment will underpin future earnings growth. Result summary 1H14A 2H14A FY14A 1H15A 2H15A FY15A 1H15 vs pcp 2H15 vs 2H14 FY15 vs FY14 Sales % 21.3% 16.8% EBITDA % 11.8% 14.3% margin 24.0% 24.6% 24.3% 25.0% 22.6% 23.8% 4.0% -7.9% -2.1% Depreciation % 19.2% 18.8% EBITA % 9.4% 12.8% Amortisation EBIT % 9.4% 12.8% margin 18.2% 18.5% 18.3% 18.9% 16.6% 17.7% 3.5% -9.8% -3.3% Interest % 3.8% -7.3% PBT % 10.0% 15.1% Tax % 11.9% 15.9% NPAT (ex SGARA) % 9.2% 14.7% EPS % 9.2% 14.7% Dividend % 16.7% 21.7% Operating Cash Flow % 9.7% -15.7% SOURCES: MORGANS, COMPANY REPORTS Normalised (ex SGARA) NPAT of A$35.0m was up 14.7% on the pcp. The final dividend increased to 7cps (50% franked) vs 6cps the pcp. This took the full year dividend to 14cps and equated to a payout ratio of 59%. Volumes rose to 23,144 hog tonnes compared to 19,268 hog tonnes the pcp. This was below TGR s original FY15 guidance for an additional 5,000 tonnes to be sold in FY14. More specifically, retail volumes increased 6.5% (+2.8% 1H15 and +10.3% 2H15) to 15,832t, wholesale volumes were up 46% to 6,426t and export volumes were 886t vs 3t. Wholesale showed a return to growth in that category for the first time in several years. Prices Retail (68% of volume) saw an average price per kg of A$13.68, up on A$13.54 in the pcp, although down on A$13.77 in the 1H15. The average wholesale price of A$12.31/kg was down from A$13.44 in the pcp and A$13.29/kg as at the 1H15. Export prices were also weaker in FY15 at A$9.45/kg vs A$13.33/kg. Sales revenue increased 16.8% to A$304.1m due to stronger wholesale and export volumes. 3

4 EBITDA (ex-sgara and interest income) increased 14.3% to A$72.3m. Due to lower prices, the EBITDA margin fell to 23.8% from 24.3% (25.0% 1H15). EBITDA/hog kg was A$3.12, down from A$3.28 the pcp (A$3.37/hog kg 1H15). Operating cashflow fell 15.7% to A$42.7m as TGR decided to optimise fish performance. Cashflow conversion was 72%, down from 92% the pcp. Capex increased to A$36.7m from A$29.8m and was spent on hatchery expansion, marine and processing infrastructure and a rendering facility. TGR finished the year with statutory net debt of A$65.7m compared to A$52.7m the pcp. Adding the RPF of A$64.5m, net debt was A$130.2m, corresponding to gearing (ND/E) of 34.9% and ND/EBITDA of 1.8x. Biomass (value of live fish) increased to A$222.9m (+18%) from A$188.8m the pcp. Inventory (finished goods stock) rose 12.7% to A$60.2m and reflects TGR s anticipated sales growth over FY16. ROA increased to 12.3% from 11.8%. TGR s target is for this ratio to increase to at least 15% by FY17. FY16 earnings guidance As expected, TGR did not provide formal FY16 earnings guidance however it did say it expects continued growth in earnings. It also made the following outlook comments: FY16 earnings growth will benefit from the De Costi Seafoods acquisition. TGR s focus is to increase domestic salmon and seafood consumption. With new retail contracts, wholesale pricing recovering and operating efficiencies, TGR has a positive outlook on its contribution margin going forward over the medium to longer term. Oversupply due to fish imports should reduce with a lower AUD as salmon products become less profitable to import. Reducing operating costs and agricultural risk also remains a focus. TGR will further optimise its supply chain by utilising the Selective Breeding Program (SBP) to deliver fish growth, lower feed conversion ratios and reduce bathing. Feed prices have fallen since 1 July TGR expects to see the full benefits from its FY15 efficiency projects in FY16. Acquisition of De Costi Seafoods Please note that the acquisition of De Costi Seafoods does not include the business trading at the Sydney Fish Markets or the two retail outlets owned by George Costi at Bondi and Chatswood. Overview of De Costi Seafoods De Costi Seafoods was formed in 1981 and is a seafood procurement, processing and sales and marketing business. Today, it is one of Australia s leading wholesale seafood businesses. Over the years, the business has built an extensive network of seafood suppliers, covering all Australian waters, including co-ops, the fishing sector, farmed fish and prawn companies in addition to a large supply of fresh seafood from abroad (largely New Zealand and the Asia Pacific). De Costi Seafoods offers a vast range of fresh seafood, as well as a large range of premium quality frozen lines. It operates in both retail and wholesale seafood markets, with a large and diverse customer base, ranging from restaurants, franchises, other large seafood distributors and 4

5 Figure 1: Strategic evolution to Seafood supermarkets. De Costi Seafoods operates two main processing sites. Its largest site is located at Lidcombe in Sydney on a 6,000m2 site. It has three main production areas with 1,800 pallet freezer capacity, cool rooms, packing rooms and dry good space to facilitate high volume production and packing for its distribution. The business has approx. 130 employees. Under TGR s ownership, George Costi, the founder and Managing Director of De Costi Seafoods, will remain in charge of the business for a minimum period of three years. George Costi's knowledge and expertise in the seafood industry is well recognised and respected. The acquisition is line with TGR's seafood growth strategy De Costi Seafoods will diversify TGR s earnings and provide it with a wider range of seafood products to sell from only salmon previously. De Costi Seafoods allows TGR to deliver its salmon and seafood growth strategy, which is about maximising domestic market per capita consumption of seafood. This is a big opportunity given the seafood market in Australia is worth about A$4.3bn (salmon is A$0.7bn and seafood is A$3.6bn). There will be significant synergies delivered overtime across the group s broader sales offering, category management and distribution/supply chain (opportunity to take out inefficiencies in the supply chain). The extra volume will deliver processing efficiencies in both Tasmania and NSW. TGR will no longer need to pay away a margin to De Costi Seafoods to process the fish. The acquisition provides TGR with an east coast presence (geographic diversification from Tasmania). TGR said that NSW is the best place to have a processing plant as it can service the entire east coast. There will be freight savings. The acquisition further cements and enhances TGR s trading relationship with existing and new customers. There is a significant opportunity to do more in foodservice. TGR recently announced an extension of its current supply agreement with Woolworths from 1 October 2015 to supply Queensland, NSW, and Western Australia for a further three years. This agreement will see TGR supply fresh salmon directly to Woolworths through De Costi Seafoods for the Queensland and NSW markets. TGR would have previously paid De Costi a processing margin for this work. TGR will supply fresh salmon to Aldi through De Costi Seafoods in Queensland and NSW for a period of 12 months from 1 October This will result in the replacement of imported salmon supply and will boost TGR s retail volumes. SOURCES: MORGANS 5

6 Attractive purchase price with incentives for management to grow the business strongly Base consideration for De Costi Seafoods was A$50m (5x maintainable EBITDA), while the maximum consideration over the three year earn-out period is A$80m. Base consideration was paid in cash (funded via debt) and the earnout will be paid in TGR scrip over a three year period (maximum of 9.2m shares). At the maximum earn-out, TGR will pay an EBITDA multiple of about 5x. TGR noted that the business has been acquired free from all debt and other encumbrances. De Costi Seafoods financials In FY15, De Costi Seafoods generated A$128m of turnover and A$10.2m of EBITDA (8.0% EBITDA margin). TGR views its maintainable EBITDA (excluding synergies) as A$10.0m. We believe there is a significant opportunity to grow De Costi's earnings overtime with TGR's strict financial discipline and the synergies (both revenue and cost/efficiencies) from combining the two companies. EPS accretive in year one; improves cashflow conversion The acquisition was effective 1 July 2015 (contributes 12 months to FY16) and is forecast to be EPS accretive in FY16 (pre-synergies). De Costi Seafoods is expected to contribute A$10m to FY16 EBITDA. De Costi Seafoods should improve TGR's cashflow conversion as it converts stock into cash more quickly than TGR s existing business. It is also materially less capital intensive than TGR s salmon business. 6

7 Table 2: Morgans forecast assumptions Forecast implications Despite weaker wholesale and export salmon prices, in FY16 we forecast operating NPAT to increase 22% to A$42.6m. We forecast double digit earnings growth over the next few years underpinned by rising domestic demand, increasing production volumes, efficiency benefits and the De Costi Seafoods acquisition. With improving supply/demand fundamentals, we forecast the export and wholesale prices to improve from FY17. We have assumed that the acquisition achieves its maximum earn-out. FY08A FY09A FY10A FY11A FY12A FY13A FY14A FY15A FY16F FY17F FY18F Volume (Hog equiv. tonnes) Retail Wholesale Export Total Volume growth Retail 35% 13% 10% 21% 19% 4% 7% 7% 7% 6% Wholesale 29% 8% -23% 30% -14% -40% 46% 17% 11% 8% Export -43% 50% 68% -26% -89% -99% 29433% 24% 7% 6% Total 21% 13% 0% 17% -4% -12% 20% 10.4% 7.8% 6.6% Volume mix Retail % 42% 46% 46% 51% 53% 65% 77% 68% 66% 65% 65% Wholesale % 44% 47% 45% 34% 38% 34% 23% 28% 29% 30% 31% Export % 14% 7% 9% 15% 9% 1% 0% 4% 4% 4% 4% Total 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% Revenue Retail Wholesale Export De Costi Seafoods Total Revenue growth Retail 41% 4% 15% 20% 18% 11% 8% 7% 7% 6% Wholesale 18% 5% -22% 29% -5% -30% 34% 14% 13% 10% Export -45% 39% 94% -42% -95% -95% 20825% 18% 10% 9% De Costi Seafoods 5% 4% Total 22% 6% 5% 16% 4% -2% 17% 50% 8% 7% Revenue mix Retail % 46% 53% 52% 57% 60% 68% 77% 71% 51% 50% 50% Wholesale % 43% 42% 42% 31% 35% 32% 23% 26% 20% 21% 21% Export % 10% 5% 6% 12% 6% 0% 0% 3% 2% 2% 2% Total 100% 100% 100% 100% 100% 100% 100% 100% 73% 73% 74% Pricing by channel (A$/Hog Kg) Retail Wholesale Export Total Growth in pricing (A$/Hog Kg) Retail 5% -8% 4% -1% -1% 7% 1% 0% 0% 0% Wholesale -9% -2% 1% -1% 11% 18% -8% -2% 2% 2% Export -4% -7% 16% -22% -54% 314% -29% -5% 3% 3% Total 1% -6% 4% -2% 8% 11% -3% 36% 0% 0% Operating costs per A$/Hog kg Growth -2% -3% 3% 0% 5% 8% -5% 45% -1% -1% Operating EBITDA Growth 32% -6% 10% 7% 19% 7% 14.3% 23.1% 10.2% 10.1% EBITDA margin (%) 20.9% 22.5% 19.9% 21.0% 19.4% 22.2% 24.3% 23.8% 19.5% 19.9% 20.6% EBITDA Margin (A$/Hog kg) Growth 9% -17% 10% -9% 23% 22% -5% 11% 2% 3% Operating cashflow Growth 96% 166% 19% 46% 21% -1% 2% -16% 21% 15% 14% Cashflow conversion 37.2% 61.3% 82.1% 103.8% 115.4% 93.4% 92.1% 72.0% 78.5% 81.0% 81.0% ROA 11.7% 11.8% 10.0% 10.2% 9.0% 10.5% 11.7% 12.3% 11.2% 11.5% 12.0% SOURCES: MORGANS, COMPANY REPORTS 7

8 Valuation Our blended valuation for TGR is A$4.20. Methods used to arrive at our valuation include PE and EV/EBITDA multiples and a DCF. We have focused on FY16F multiples in relation to our PE and EV/EBITDA valuation. Our EV/EBITDA valuation is diluted for TGR s ongoing use of a receivables purchase facility (off-balance sheet), which adds a further A$64.5m of debt. We include a DCF valuation to capture some of the medium to longer term upside from the acquisition and synergies with De Costi Seafoods which should underpin strong earnings growth over the next few years. Our valuation is highly sensitive to changes in our volume, price, margin, capex and working capital assumptions. Our DCF valuation applies a WACC of 10% and a terminal growth rate of 3%. Table 3: Morgans blended valuation summary (A$) Weighting Valuation PE 14.5x FY % $4.20 EV/EBITDA 8.5x FY % $3.83 DCF 33.3% $4.57 Average $4.20 SOURCES: MORGANS Investment view We re-instate coverage with an Add recommendation and A$4.20 price target. TGR is trading at a sizeable discount to the agri/food sector (FY16F PE of 13.2x vs 20x) which is unwarranted in our view. TGR is a quality business (market leader and strong brand name) with a clear growth strategy. It is a beneficiary of healthy eating trends and the growing demand for salmon and seafood. We view the acquisition of De Costi Seafoods positively and it will further underpin TGR s growth profile over the next few years. The company has an excellent track record of bringing new innovative salmon products to market and growing per capita consumption and we expect that this will now be replicated in the broader seafood category. In recent years, the company has been successful in derisking its farming operations and reducing its operating costs. We expect further operating efficiencies will be delivered over the next few years. There are barriers to entry in salmon farming - salmon farming has a seven year breading cycle, a five year capital cycle and is therefore, highly capital intensive. Government issued marine leases are also strictly limited. TGR s achievements in sustainable salmon farming should be applauded. Key risks to our view include: Oversupply and pricing pressure In FY15 an oversupply of domestic salmon and increased imports put pressure on both the wholesale and export price. There were increased imports following the Russian ban on Norwegian salmon. Importantly, over the last three months, export prices have started to rise. According to Huon Aquaculture, global supply is expected to be constrained in It highlighted that biomass in Norway is lower than last year, smolt to sea is not increasing, feed sales are lower than last year and there was a cold summer and higher incidences of sea lice. Huon also noted that Amoebic Gill Disease (AGD) is increasing in Norway, Scotland, Ireland, Canada and the US and production is forecast to decline in Chile. Norway and Chile have historically dominated the global production of Atlantic salmon, a pattern that is likely to continue in the future. Barriers to expansion are also increasing worldwide and leases are becoming more difficult to obtain. Global demand for salmon is also growing strongly. 8

9 May-06 Aug-06 Nov-06 Feb-07 May-07 Aug-07 Nov-07 Feb-08 May-08 Aug-08 Nov-08 Feb-09 May-09 Aug-09 Nov-09 Feb-10 May-10 Aug-10 Nov-10 Feb-11 May-11 Aug-11 Nov-11 Feb-12 May-12 Aug-12 Nov-12 Feb-13 May-13 Aug-13 Nov-13 Feb-14 May-14 Aug-14 Nov-14 Feb-15 May-15 Aug-15 Food & Beverages Australia Equity research September 14, 2015 Chart 1: Global salmon price (USD/kg) SOURCES: INDEXMUNDI Hot summer water temperatures can detrimentally impact fish growth and survival - Salmon farming requires cool water temperatures to both maintain health and optimise growing conditions. Warm temperatures for an extended period of time (18-20ºC) can reduce stock growth, result in higher feed costs given that greater feed amounts are required to maintain fish weight, increase the risk of disease (AGD) and increase mortality rates. To try and mitigate risk, TGR has implemented a harvest strategy in South East Tasmania that allows it to harvest fish at a quicker rate and therefore maximise the survival of its fish and maximise fish biomass. Amoebic Gill Disease (AGD) AGD is a disease that thrives when water temperature is warm, affecting the gill function. This disease can be treated by bathing fish in fresh water. While Tasmania is the best place in the world to breed salmon, it has one of the highest cost of production (by up to A$1.14/kg) due to AGD. TGR spends A$1.20/kg bathing the fish in fresh water to try and wash away this disease. To mitigate this risk, TGR grows additional fish in Macquarie Harbour where there is no AGD and 100% of its fish now come from its Selective Breeding Program (SBP). The SBP is designed to breed a more robust salmon and remove the requirement of one bath per fish growing cycle. Predators (fur seals and birds) lead to direct losses when they attack/stress the salmon, or indirect, where holes are created in the nets leading to potential escape. Birds are attracted to the pens due to the movement of fish in the water as well as being a protein rich feed. Seals also see the salmon as a food source. Given fur seals are protected wildlife, managing them is a significant challenge and is costly. TGR s rollout of Kikko nets (made from semi-rigid polyester monofilament as opposed to the old copper treated nets) has reduced the incidence of damage to the salmon from the seals. Algae blooms and jellyfish - The presence of jellyfish and outbreaks of algae blooms can also lead to increased mortalities. Rising feed costs can impact margins - Feed costs represent 50-60% of TGR s salmon farming costs. Salmon feed is made up of land animal ingredients (chicken meal and chicken oil), vegetable ingredients (grain and protein meal), fish meal and fish oil, vitamins and minerals and carotenioids (astaxanthin). Fish meal and fish oil are sourced from forage fish (high protein ingredients that are made from small bony fish such as sardines or anchovies). TGR has worked to reduce its forage fish meal input and increase protein from other sources. 9

10 Pricing pressure from the major retailers could put pressure on margins - The Australian grocery retailing market is one of the world s most consolidated and profitable markets, with the top two industry participants, Woolworths and Coles, accounting for about 70% of the market. They therefore have the buying/negotiating power to extract a disproportionate share of the value chain, exerting pressure on their suppliers. The major retailers competitive stance on lowest price leadership (eg. Coles' Down, Down campaign and Woolworths Cheap, Cheap campaign) are driving an increase in the percentage of food sold through supermarkets on promotion. Private label push from the major retailers could limit growth - The major retailers have a strategy of increasing their private label product offering at the expense of branded product. Retailers are also cutting the selling price of private label products. Shelf space availability to food manufacturers is being influenced by the supermarkets as they expand their private label offering. TGR s private label contracts also mean that it is a beneficiary of this switch. Loss of a major customer - In FY15, 68% of TGR s sales came from the Retail channel. TGR supplies all of Coles requirements for fresh and smoked salmon. TGR supplies about 60% of Woolworths requirements, with the rest coming from its competitors and imports. TGR (through De Costi Seafoods) will shortly start supplying Aldi which is currently importing frozen salmon. Success of new product development (NPD) - NPD is an important driver of growth for TGR. The success of new products depends on TGR s ability to accurately anticipate consumer needs, ability to innovate, successfully launch new products in a timely manner, price products competitively and differentiate products to those of its major competitors. There is a risk that TGR s NPD is not supported by sufficient market interest and purchases. Brand damage - TGR s brand names are a key aspect and strength of the business. The reputation and value of the brand may be adversely affected by a number of factors such as failing to provide customers with the quality of product they expect, disputes or litigation with third parties, employees, suppliers or customers or adverse media coverage. Product risk - The risk of product contamination or any other type of food safety incident, liability and product recalls could cause severe reputational damage to TGR. Substitution Salmon/seafood consumption could be affected by changing eating preferences or relative pricing. Substitute products include beef, pork and poultry. We believe the risk of substitution is low to moderate, given the trend to healthier diets. Salmon is a major source of low-fat protein rich in Omega-3. Regulatory risks Over the past year the Federal Government s Senate inquiry into Tasmania s aquaculture regulations has been a headwind for the sector. Senators from the Greens have been worried about the environmental impacts of salmon farming. An investigation carried out by a Senate Committee determined there is no evidence that the Tasmanian salmon industry is damaging the state's waterways and that regulatory measures governing the sector are adequate. TGR has a clear focus on sustainability. This year it released its forth Sustainability Report. TGR is viewed as a global leader in sustainable salmon farming. The company was the first salmon grower in the world to certify all of its marine farming operations to the Aquaculture Stewardship Council (ASC) Salmon Standard. It has signed a three year agreement with WWF Australia, the World Wildlife Fund. TGR is the only Australian salmon or aquaculture company to have this partnership. TGR also recently won the Australian Business Award for Sustainability which is judged against international performance 10

11 standards. The aquaculture industry has huge social benefits for Tasmania and TGR is one of the state's key employers. De Costi Seafoods acquisition risks - Other than not meeting the conditions of the acquisition, we believe the main risks of this transaction for TGR are the normal acquisition ones of paying too much, poor integration and execution, not realising the expected synergies and new business risk. It is also important that TGR doesn t cannibalise its existing salmon sales. Overview of Tassal Group Limited (TGR) TGR is Australia s largest producer of salmon products. It is based in Tasmania where salmon thrives in its pure, cool water. Nowhere else in Australia is the water temperature more suitable to salmon farming. TGR is vertically integrated and operates across freshwater hatcheries and saltwater aquaculture, salmon processing, value adding stages through to distribution, wholesaling and export. In salmon it operates two directly controlled hatcheries, six marine farming locations, three processing facilities, two retail outlets and has 2,000 points of retail presence. It produces quality fresh, smoked, canned and frozen Tasmanian grown Atlantic salmon products. TGR sells both branded and private label products. It brands are Tassal, Superior Gold and Tasmanian Smokehouse. Following the De Costi Seafoods acquisition, TGR now processes and sells a wide range of seafood. TGR is recognised as a global leader in sustainable aquaculture. It employs more than 1,100 people in Tasmania. Figure 2: Tassal s operations SOURCES: TASSAL 11

12 Company strategy TGR s strategy is based on maximising per capita consumption growth of salmon and now seafood. In recent years, TGR has successfully transitioned the business away from volatile and lower margin export and contract growing business towards domestic market sales. TGR s preference for domestic retail sales are due to this market s more predictable pricing and ability to enter longer term contracts which allows the company to plan its future supply volumes. The retailers are supportive of the salmon category as customers who purchase salmon spend more in store. TGR is focused on increasing profitability growth and A$/kg returns through sales initiatives and operating efficiencies (maximising biomass growth, reducing operating costs ie. the cost of growing, processing, supply and logistics and continuing to mitigate agricultural risk). Overtime, TGR is targeting to achieve a ROA (includes biological assets mark-to-market) of 15%. Achieving this target will be underpinned by: maintaining price and increasing where possible; domestic market strategy investment in marketing and promotions, new product development, support of major customers; and reducing production costs through Macquarie Harbour and its Selective Breeding Program (SBP) delivering significant results from AGD, growth and survival perspective. The lifecycle of Tassal Tasmanian salmon Salmon have a three year lifecycle from egg to harvest. The salmon generally have about one and a half years in fresh water and then one and a half years in the sea. Eggs are incubated using recirculation-water systems, which allow control of growing conditions. Fish are then moved to outdoor tanks, where they continue to grow until they reach around g (smolt). At this point, they are transferred to the sea. This process takes up to 14 months. Smolts are transferred from the hatchery to the sea, where they continue to grow until they are ready to harvest. TGR s multiple sites assists in risk mitigation. This phase takes up to months. The average harvest weight is about 5.0kg. The company undertakes processing at its Dover (gutting and grading), Huonville (cold smoking) and Margate facilities (value adding). Fish are classified by size and quality and are either sent for Value-Added Processing or dispatched to market as fresh HOGG product. The Dover site is capable of harvesting and processing up to 18,000 fish per day at peak times. 12

13 Figure 3: The lifecycle of Tassal Tasmanian salmon SOURCES: TASSAL 13

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