Company Reports

We raise our fair value estimate for shares in no-moat-rated Bega by 5% to AUD 4.20, given the buoyant first-half fiscal 2024 profit in the core branded business. Adjusted EBITDA of AUD 77 million was 11% lower than in the first half of fiscal 2023. But considering hostile conditions in the bulk segment, the result is impressive. Profitability in the bulk division, which processes milk, was weighed down by high Australian farm gate milk prices and low global prices squeezing margins. The bulk division lost AUD 6 million versus a AUD 50 million EBITDA profit a year ago. The shares appear roughly fairly valued at current prices.

Despite Bega Group's strategic shift toward a more diverse product offering, we expect dairy products to continue to represent the majority of sales over the next decade, exposing the firm to commodity pricing and volatile input costs. In our view, Bega has not carved an economic moat required to consistently generate economic profits, and we expect its powerful customers to limit margin growth potential.

While Bega Group shares have recovered strongly from lows of less than AUD 2.50 in October 2023, they still screen as undervalued compared with our unchanged AUD 4 fair value estimate. While profitability in Bega’s bulk segment has collapsed, the branded segment remains resilient.

On a consolidated basis, no-moat Bega's fiscal 2023 result appeared to meet expectations. Underlying EBITDA slid 11% to AUD 160 million, in line with our forecast and company guidance. But the segmental breakdown was concerning, with the bulk business significantly more challenged than we appreciated—turning loss-making in the second half. Our prior thesis, for the elevated milk price to drive an increase in supply, supporting profitability in bulk is unlikely to play out, particularly now that the business is going to be materially smaller. We lower our fair value estimate for Bega by 18% to AUD 4.00 per share. We lower our fiscal 2024 EBITDA forecast to AUD 160 million, from AUD 182 million previously—at the bottom of Bega's guidance range of AUD 160 million to AUD 170 million. We cut our prior fiscal 2028 EBITDA forecast by 17% but expect Bega can reach its new medium-term EBITDA target of AUD 250 million by fiscal 2028, with earnings almost entirely driven by the branded business. We had previously expected bulk to be about one third of earnings by fiscal 2028, now it accounts for just 10%. Despite the cut to our valuation, shares still screen undervalued. We estimate the strength of the branded segment alone can justify Bega's current stock price, with bulk offering potential upside should the business turn around faster than we expect.

That Bega's first-half fiscal 2023 result was weak is not particularly surprising given the impact of cost inflation on the business. However, it was weaker than expected, particularly in the branded segment. Partly this reflects the pricing cycle and the impact of rising raw materials costs on Bega. But it is also a reflection of Bega's inability to timely renegotiate prices and the importance of powerful supermarket customers to Bega's profitability. Adjusted net profit after tax for the first half of fiscal 2023 declined 74% to AUD 10 million or 2.7 cents per share compared with the same half in fiscal 2022.

Near-term profitability is under pressure at Inghams and Bega. Input costs, notably labour, chicken feed, and milk, are elevated, and the firms have been unable to pass through increased costs in their entirety. Bega and Inghams are both highly reliant on supermarket giants Coles and Woolworths. Together the latter account for about two thirds of food retailing in Australia, and command substantial bargaining power over suppliers. We don't think Inghams or Bega have garnered brand equity sufficient to warrant an economic moat. We think the balance of power lies with the supermarkets, keeping a lid on margins.

We maintain our AUD 5.20 fair value estimate for no-moat Bega following the release of fiscal 2022 results. Underlying EBITDA was AUD 180 million, up 6% from the prior year and 5% below our forecast. The period was marred by pandemic-related cost increases, mostly from high absenteeism as staff were forced into isolation, and elevated input costs weighing on margins. However, the earnings impact was more than offset by the first full year of earnings from the Lion Dairy and Drinks acquisition coming online.

We maintain our AUD 5.20 fair value estimate for shares in no-moat Bega Cheese following a trading update. Given elevated pandemic-related costs, rising input costs, and supply chain disruptions, Bega has lowered its fiscal 2022 EBITDA guidance to AUD 175 million to AUD 190 million, from AUD 195 million to AUD 215 million previously. We make no changes to our fiscal 2022 EBITDA forecast of AUD 190 million, which now sits at the top of the firm's amended guidance range.

We maintain our AUD 5.20 fair value estimate for shares in no-moat Bega Cheese following its reported earnings for the first half of fiscal 2022. Underlying EBITDA, which excludes one-off items including transaction costs related to the Lion Dairy and Drinks acquisition, lifted 46% on the prior corresponding period to AUD 106 million. The sizable increase in EBITDA represents the inclusion of earnings from the Lion Dairy and Drinks business--now Bega Dairy and Drinks--from January 2021. Bega declared an interim dividend of AUD 5.5 cents per share, up 10% on the prior corresponding period, and we continue to forecast full-year dividends of AUD 11 cents per share, an increase of 10% on fiscal 2021. We expect Bega can comfortably continue to pay out 50% of EPS without compromising its organic expansion plans while continuing to partake in industry rationalization via acquisitions.

Bega Cheese's environmental, social and governance, or ESG, risks primarily relate to carbon emissions, waste generation, and resource use. The firm's value chain exposes the company to penalties from breaching environmental protection regulations, tarnished community relations or increased operating expenditure. Food manufacturing and distribution is energy-, water-, and waste-intensive, and sourcing raw materials is water-intensive and creates emissions such as methane and pesticides. We estimate at least 70% of Bega's energy consumption is from fossil fuel generation.

We raise of fair value estimate for Bega Cheese by 4% to AUD 5.00 per share due in equal parts to improving margins in the bulk business and time value of money following the first half fiscal 2021 result. First half normalized EBITDA increased 51% relative to the prior corresponding period to AUD 73 million as a shift toward higher-margin products within the bulk business offset lower direct milk volumes and weaker commodity milk prices. Bega completed the acquisition of Lion Dairy and Drinks in January 2021 and we forecast the acquisition to contribute AUD 12 million of EBITDA in the second half. Despite slightly softer revenue than anticipated, earnings were broadly in line with our expectations and we maintain our fiscal 2021 EBITDA forecast of AUD 138 million. Bega declared an interim dividend of AUD 0.05 per share, in line with our unchanged full-year forecast of AUD 0.10 per share.

We initiate coverage of Bega Cheese, an Australian dairy processor and food manufacturer of well-known brands including Bega Cheese and Vegemite, with a fair value estimate of AUD 4.60. Bega generates approximately 70% of its sales from the Australian market, with the remainder from exports, primarily to Asia. Despite a strategic shift in focus towards becoming a diversified branded consumer packaged food business, we expect most of Bega's sales over the next decade to continue to come from the dairy category. In our view, Bega has not carved an economic moat required to sustainably earn economic profits, and we expect the firm's powerful supermarket customers to limit margin growth. Fiscal 2020 is likely to be disappointing as increased input costs and lower production volumes, largely stemming from drought in the Tatura region, weigh on near-term margins. We forecast underlying earnings to fall 33% to AUD 26 million.