TASSAL made an announcement about its salmon distribution last week and withdrew from bidding for two supply contracts for Coles which will expire in 2016 financial year (FY16).
The underlying problem is that salmon productivity this year is likely to be lower than expected as a result of warm ocean water. Since Tassal (ASX code TGR) is integrated into the supply chains of all the big supermarkets, my interpretation is that it was prudent to forego certain business to ensure they could meet all their supply obligations. Excess lost sales volume will be sold into export markets, where a low Australian Dollar and higher prices anticipated later in the year due to the supply shortage, may offset earnings lost due to production volume shortfalls caused by the warm water. This should result in higher margins.
I like the underlying fundamentals of aquacultural stocks, given structural growth in demand for seafood. TGR has been sold off post the half yearly result (2016) and is now approaching value territory, albeit with higher risk. The disappointment and comments by management at the result of potential pricing pressures but a stronger second-half result will probably contribute to a more cautious approach by investors, until there is more detail about the performance of the DeCosti acquisition (which occurred in August 2015).
I believe the market may be underestimating the synergies from this acquisition both on the cost and revenue side over the medium term. Tassal is now a leader in the Australian Salmon and Seafood market. The optimising of supply chain is likely to take another 18 months to achieve material benefits to earnings. The business is well managed and the recent decision to forgo next season fresh salmon contracts with Coles to maintain margins and ensure ability to meet market demand is a prudent one for the business long term.
A catalyst for a re-rating in TGR is likely to occur at the FY16 result in August when TGR provides an update to reassure the market, the integration is exceeding expectations and margins have been maintained with an increase expected in FY17, following a mix shift to whoelsale channels.
*Christopher Hindmarsh is an adviser at JBWere Limited which is owned by NAB. Email christopher.hindmarsh@jbwere.com or contact (02) 9325 2639. This article contains general advice only. In preparing it JBWere didn't take into account the investment objectives, financial situation and needs of any particular person. Readers should assess if the information is appropriate for their circumstances, or contact a licensed financial adviser.
