Bega Cheese Ltd (BGA)

Transcription

1 24 September 2013 Analyst Jonathan Snape Authorisation TS Lim Bega Cheese Ltd (BGA) Maître affineur Recommendation Buy (Initiation) Price $3.40 Target (12 months) $3.80 (unchanged) Expected Return Capital growth 11.8% Dividend yield 2.4% Total expected return 14.2% Company Data & Ratios Enterprise value Market cap $601.8m $515.1m Issued capital 151.5m Free float 100% Avg. daily val. (52wk) 396, month price range $ GICS sector Food Beverage and Tobacco Price Performance (1m) (3m) (12m) Price (A$) Absolute (%) Rel market (%) Dairy with a twist BGA is a B2B supplier of dairy products with a presence in over 40 countries worldwide. BGA has long term customer agreements covering ~65% of core dairy volumes, as well as providing annual royalty revenues of ~$5.5m. BGA has a leading position in the domestic cheese market, an expanding presence in the growing Chinese infant formula market and leverage to a weakening Australian dollar and rising international dairy prices on export sales (~30% of revenues). In addition BGA is pursuing what could be a highly EPS accretive acquisition of Warrnambool Cheese & Butter (WCB). We initiate coverage with a Buy rating and $3.80ps target price. WCB could compliment the growth profile BGA is currently pursuing an acquisition of WCB that looks to be highly EPS accretive if successful. The BGA offer is at an implied 40% premium to Murray Goulburn s 2010 offer for WCB and at ~10.7x FY14e EBITDA (in line with the industry average of 9.8x). Significant synergies look to be available in combining the business, with the removal of duplicate costs (~$165m in compressible costs) and consolidation of operating facilities (ie. cut & pack operations) the most logical. Assuming only modest operating synergies of $ m (BGA management forecasts of $7.5m) and the annualised benefit of WCBs recent investment strategy (i.e Lactoferrin) we see the potential for the acquisition to be 8-18% EPS accretive on a ProForma FY14e basis. Investment view: Initiate coverage with a Buy rating Bega Cheese (BGA) is a unique exposure in the dairy segment, with a high level of contracted volumes, underpinning a more consistent returns profile than is typically associated with an agricultural investment. In addition BGA holds a leading position in the domestic cheese market, exposure to growing infant formula demand in Asia and in the midst of a potentially highly EPS accretive acquisition of WCB. We initiate coverage with a Buy rating and a $3.80ps target price. Absolute Price $4.0 $3.5 $3.0 $2.5 $2.0 $1.5 $1.0 Sep 11 Mar 12 Sep 12 Mar 13 Sep 13 BGA S&P 300 Rebased SOURCE: IRESS Earnings Forecast Year end June e 2015e 2016e Sales (A$m) EBITDA (A$m) NPAT (reported) (A$m) NPAT (adjusted) (A$m) EPS (adjusted) (cps) EPS growth (%) PER (x) FCF Yield (%) EV/EBITDA (x) Dividend ( ps) Franking (%) Yield (%) ROE (%) SOURCE: BELL POTTER SECURITIES ESTIMATES BELL POTTER SECURITIES LIMITED ACN AFSL DISCLAIMER AND DISCLOSURES THIS REPORT MUST BE READ WITH THE DISCLAIMER AND DISCLOSURES ON PAGE 23 THAT FORM PART OF IT. Page 1

2 Contents Background and Investment overview... 3 The Warrnambool proposal... 7 The milk market Financial performance Board and management Shareholding structure and limit Appendix: Milk production flows Valuation and risks Page 2

3 Background and Investment overview Figure 1 - BGA company overview and milk flows Divisional overview Background and Investment Strategy Bega (BGA) commenced life in 1899 as a co-operative in the town of Bega; in 2007 BGA acquired a 70% interest in Tatura and in 2008 BGA was restructured from a co-operative to an unlisted public Company. In 2011 BGA listed on the ASX and subsequently acquired the minorities of Tatura. BGA operates five processing facilities across NSW & VIC with the capacity to process ~250kt of product across three operating divisions while also holding strategic investments in both Warrnambool Cheese & Butter (18%) and CCFA (25%), a fresh milk processor in Canberra. An overview of the core operating divisions of Bega, milk flows and major customers is detailed in the table below. Division Volume Facility Products Material Contracts Competitors Core Dairy 92,035 FMCG 103,047 Nutritional Products 20,856 Lagoon St (Bega) Coburg (VIC) Tatura (VIC) Ridge St (Bega) Strathmerton (VIC) Tatura (VIC) Bulk Cheddar, Bulk Whey & Dairy Products, Protein isolate, Bulk Foodservice & cream cheese Butter Packaged block & grated cheese, Packaged sliced cheese, Individually wrapped cheese slices, Canned cheese, String cheese, Cheese sticks Infant formula, Lactoferrin Fonterra Ingredia Kraft Coles Aldi Mead Johnson Omniblend nourish Fonterra National Foods Parmalat Murray Goulburn Warrnambool Cheese & Butter Norco Co-operative United Dairy Power Burra Foods Strategic Investments 15% Shareholding in Warrnambool Cheese & Butter (WCB.AX) 25% interest in CCFA. Milk processing and distribution in Canberra. Milk flow Chart Intake Core Dairy Manufacturing FMCG Nutritional Products Facility Capacity(t) Products Facility Capacity(t) Products Facility Capacity(t) Products Bega 200mL Lagoon St 30,000 Bulk Cheddar Strathmerton 70,000-80,000 Bulk Whey & Dairy Products Coburg 100mL Coburg 10,000 Protein isolate Ridge Street 75,000 Bulk Foodservice & cream cheese Tatura 350mL Tatura* 85,000 Butter Mozzarella Bulk fresh milk FMCG Entities Packaged block & grated cheese Packaged sliced cheese Individually wrapped cheese slices Canned cheese String cheese Cheese sticks Tatura* Infant formula Lactoferrin Hyperimmune colostrum Direct from Farm Material long-term contracts Customer Volume Renewal Duration Option Product Contract style Fonterra trademark licence 13, years +25 years Cheese Royalties linked to sales. Royalties in 2012 were $5.5m. Fonterra product supply years Pricing agreed to 2021 Kraft 8, years +10 years Cheese Cost plus Mead Johnson 9, years Infant formulae Cost plus Ingredia 3, years Milk protein isolate Coles 19, years Cheese Cost plus Aldi 3,500 Cheese Cost plus Omniblend nourish 3, Infant formulae Supply and services agreement * Tatura capacity reflects combined total SOURCE: COMPANY DATA AND BELL POTTER SECURITIES ESTIMATES The earnings of BGA are underpinned by long-term supply contracts that account for the ~65% of BGA s core dairy production. Contracts are executed on a cost plus basis meaning that returns in these facilities are primarily a function of volume. The majority of product produced in these facilities is destined for the companies cut and pack operations at Ridge St and Strathmerton that also receive third party cheese supporting annual production capacity utilisation of ~55%. Investment strategy: Initiate coverage with a Buy rating We initiate coverage on BGA with a Buy rating and a $3.80ps target price. The business model of BGA is somewhat unique in the listed agriculture space with a high level of Page 3

4 earnings generated under long-term supply contracts, while still providing exposure to favourable demand trends in Asian dairy. Our Buy rating on the stock is supported by five key drivers: 1. Long-term contracts supporting returns: BGA has seven key supply contracts that underpin demand for ~65% of core production volumes. In addition BGA receives a royalty stream from the Fonterra trademark licence on the Bega brand, which historically has generated $ m in annual EBITDA. These agreements support volume throughput and returns in the core business. 2. Favourable international pricing backdrop and leverage to falling AUD: A weakening AUD and strengthening of the Global Dairy Trade (GDT) index suggest a favourable near term backdrop for the groups export facing businesses. While the majority of any move is passed through to farmers in the form of higher farmgate milk prices we expect an element of the move retained to be retained by export facing processors. 3. Growing demand for dairy in Asia: Primarily a driver of demand for the export facing business of Tatura, exports from Australia to China grew 17% in FY12, with growth in infant formula (+50% to ~2.4mt) and Cheese (+39% to ~8.8mt) drivers of this and a thematic BGA has leverage to. 4. Corporate activity in the segment: The Australian and New Zealand dairy segment has been in a state of consolidation for the last two decades and we expect consolidation will remain a feature as shareholder structures unwind. Transactions in the sector have been executed at an average 10.4x EBITDA and excluding the Tatura merger in a range of x. 5. A potentially highly EPS accretive acquisition of WCB: On a ProForma FY14e basis we estimate an acquisition of WCB could be 8-18% EPS accretive, with significant synergies to be extracted in the removal of duplicate overhead and upside from recent investments by WCB, that commence delivering returns in FY14e. Valuation We value BGA using our ROIC model. We have assumed an unleveraged beta of 0.7x, below the usual 0.92 we use for a standard industrial company reflecting the more static nature of the food processors, which tend to have an unlevered beta of x. This results in a pre-tax WACC of 9.6% which drives an EV/EBITDA multiple of 8.16x FY15e for the base business, deriving a value of $3.80ps when the WCB stake is incorporated. If successful in acquiring WCB on the current metrics our preliminary valuation range is $ ps based on our ProForma FY15e forecasts. Figure 2 ROIC based valuation BGA Standalone ProFormaBGA/WCB Lo Hi Lo Hi EBITDA Asset Beta Depreciation & Amortisation Net debt/(net debt+equity) 14% EBIT Equity Beta Invested Capital Risk Free Rate 5.5% ROIC Borrowing Margin 2.0% 12.5% 13.3% 13.3% 13.4% 11.1% 11.8% 11.9% 12.6% WACC (% ) Mkt Risk Premium 5.5% 9.6% 9.6% 9.6% 9.6% 9.6% 9.6% 9.6% 9.6% Long-term growth (% ) 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% EV/EBITDA Enterprise Value ($m) Net Debt (86.7) (91.3) (89.9) (85.0) (257.9) (257.9) (257.9) (257.9) Surplus franking credits Value of WCB stake WCB Investmnet properties Estimated market value ($m) Shares on issue Valuation ($ps) SOURCE: COMPANY DATA AND BELL POTTER SECURITIES ESTIMATES Page 4

5 Figure 3 International comparison table As a cross check we compare this to other listed dairy exposures both domestically and internationally highlighting the BGA is relatively attractively priced relative to the likes of the Fonterra Shareholders Fund and Synlait in addition to the international peer group. Ticker Year Currency Last Shares Market Net Ent. Net Debt/ EV/EBITDA Jun PE Div Yield (%) End Price Out (m) Cap ($m) Debt ($m)* Val. ($m) EBITDA e e e Australia Fonterra Cooperative Group Ltd FSF AU JUN AUD , ,194 4, , % 5.0% 5.2% Freedom Foods Group Ltd FNP AU JUN AUD % 0.8% 1.2% Synlait Milk Ltd Limited SML.NZ JUN AUD % 0.0% 0.0% Warrnambool Cheese & Butter Factory WCB AU JUN AUD % 1.4% 2.4% Average % 0.7% 1.2% Europe Dairy Crest Group PLC DCG LN MAR GBP % 4.4% 4.6% Danone SA BN FP DEC EUR ,221 6, , % 2.6% 2.8% Emmi AG EMMN SW DEC CHF , , % 1.4% 1.5% Nestle SA NESN VX DEC CHF , ,614 17, , % 3.4% 3.6% Parmalat Spa PLT IM DEC EUR , ,492-1, , % 1.8% 1.9% Average % 2.7% 2.9% Asia Bongrain SA BH FP DEC EUR , % 2.6% 3.0% Bright Dairy & Food Co Ltd CH DEC CNY , , , % 0.9% 1.2% China Mengniu Dairy Co Ltd 2319 HK DEC HKD , ,328 1, , % 0.6% 0.8% Dairy Farm International DFI SP DEC USD , , , % 2.4% 2.8% Maeil Dairy Industry Co KS DEC KRW 38, ,240 72, , n.a % 0.3% 0.3% Morinaga Milk Industry Co Ltd 2264 JP MAR JPY ,035 97, , % 2.2% 2.2% Yakult Honsha Co Ltd 2267 JP MAR JPY 4, ,237-25, , % 0.5% 0.5% Average % 1.4% 1.5% North America Dean Foods Co DF US DEC USD ,784 1, , % 0.0% 0.0% Mead Johnson Nutrition Co MJN US DEC USD , , % 1.7% 2.1% Saputo Inc SAP CN MAR CAD ,423 1, , % 1.7% 1.7% WhiteWave Foods Co WWAV US DEC USD , , % 0.0% 0.0% Average % 0.9% 1.0% Other International Almarai Co Ltd ALMARAI AB DEC SAR ,298 9, , % 1.5% 2.0% National Agriculture Development Co NADEC AB DEC SAR ,668 1, , % 4.3% 5.0% Zydus Wellness Ltd ZYWL IN MAR INR ,376-1, , % 1.0% 1.3% Average % 2.3% 2.8% International Average % 1.8% 2.0% Overall Average % 1.6% 1.9% Bega Cheese BGA.AU JUN AUD % 2.2% 2.4% Bega Cheese (EX-WCB stake) Note: All data in local currency, net debt FY12 SOURCE: IRESS CONESNSUS AND BELL POTTER SECURITIES ESTIMATES CORPORATE MULTIPLES HAVE BEEN HIGH Since farmgate deregulation in 2000 the dairy processing sector has seen significant consolidation with five large deals in the listed space and the formation of DairyWest in the private equity arena (Archer capital via the acquisition of Brownes Foods and West N Fresh in 2011). Average transaction multiples in the sector have been large at x EBITDA (excluding the minorities merger of Tatura in 2011) and an average of 9.8x. Figure 4 - Corporate multiples in the Australian dairy segment Year Target Acquirer EV (A$m) EV/EBITDA (x) 1998 Pauls Parmalat King Island Dairy National Foods NZDF Rank Group National Foods San Miguel Corp NZDF Goodman Fielder Bonland Foods Fonterra n.a Dairy Farmers Kirin Tatura (30% minorities) Bega Warrnambool Cheese & Butter Bega Average 9.9 SOURCE: COMPANY DATA AND BELL POTTER SECURITIES ESTIMATES REMOVING THE SHAREHOLDER CAP BGA currently has a 10% shareholder cap in place, which will remain through to August 2016, when shareholders will have the option to remove the cap or raise it to 15% for a further five years. The shareholder cap makes opportunistic bids difficult to succeed, especially given that 44% of the stock is in the hands of holders with less than 1,000 shares. Removal of the shareholder cap could prove a catalyst for a BGA to become a corporate target. Page 5

6 Figure 5 - BGA Shareholder cap Shareholder cap Expiry Cap Year /08/2013 5% Year /08/ % Year 6-10 (contingent on shareholder vote) 18/08/ % SOURCE: COMPANY DATA AND BELL POTTER SECURITIES ESTIMATES Page 6

7 The Warrnambool proposal The proposal BGA has recently put a takeover proposal to Warrnambool Cheese & Butter (WCB) shareholders looking to acquire the 82% of the company they currently don t own. The offer consists of 1.2 shares in BGA plus $2.00ps cash for every WCB share, implying an enterprise value of $411m at current BGA share prices or 15.9x FY13 EBITDA or 10.7x FY14e Consensus EBITDA, which compares favourably to past transaction at an average multiple of 9.8x (ex- BGA/WCB). Figure 6 - WCB acquisition metrics e Debt component Equity component Minority cost ($m) Grossed up value ($m) Debt assumed 75.5 Enterprise Value ($m) Consensus FY14e EBITDA EV/EBITDA (x) SOURCE: COMPANY DATA AND BELL POTTER SECURITIES ESTIMATES BGA currently holds an 18% interest in WCB, having acquired an initial 15% stake in WCB via a placement and entitlement offer as part of a recapitalisation of the business in In addition Murray Goulburn holds a 16.3% interest in the business having previously made an offer for to acquire the business in CAN MURRAY GOULBURN COME OVER THE TOP? In December 2009, WCB revealed that it had rejected two indicative takeover proposals one made by Murray Goulburn and one made by a third party. On 29 January 2010 Murray Goulburn made a proposal to WCB s Board to acquire WCB, which was upwardly revised to $4.35ps on the 19 February In February 2010, Murray Goulburn provided a submission to the ACCC seeking clearance of a proposed acquisition of WCB at which time the ACCC came back with a numbers of issues: 1. The ACCC s preliminary view was that the proposed acquisition would be likely to substantially lessen competition for the acquisition of raw milk from farmers in the south west region of Victoria and the central and south east regions of South Australia. 2. The ACCC considered that competition concerns may arise in relation to the bulk supply of raw milk to dairy product manufacturers in south east South Australia where the merger parties supply raw milk in bulk volumes. In June 2010 Murray Goulburn announced that it did not intend to proceed with the acquisition, without responding to the Statement of issues. While it is possible that Murray Goulburn could counter with a higher offer, it would appear unlikely given the ACCC issues of 2010 and if they were to make a superior offer then BGA would benefit to the extent of the offer in the value uplift of its holding. Background to Warrnambool Cheese & Butter (WCB) Situated on the Great Ocean Road at Allansford near Warrnambool, WCB is one of Australia s largest milk processors, drawing milk supply from South West Victoria and South East Adelaide, two of the most productive dairy regions in the country. WCB sources approximately 900mL of milk annually and produces high quality cheese, milk powders, whey protein concentrate, butter, milk and cream for customers in domestic and export markets. WCB also produces fresh milk under the Sungold brand while also holding a 50% Page 7

8 Figure 7 - WCB company overview Divisional overview interest in Great Ocean Ingredients (GOI) which produces high value add nutritional ingredients such as galacto oligosaccharides and a 50% interest in WCB Japan. Division Manufactured products Consumer Foods Nutritional Products Joint Ventures Facility Products Material Contracts Competitors Allansford Allansford Mt Gambier Bulk Cheddar, Bulk Whey & Dairy Products, Protein isolate, cream & butter Packaged milk and cheese Great Ocean Ingredients - galacto oligosaccharides WCB Japan - Distribution JV of WCB product in Japan Lion Kraft Kraft Coles Aldi Allansford Infant formula, Lactoferrin, Colostrum Mitsubishi Fonterra National Foods Parmalat Murray Goulburn Warrnambool Cheese & Butter Norco Co-operative United Dairy Power Burra Foods Material long-term contracts Customer Volume Entered Duration Product Contract style Kraft crème cheese 5, n.a. Cheese Supplied by Kraft for export to WCB customers Kraft livefree cheese 3, n.a. Cheese Developed 80% fat free cheese for Kraft Coles Great Ocean Rd Che 3, years Cheese Exclusive brand use in Coles Aldi - Emporium cheese 1, n.a. Cheese Cost plus National Foods 20, n.a. Cheese Cheese supply for Coon & Cracker Barrel SOURCE: COMPANY DATA AND BELL POTTER SECURITIES ESTIMATES Since listing in 2004 WCB has grown milk intake at a compound rate of 3.1% pa resulting in volume growth of 7.3% pa. However this has not translated to earnings growth with the business highly dependent on export prices for dairy commodities, given ~50% of volumes are destined for foreign markets, as a result earnings and returns in the business have been far more volatile than BGA historically. Figure 8 Milk intake and production history Figure 9 Sales and EBITDA margin history 1, , % , % , % 2.0% , % % , % , % Total milk intake (ml) - LHS Product sold ('000t) - RHS Group revenue ($m) EBIT Margin (%) Over the last two years WCB has been actively investing in new capacity to move up the value chain, with investments in new milk capacity (+50% in fresh milk capacity at Sungold), milk powders (Instantised WPI plant upgrade) and Lactoferrin (+20T capacity by 2H14e); as well as entering new supply agreements with Coles, Aldi, Kraft and Mitsubishi all likely to improve margins over the next two years. The majority of this investment has yet to translate to earnings for WCB and in part we suspect some of the appeal of acquiring the business. CONSOLIDATING THE BUSINESS If successful in acquiring WCB, the merged entity would become the fourth largest dairy processor in Australia, accounting for ~17% of Australia milk intake (comparable to Fonterra) while also having milk collection pool across NSW, Victoria and South Australia. While BGA would still have a substantial exposure to FMCG markets, the share of volume destined for export markets would lift from ~30% to ~40% increasing the relevance of the Page 8

9 business to the global market, while allowing for synergies in sales, marketing and logistics to be released over time. Figure 10 Milk industry intake FY13 Figure 11 product mix ProForma FY FMCG 32% 2000 BGA/WCB would hold ~17% of Australia's milk Commodity 58% Murray Goulburn Lion (NFD/DF) Fonterra Bega Parmalat Norco UDP Other Nutritional 10% Figure 12 - BGA/WCB estimated EBITDA synergies and gains SOURCE: COMPANY DATA AND BELL POTTER SECURITIES ESTIMATES BGA management have estimated synergies of $7.5m could be extracted in the first full year of an acquisition. However, when analysing the potential EPS accretion to BGA shareholders we expect the benefit of WCB s Lactoferrin investment and the potential to release greater synergies from both consolidating cut and pack operations and removing costs from a compressible base of $165m as providing more upside. We have conservatively estimated synergies at $ m and total net benefits to BGA of $ m at the EBITDA level when incorporating the benefit of recent investments, resulting in EPS accretion of 8-18% on a ProForma FY14e basis (based on our own forecasts for WCB). Lo Hi Comment Consolidating cut & pack operations ,000t of cheese relocated to Strathmerton Board fees and senior management savings Board & CEO pay is $1.5m pa. Senior mgmt pay ~$2.5m Duplicate cost removal Compressible costs of ~$165m pa Estimated synergies Compares to BGA estimate of $7.5m in operating synergies Lactoferrin upside at WCB Lactoferrin return in excess of WPI value Less WCB dividends (1.0) (1.0) Estimated EBITDA upside from FY14e Additional D&A for Lactoferrin investment (1.0) (1.0) Estimated EBIT upside from FY14e Bega Warrnambool Adjustments Consolidated Lo Hi Lo Hi Sales 1, , ,665.1 EBITDA EBITDA Margin (% ) 6.5% 5.6% 6.6% 7.0% EBIT EBIT Margin (% ) 4.5% 3.6% 4.6% 4.9% Net Interest (8.4) (9.7) (9.7) (18.1) (18.1) Profit before tax 40.6 (3.2) Taxation expenses (12.2) (16.7) (18.4) Outside equity interest NPAT ($m) Shares on issue EPS ( ps) EPS accretion/dilution 7.9% 17.9% Beyond what we have identified we would see further benefits likely emerging in areas such as consolidating export facing businesses as well as turning around the loss making FMCG business of WCB which are scale deficient and could be consolidated with the existing BGA business given the overlap in material customers such as Kraft, Coles and Aldi. Page 9

10 The milk market Figure 13 Australian landscape in a global context There are 6,770 registered dairy farmers in Australia producing ~ BnL of milk annually worth ~$4Bn to the Australian economy. The sector has undergone substantial change in the last 25 years with the phasing out of government support resulting in a significant gain in efficiencies at the farmgate level and a substantial change in industry structure at the processor level. While a large umbrella the dairy market can be broadly separated into two clear categories: 1. Domestic fresh sales: Accounting for ~25% of annual milk intake, this sector is dominated by two large processors in Kirin Holdings (which acquired the assets of National Foods and Dairy Farmers) and Parmalat (which acquired the assets of Pauls). These businesses require year around milk supplies and tend to pay a premium for milk to reflect the high on farm costs. 2. Processed milk products: Accounting for ~75% of annual intake this business tends to be exported dominated and focused in Victoria, resulting from an early adoption of deregulation in that State. The market is dominated by two large co-operatives in Fonterra (Formerly Bonlac Foods) and Murray Goulburn. Export focused Domestic focused SOURCE: DAIRY ASTRALIA, USDA & BELL POTTER Cheese WMP/SMP Butter Infant Formulae Other Fresh Drinking Milk Production 340,340t 370,710t 119,715t 28,000t 296,584t 2.3BnL CAGR 5yrs -1.4% pa +3.1% pa -2.3% pa n.a. n.a. +2.8% pa Domestic consumption 248,741t 113,158t 55,492t 12,622t 296,584t 2.3BnL Supermarket share 47% n.a. 77% 50% 77% 55% Major Participants Largest regional exporters Australian destination markets Bega Murray Goulburn Fonterra Fonterra National Foods National Foods National Foods Fonterra Murray Goulburn Murray Goulburn Parmalat Parmalat Murray Goulburn Bega WCB Bega Fonterra Murray Goulburn Norco WCB Ballantyne WCB Burra Foods Norco UDP UDP Burra Foods WCB WCB Ballantyne Freedom Foods Fonterra EU - 47% EU - 22% New Zealand - 61% New Zealand - 16% New Zealand - 47% US - 8% US - 17% US - 14% EU - 18% Australia - 11% Australia - 7% Australia - 8% Argentina - 4% Argentina - 14% Argentina - 3% Asia - 87% Asia - 70% Asia - 52% Middle East - 6% Middle East - 21% Middle East - 19% Africa - 2% Africa - 3% EU - 18% ROW - 4% ROW - 6% ROW - 11% Figure 14 - Utilisation of Australian milk (2011/12) Figure 15 Estimated milk intake 2012 SMP/Butter 28% Other 1% Cheese 34% National Foods 9% NorcoOther Bega 2% 4% 7% Murray Goulburn 31% Casein/Butter 1% Parmalat 9% WMP 11% Drinking milk 25% Warranbool 10% Dairy Farmers Supply co-op 10% SOURCE: SOURCE: COMPANY DATA AND BELL POTTER ESTIMATES Fonterra 18% Page 10

11 Since farmgate deregulation in 2001 the sector has seen a sharp contraction in both farm numbers (down 48%) and milk production (down 13%). An erosion in farmgate milk prices has driven a need for larger more efficient farms, which is noted by a +66.5% uplift in milk output per farm and +16.5% uplift in yield per cow over the same time frame. Recent forecasts from Dairy Australia based on herd growth rates and yield improvements have estimated milk production in 2016 of BnL, up % from FY12 levels and supporting industry wide volume growth of % pa. Based Figure 16 Farm numbers and yield per farm Figure 17 Milk production and yield per cow Farm numbers - LHS milk production per farm ('000L) - RHS Milk production (ml) - LHS milk production per cow (L) - RHS 4000 BGA in the Australian market BGA sources milk from ~500 farmer suppliers. Traditionally there are no long-term contracts, with supply agreed on an annual basis. Milk intake dictates production volumes and will be driven by seasonal factors as well as supply decision based on farmgate pricing. In a typical year BGA accounts for ~7% of Australia annual milk intake yet has accounted for ~11% of the growth in industry volumes since 2008 as new supply agreements with Aldi and Coles as well as an above sector farmgate price have attracted new supply. Operating at ~81% capacity utilisation in the core dairy facilities there would look to be the scope for further incremental growth in volumes, with our organic forecast growth of +2.5% pa. Figure 18 BGA Milk intake and production ratio Figure 19 Milk intake shares National Foods 9% NorcoOther Bega 2% 4% 7% Murray Goulburn 31% Parmalat 9% Milk intake (ml) - LHS Production ratio (kg/l) SOURCE: COMPANY DATA Warranbool 10% Dairy Farmers Supply co-op 10% SOURCE: COMPANY DATA AND BELL POTTER ESTIMATES Fonterra 18% FOCUS ON THE DOMESTIC CHEESE MARKET With cheese production accounting for ~60% of BGA s output it is the largest determinant of profitability. Domestically per capita consumption of cheese has been growing at ~3%pa, with compound growth of ~5%pa since 2006, though this looks to have peaked in recent Page 11

12 years. Over the same time we have seen a shift towards private label product, which has doubled to ~28% of the market and a trend we expect to remain for the near term. BGA is well positioned in the domestic cheese market with Bega (marketed by Fonterra) one of the leading brands at the retail level while also holding private label contracts with Coles and Aldi. In total we estimate BGA has contracts covering ~25% of the domestic cheese market, which is an exceptionally strong position. Figure 20 Estimated cheese market share at supermarket Figure 21 Australian per capita cheese consumption Others 18% Mainland 14% Bega 13% Private Label 28% Devondale 10% SOURCE: RETAIL WORLD Perfect Italiano 2% Mil Lel 1% Coon 4% Cracker Barrel 10% While domestic growth is a core driver of revenues, international demand growth has also been absorbing the balance (with ~45% of production is exported). Growth in cheese consumption in China is a key driver of growth, with Australian exports into China growing +39% in FY13. Australia in a global context Milk production is for the most part a domestically focused venture, with global milk production in 2012 of 644nL and only ~8% (or ~54BnL) destined for export markets and the source of these exports highly concentrated, with the leading six exporters accounting for 98% of trade. In a global sense Australia is a relatively small producer accounting for only ~2% of global milk production yet contributing ~8% of dairy exports. Figure 22 Global dairy production 2012 (~644BnL milk equiv.) Figure 23 Major exporting dairy regions Other 28% Argentina Australia 2% 1% Brazil 5% Canada 1% China 5% Ukraine 2% Argentina 6% US 15% Other 2% EU 30% EU 22% United States 14% Australia 8% Ukraine 2% Russia 5% NZ 3% Japan Mexico 1% 2% India 9% New Zealand 37% Production in the key regions of the EU-27, New Zealand, US, Australia and Argentina are the key drivers of balance in the global market. Milk production in these regions has grown at CAGR 1.7% pa over the last 5years, translating to 7.1% pa growth in exports of Cheese, Butter and SMP/SMP. Page 12

13 Figure 24 Supply growth in the big 5 Figure 25 Export growth in the big Argentina US EU-27 Australia New Zeland e US EU-27 Australia New Zealand Argentina SOURCE: USDA SOURCE: USDA In the near term drought in New Zealand and the US as well as a delayed spring onset in the EU-27 have had a major impact on the supply side of the equation resulting in substantial growth in prices (GTD up +22% YTD and +57% YOY). The largest importers of dairy product are China, Saudi Arabia, Russia, Algeria and Indonesia, with Australian product largely finding its way into Asia, with Japan, China and Singapore accounting for ~31% of exports by volume and ~42% by value. Demand growth has been strongest in Asia and South America up 13% and 11% respectively since Figure 26 Largest imports of dairy Figure 27 Largest imports of Australian dairy China 12% Japan 15% Saudi Arabia 5% Other 28% Other 53% SOURCE: RETAIL WORLD Egypt 3% Russia 7% Indonesia 3% Japan 3% Philippines 3% Singapore 3% Venezuala 3% Algeria 5% United Emirates 3% South Korea 4% Philippines 4% New Zealand 4% Thailand 4% Malaysia 6% Indonesia 6% China 14% Singapore 12% With such a limited presence in the global market, Australia is essentially a price taker in commodity products, with weather patterns in NZ, Europe and the USA largely dictating the volatility in prices. Investment in value added products such as infant formulae can generate excess returns for producers, which we believe will be one of the growth stories for BGA over the years. FOCUS ON INFANT FORMULA Investment in infant formula capacity has been a thematic in the Australian market, with Murray Goulburn, Bega and WCB investing in blending and packaging capacity over the last five years. The global infant formulae market is worth ~US$17Bn annually with the Top 5 global producers accounting for ~62% of supply. Market demand has been growing at ~8% pa over the last five years with growth in China at ~15% pa over the same time frame. The China market while second to the US in terms of volumes is worth almost double North America in dollar terms given the relatively high price point (typically 3-4x the equivalent shelf price in Australia) at US$6Bn. Page 13

14 Approximately 20-25% of Chinese formula demand is imported with NZ accounting for ~20% of this and Australia ~5%. With strong population growth dynamics and relatively low per capita consumption (China 6kg / pcc vs. average if 32kg / pcc) of infant formula, China would look to be a source of growth for what is a higher margin value added product for Australian producers, with expectations that the market could double in size by 2016 (Source: Danone investor seminar 2011). BGA is strongly leveraged to this thematic and has been investing in new capacity in this space. Figure 28 Global infant formulae market (~US$17Bn) Figure 29 Chinese imports by country SE Asia 18% Other 26% New Zealand 21% Japan 5% Middel East 4% China 36% Australia 5% Eastern Europe 6% Singapore 10% Western Europe 7% North America 19% South America 5% France 18% Netherlands 20% SOURCE: AS CORPORATION SOURCE: CN AGRI Farmgate pricing Farmgate milk prices are typically set on a July to June financial year or season basis. Milk rates consist of an opening pay rate and allowance for deferred loyalty payments that are linked to the operating performance of the business % of Australia s milk production finds its way in export markets (~44% in 2012) and as such international dairy prices and the Australian dollar are the largest drivers of farmgate pricing assumptions. Farmgate prices are driven by the level of returns generated by large Victorian processors, which account for two thirds of Australian production and heavily reliant on export markets. Prices paid to farmers are determined by export prices and milk solid content (butterfat and protein). Major co-operatives set farmgate prices based on net returns that can be achieved, making allowances for capital costs and workings capital. Regional variances in pricing are largely a function of transport costs and seasonal factors. Figure 30 Farmgate prices vs. production and commodity prices Figure 31 Farmgate milk prices vs. AUD dairy commodity price Price Index Farmgate Index Production Index Butter price (A$/t) - LHS Cheese price (A$/t) - LHS SMP price (A$/t) - LHS WMP price (A$/t) - LHS Farmgate milk price ( /L) - RHS SOURCE: FONTERRA GDT Page 14

15 Farmgate prices are a function of global dairy prices and regional supply/demand economics. In determining our farmgate prices estimates we look at both factors as discussed below: Milk commodity prices: Since 1967 there is a 96% correlation between farmgate milk prices and international dairy prices (in AUD terms). USD commodity prices and the strength of the AUD is the largest single driver of farmgate prices. Regional economics: Milk availability in the core catchments of BGA will impact the profitability of the business, with transport costs of milk high and shelf life limited, any weather induced production issues will impact prices paid. This is somewhat reflected in figure 31 which highlights that milk production can have an impact on farmgate prices (notably 2002, ). Significant investment in capacity in the last decade suggests pricing for milk intake is likely to remain competitive in the near term. In the last 9 seasons farmgate prices have tended to lift through the season which is why we see a traditional bias in EBITDA to the first half. Over the last four years milk costs have reflected 30-36% of COGS ad 27-33% of revenues for BGA. Page 15

16 Financial performance Revenue and earnings BGA has grown revenue at a compound rate of +7.2% pa over the last five years and this has broadly flowed through to EBITDA which has grown at +6.2% pa over the same time frame. Growth in the FMCG business with the acquisition of Strathmerton and securing contracts with Coles and Aldi has been the largest drivers of this growth with volumes lifting +9.4% pa over the same timeframe Figure 32 Revenue and Margin history Figure 33 Production and revenue per t 1, % 250,000 5,500 1, % 200,000 5,000 1, % ,000 4, % % 100,000 4, % 50,000 3, Bega revenue ($m) - LHS Tatura revenue ($m) - LHS Bega EBITDA margin (%) - RHS Tatura EBITDA margin (%) - RHS 0.0% Production ('000t) - LHS Revenue per ton ($) - RHS 3,000 SOURCE: FONTERRA GDT The heavy skew in earnings of BGA towards FMCG cost-plus contracts has also ensured that margins in the business have been more stable over time than other listed and unlisted dairy plays. This was particularly clear in 2009, when the Bega business significantly outperformed the performance of the export facing businesses of Murray Goulburn, WCB and Tatura when farmgate prices rose steeply. Figure 34 Sector EBITDA margins 10.0% Figure 35 Farmgate prices % % 4.0% 2.0% 0.0% % % Bega Cheese EBITDA Margin (%) Tatura EBITDA Margin (%) BGA EBITDA Margin (%) WCB EBITDA Margin (%) Murray Goulburn EBITDA Margin (%) Norco EBITDA Margin (%) Butter price (A$/t) - LHS Cheese price (A$/t) - LHS SMP price (A$/t) - LHS WMP price (A$/t) - LHS Farmgate milk price ( /L) - RHS BGA is reasonably reliant on the domestic cheese market and this can be characterised as mature with limited scope for growth, outside of a continued shift in sales mix from branded to private label (given the exposure BGA has to Aldi and Coles). Looking into FY14-15e we expect earnings growth for BGA to come from: 1. Continued push up the value chain: Investment in new infant formula capacity continues to see a push up the margin curve by BGA. We expect Nutritionals to make up ~10% of sales volumes by FY16e, reflecting growth of ~15% from FY13 levels. At Page 16

17 price points 30% above that of the core business this should generate a favourable margin shift. 2. Growth in international dairy prices: Prices for dairy commodities are cyclical by nature and subject to seasonal factors. The recent surge in USD dairy prices and weakening in the Australian dollar is likely to have a beneficial impact on the 30% of sales revenue in BGA which is export facing. 3. Production volumes: In line with industry growth rates we are forecasting growth in milk intake of % pa through to FY16, with average yield recoveries consistent with FY13 levels. This profile supports growth in volumes of %pa, which we expect will increasingly be sold into export markets, with BGA s exposure to fast growing markets in Asia (~24% of sales) and the Middle East (~4% of sales) likely to absorb the majority of this. Balance sheet and cashflow Net debt is highly manageable at 1.35x FY13 EBITDA and 0.7x when adjusted for liquid investments. Operating cashflow is also strong with EBITDA converted to operating cashflow averaging 75% since 2008 and 98% excluding FY12, when inventory was accumulated for the Coles supply contract. However, if successful in acquiring WCB Net Debt/EBITDA will lift to x, historically a high level for agricultural businesses. Figure 36 EBITDA operating cashflow conversion Figure 37 Net debt/ebitda ratio % % 120.0% 100.0% 80.0% Net Debt lifts to x ProForma FY14e EBITDA post WCB % % % (10.0) (20.0) Operating cashflow ($m) - LHS EBITDA operating cash realistaion (%) - RHS 0.0% -20.0% -40.0% SOURCE: FONTERRA GDT In FY13 BGA established a syndicated facility structure with; Cooperative Centrale Raiffeisen-Boerenleenbank B.A. and Westpac Banking Corporation. The facility includes a 3.5 year revolving cash advance facility of $80m due to expire on 31 January 2017 and a 5 year revolving cash advance facility of $60m is due to expire on 31 July In addition to the Syndicated Facilities, Bega Cheese and Tatura Milk continue to operate three separate banking facilities, including a $50m inventory facility and other facilities which consist of a Tatura milk overdraft facility and the VAT financing facility, totalling $8m. All these facilities were extended on 20 June 2013 until 1 July 2014 except for the VAT facility which is a revolving facility of $1.5m. At balance date BGA had $87m of undrawn facility headroom. Page 17

18 Board and management Barry Irvin AM Executive Chairman Bega Cheese Barry Irvin has extensive experience in the dairy industry and has been Chairman of Bega Cheese since Barry s leadership has seen Bega Cheese grow from a small regionally based dairy company to now one of the largest dairy companies in Australia, supplying a large range of dairy products in Australia and around the world. Barry s depth of knowledge of the industry includes a significant understanding of the issues affecting Australian dairy farmers, the key investments required to meet changing consumer needs and the management of long term customer relationships. Barry was awarded the NAB Agribusiness Leader of the Year in 2009 and the Rabobank Leadership Award for Barry is very aware of the importance of social responsibility, he has been Chairman of Giant Steps, an organisation providing services to children and young adults with autism since In 2008 Barry was awarded a Member of the Order of Australia for contributions to children with disability and the Australia dairy industry. Aidan Coleman - Chief Executive Officer Aidan was appointed CEO of Bega Cheese in May He has 28 years of experience in the international marketing and manufacturing of consumer dairy products and dairy ingredients primarily in Australia, New Zealand, China, Japan, South East Asia, Latin America and the Indian sub-continent. Aidan has held senior management positions in the dairy industry including MD-Fonterra Brands Australia, CEO of Bonland Dairies-Australia, MD New Zealand Milk in Sri-Lanka and was GM Consumer Foods at Tatua Dairy Co-op in New Zealand. In 2008 he was appointed CEO of Tatura Milk Industries in Australia prior to becoming CEO of Bega Cheese Limited. He holds a BA in economics and psychology from Auckland University, a Business Degree in marketing from Massey University in New Zealand and is a graduate of the Australian Institute of Company Directors. Aidan is a Director of Dairy Innovation Australia Limited, and Tatura Milk Industries Colin Griffin - Chief Financial Officer / Company Secretary Colin was born in the town of Bega and completed a BA (Accounting) in 1985 and after which he obtained his Chartered Accountant membership in With a background in auditing and corporate advisory at KPMG, Colin joined the Bega Cheese team as Finance Manager and Company Secretary in With 19 years experience in the dairy industry, Colin is a pivotal contributor to the strategic and corporate development of Bega Cheese. He leads the Group finance team and is responsible for finance, treasury, administration information technology and legal affairs. He is a Director of Tatura Milk Industries and Capitol Chilled Foods. Page 18

19 Shareholding structure and limit The shareholding structure of BGA is diverse with the Top 20 holders accounting for ~33% of the listed capital of the stock. This is a reflection of the former co-operative structure which sees a total of 3648 holders on the register with 80% holding fewer than 5,000 shares and 44% holding fewer than 1,000 shares. Figure 38 - BGA largest shareholders Holding Karara Capital 3.7% Perpetual 3.7% Paewai Pty Ltd 2.5% RE Platts 2.4% Aljo Pastoral Pty Ltd 2.0% SOURCE: COMPANY DATA AND BELL POTTER SECURITIES ESTIMATES SHAREHOLDER CAP There is a 5% shareholder cap in place until for the first two years from listing (18/08/13) and 10% cap from the end of the two year period and to the anniversary of the fifth year of listing (18/08/16). The Shareholding Limit must be put to Shareholders for renewal for another five years by way of ordinary resolution by no later than the fifth anniversary of the listing. If the Shareholding Limit is not renewed, it will automatically cease. If the Shareholding Limit is renewed, the Shareholding Limit will increase to 15% will automatically cease at the tenth anniversary. The Shareholding Limit will cease to have effect on the earlier of: (a) The Constitution being amended by special resolution of Shareholders to remove the Shareholding Limit; (b) The fifth anniversary of the Listing Date if the continuation of the Shareholding Limit is not approved by Shareholders at the fifth anniversary; or (c) The tenth anniversary of the Listing Date if the continuation of the Shareholding Limit is approved by Shareholders at the fifth anniversary. Page 19

20 Appendix: Milk production flows Figure 39 - Milk manufacturing process SOURCE: FONTERRA AND DAIRY AUSTRALIA Page 20

21 Valuation and risks COMPANY DESCRIPTION Bega Cheese Limited (BGA) is engaged in the processing, manufacturing and distribution of dairy and associated products to both Australian and international markets. BGA operates five processing facilities across NSW & VIC with the capacity to process ~250kt of product across three operating divisions while also holding strategic investments in both Warrnambool Cheese & Butter (18%) and CCFA (25%), a fresh milk processor in Canberra. INVESTMENT STRATEGY BGA is a unique exposure in the dairy segment, with a high level of contracted volumes, underpinning a more consistent returns profile than is typically associated with an agricultural investment. In addition BGA holds a leading position in the domestic cheese market, exposure to growing infant formulae demand in Asia and in the midst of a potentially highly EPS accretive acquisition of WCB. VALUATION Our $3.80ps target price for BGA is based on our ROIC methodology which incorporates an ROIC of 13.4% in FY14-16e and a pre-tax WACC of 9.6%, deriving an FY15E EV/EBITDA multiple of 8.16x for the base business, we then add back the WCB stake value. As a cross check we also look at international comps, highlight BGA trades at a 20-25% discount to the peer group. RISKS Risks facing BGA include but are not limited to: AUD commodity prices: With ~30% of revenues exposed to export markets, BGA is exposed to both movements in the AUD and global dairy commodity prices. While the impact is insulated sharp movements up or down can have a meaningful impact on profitability, particularly in the Tatura business. Seasonal risk factors: BGA is exposed to the impact of weather conditions such as droughts and other factors that may reduce the level of milk produced in the catchment area. Milk supply and costs: BGA purchases milk from dairy farmers on annual basis, seasonal factors or competitive response may limit supply or result in changes to farmgate milk pricing assumptions greater than we have allowed. Change in long-term relationships: BGA distributes its branded and other cheese products through long term cost plus contracts with companies including Fonterra, Kraf,, Coles and Aldi Any loss of a material cheese contract could hamper returns in the business. Page 21