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Quantum’s improved, but struggling to win investor trust

Why Intellidex gives its shares a ‘speculative buy’ recommendation.

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While Quantum Foods is in much better shape than when it was unbundled from Pioneer Foods two years ago, it is struggling to win the trust of investors. Its shares have shed more than a third of their listing value on the back of subdued earnings.

In the year to end-September its headline earnings fell 48% to 28c/share (FY15: 54c/share) on the back of a 56% plunge in operating profit. Revenue was, however,13% higher at R3.9 billion (FY15: R3.5 billion).

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There is little Quantum could have done to avert its poor performance since listing; much of it was due to industry factors. About a year after its listing, SA’s agricultural output was the worst in about 40 years due to the drought. This saw feed costs – the most important factor in the profit equation of chicken companies – rise strongly. Safex yellow maize futures peaked at about R4 000/tonne, way higher than the historical average range of R2 000/tonne to R2 300/tonne. Soya beans futures at one point this year traded at R7 500/tonne against their historical average of about R5 300/tonne.

Given those cost dynamics, it is difficult for poultry companies to grow earnings. Quantum estimates that a R100 change in the price of a tonne of yellow maize affects operating profit by R8.1 million, while a similar movement in the price of soya beans affects operating profit by R1.1 million.

A spike in poultry imports over the past year exacerbated the situation. In March this year nearly 60 000 tonnes of poultry products – the highest monthly import volume in three years – were imported as the SA-US Agoa trade agreement took effect. Furthermore, the gazetting earlier this year of lower limits on brine levels for chicken created negative sentiment over poultry stocks, even though Quantum is not directly affected.

While we expect conditions to remain tight in the short term, we are encouraged by the declining trend in input costs. Futures contracts for yellow maize with deliveries in April and July next year are trading at R2 584/tonne, way below what players were paying a few months ago. Poultry producers typically buy their supply requirements on the futures market six or so months ahead. This means the lower prices should start reflecting in the second half of next year.

Based on that assumption we value Quantum at R4.49/share, which gives it a ‘buy’ rating. The key attraction with Quantum is its valuation; it is on a forward price:earnings ratio of 3.9, which does not seem to tie in with its declining input costs. We are also encouraged by the changes in the group’s broiler model.

Following the sale of its last abattoir to Sovereign Food last year, Quantum no longer sells final products into the broiler meat market but sells live broilers to other abattoirs. It has secured supply contracts that effectively hedge its exposure to the commoditised broiler meat market in South Africa.

The ‘buy’ call is, however, speculative. It is based on the assumption of a good 2016/17 farming season, which can be affected by factors other than the rainfall.

Bull factors
• Changes in the broiler business model reduce market risk
• Declining futures prices for chicken feed products to bolster earnings

Bear factors
• Sluggish growth in consumer spending

Nature of business: Quantum Foods is a primary agriculture business with three focus areas: animal feeds, eggs and layer livestock and broilers. It operates in SA, Zambia and Uganda.

Disclosures: The analyst has no financial exposure to the instrument discussed. The opinion represents his true view. For Intellidex’s full disclaimer, methodologies and definitions please click here.

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