Astral has had a very good year. The poultry division has recovered its profitability remarkably following tariffs imposed on European poultry imports by SA. This is in addition to trade restrictions already in place against Brazil, a natural low-cost producer. Astral’s annual results show that value was created from increases in sales volumes and prices as well as in improved production efficiencies.
This year will prove difficult for three reasons: additional poultry imports from the US have recently been approved; SA is suffering under a drought; and the weak rand will push up the export-parity price of maize and other imported inputs. It is possible that market prices will increase because of the drought, but prices tend to be constrained by imports that will not face the same climactic factors. As in the past, overcapacity is compromising the industry’s ability to pass on price increases to track rising input cost.
Prior to the 2014 poultry tariffs, imports were estimated at 30% of local production and they fell by 6% post-tariff implementation. However, with the approval of 65 000 tonnes of imports from the US to satisfy the US African Growth and Opportunity Act (Agoa) requirements, it looks like imports will revert to their pre-tariff volumes.
Another negative overhang is that the agriculture, forestry and fisheries department is still to implement its promises to the World Trade Organisation in 2013 that it would cap brining levels (injecting fluids to add weight and flavour) at 15%, from about 30%. That would force producers to increase prices, a seemingly unsustainable move given the threat of cheaper imports. Perhaps import quotas can be more effective.
While the macro environment is bleak, SA has deep-seated structural challenges affecting both the demand and supply sides of the economy. However, in the long term, Africa offers huge market potential as rapid urbanisation promotes rising incomes and people substitute starch with meat protein. Africa’s annual consumption of chicken is 4.1kg/capita compared with 9.9kg/capita for the developing world and a global average of 13.2kg/capita. But there are peculiar micro and macro challenges to doing business in Africa. In the year under review Astral experienced forex-related losses in Zambia and in the past has suffered losses related to unskilled labour. Furthermore, the expected growth in demand is not exciting in the short to medium term.
The supply-demand dynamics of the poultry industry are not convincing from an investment perspective. While much has been done to protect the industry, through Agoa, the government seems willing to sacrifice the sector for the greater good of the economy.
From a purely economic perspective, a globally uncompetitive industry is unsustainable in the long run. For the South African poultry industry, even with protectionist policies, the influx of cheap imports still presents challenges.
On a surface level, Astral has a very attractive valuation profile. It has a price:earnings ratio of 5.8 (similar to it listed peers Sovereign and Quantum) and a very generous dividend yield of 9.8%. Our discounted cash-flow valuation suggests significant upward potential, which is not uncommon with low price:earnings counters. However, we think it is too risky given the supply-demand dynamics. As such we think investors are better off putting their money in other sectors.
The share price has lost a third of its value since the beginning of November on the back of the drought and US imports. The March 2016 futures contract for yellow maize rose 16% in the same period. Although our recommendation for average retail investors is a sell, risk-seeking investors might want to take a speculative punt on it because if Astral can maintain its margins in the face of these numerous risks, it would be undervalued at the current share price.
Disclosures: The analyst has no financial exposure to the instrument discussed. The opinion represents his true view.