ArborGen Holdings — Green shoots appear in the spring

ArborGen Holdings (NZX: ARB)

Last close As at 21/02/2024

NZD0.16

0.00 (0.00%)

Market capitalisation

NZD87m

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Research: Industrials

ArborGen Holdings — Green shoots appear in the spring

We believe ArborGen Holdings is in prime position, not only to address increasing demands from clients for its seedlings, but also for its ongoing investment in genetic improvement to continue to drive the switch to sales of higher-value, higher-margin seedlings to all its key markets. While this process plays out, underlying EBIT is set to increase five-fold in the next two years as gross margins return to and then exceed historical levels. We determine a value of NZ$0.49/share, implying attractive upside.

Andy Murphy

Written by

Andy Murphy

Director, Financials & Industrials

forestry04

Industrials

ArborGen Holdings

Green shoots appear in the spring

FY23 results

Basic materials

24 July 2023

Price

NZ$0.19

Market cap

NZ$96m

US$0.61/NZ$

Net debt, ex leases at 31 March 2023

US$13.0m

Shares in issue

506.3

Free float

34%

Code

ARB

Primary exchange

NZX

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

0.5

(2.1)

(17.3)

Rel (local)

(0.7)

(1.8)

(19.6)

52-week high/low

NZ$0.24

NZ$0.18

Business description

ArborGen Holdings is a New Zealand-listed investment company and is the world’s largest integrated developer, commercial manufacturer and supplier of advanced forestry seedlings, with operations in the United States and Brazil.

Next events

Interims

November 2023

Prelims

May 2024

Analysts

Andy Murphy

+44 (0)20 3077 5700

Natalya Davies

+44 (0)20 3077 5700

ArborGen Holdings is a research client of Edison Investment Research Limited

We believe ArborGen Holdings is in prime position, not only to address increasing demands from clients for its seedlings, but also for its ongoing investment in genetic improvement to continue to drive the switch to sales of higher-value, higher-margin seedlings to all its key markets. While this process plays out, underlying EBIT is set to increase five-fold in the next two years as gross margins return to and then exceed historical levels. We determine a value of NZ$0.49/share, implying attractive upside.

Year end

Revenue (US$m)

EBITDA*
(US$m)

EBIT**
(US$m)

EPS
(c)

P/E
(x)

Net debt*** (US$m)

03/22

47.6

10.1

2.7

0.3

33.2

16.5

03/23

56.1

9.2

1.6

(0.5)

N/A

17.9

03/24e

68.0

14.4

6.8

0.8

13.6

11.4

03/25e

74.7

17.1

9.5

1.2

9.3

6.5

Note: *EBITDA is US GAAP, adjusting for investments in intellectual property, government grants, inventory adjustments, public company costs and exceptionals. **EBIT excludes strategic review costs, grants and exceptionals. ***Includes capitalised leases.

Investment drives genetic improvement

ArborGen has evolved into an advanced developer and supplier of advanced genetics pine and eucalyptus seedlings in the US South and Brazil, and is increasingly looking to develop a presence in the high-growth carbon markets. Its technology-driven genetic development programmes are producing seedlings that are significantly more productive (tons/acre) and valuable (higher % of sawtimber) versus lower gen trees. These latest-generation mass control pollinated (MCP) seedlings deliver significant step-change gains to forest owners and command price premiums 2–4 times that of earlier-generation open pollinated (OP) seedlings. The ongoing switch to higher-priced MCP seedlings and continued strong growth in Brazil is expected to drive margins and profits materially higher.

Outlook improving in US and Brazil and in carbon

Management is expecting a ‘materially’ improved performance in FY24, driven by increased volumes of seedling sales in the US (including MCP seedlings) and in Brazil from sales of eucalyptus and pine seedlings, higher seedling sales in carbon markets and improved gross margins from lower MCP seed costs and recent expansionary activity. This confidence is based on the knowledge that despite being in the early stages of the current financial year, ArborGen has already sold over 80% of its budgeted seeding volumes in the US and in Brazil it has sold all its budgeted eucalyptus seedings and c 80% of its budgeted pine seedlings.

Valuation: DCF offers material upside

We believe there are a number of drivers of revenue growth that will push the top line in a positive direction, which will be augmented by margin expansion, thus allowing underlying EBIT to increase five-fold over the next two years. Furthermore, the business should see cash generation improve as profits rise and the build-up in working capital eases. This should result in reduced net debt such that balance sheet capacity expands, offering increased optionality in future years. These characteristics are reflected on our DCF, which implies a value for ArborGen of NZ$0.49/share, materially above the current share price.

Investment summary

Company description: World’s largest tree seedling supplier

ArborGen Holdings claims to be the world’s leading commercial supplier of advanced genetics tree seedlings, specialising in loblolly (pine) in the United States, and eucalyptus and pine plantation forestry species in Brazil. It is a leading provider of advanced genetics for the forest industry in these regions, operating across the entire technology spectrum and offering high-value products that significantly improve the productivity of a given acre of forestry land.

ArborGen is developing and expanding its pipeline of industry-leading advanced genetics, including building a future supply of high-value premium MCP products in the United States and transitioning its customers from OP genetics to advanced genetics in the United States, where it believes its largest earnings uplift will come from in the future.

Its MCP seed production is projected to grow significantly as its larger, younger and more advanced seed orchards approach their maximum seed-yielding years, the direct result of investments made in expanding its MCP orchard capacity five to 10 years ago, allowing it to meet growing demand for its products and build sufficient inventory to mitigate adverse weather events.

Its production assets are located across the United States southern forestry region and in Brazil, comprising 14 seedling production nurseries (eight in the US and six in Brazil) and 10 seed-producing orchards in the US. It has overall production capacity of more than 450m seedlings in the US South and Brazil (including outsourced production).

ArborGen has extensive ongoing field trials throughout the US demonstrating the performance of its advanced genetic products. Furthermore, ArborGen is the only company in Brazil offering proprietary, advanced genetic pine and eucalyptus products to the market. Customers include integrated companies with their own tree improvement programmes needing genetic alternatives, which represent approximately 40% of ArborGen’s sales in Brazil.

Valuation: Attractive volume and margin-driven growth

Our discounted cash flow (DCF) points to a valuation of US$0.30/share, which at an exchange rate of US$0.61/NZ$ translates to NZ$0.49/share, versus the current share price of NZ$0.19, implying material upside. The attractive potential upside is largely driven by the strategy to increase sales of higher value, higher margin MCP seedlings compared to a low starting point.

Our sensitivity table (Exhibit 10) gives an indication of the potential upside if the cost of capital falls from the 9.9% in our DCF model, or the terminal growth rate edges up from the 3% we have assumed to, say, 5%. Much of the seedling output is destined for the (residential) new construction and remodelling markets in the US and, pulp markets in Brazil. Given the increasing populations of both the US and Brazil, it seems likely that long-term demand for timber should remain robust.

Financials: Solid FY23, material improvement in FY24e

FY23 group revenue increased by 17.9% to US$56.1m, principally driven by strong revenue growth in Brazil. Gross profit edged up 2.2% to US$18.2m, which implied a 500bp drop in the gross margin. The increase in administration costs led to lower underlying operating earnings (ie profit before exceptionals and therefore a measure of underlying profit) of US$1.6m, down from US$2.7m in FY22.

Management expects a ‘materially’ improved performance in FY24, driven by increased volumes of seedling sales in the US (including MCP seedlings), and in Brazil from sales of eucalyptus and pine seedlings, higher seedling sales in carbon markets and improved gross margins from lower MCP seed costs and recent expansionary activity This optimism underpins our strong earnings growth expectations from relatively low levels. By FY25, we anticipate a five-fold increase in underlying EBIT versus FY23.

Sensitivities: Relatively limited downside sensitivities

ArborGen is particularly sensitive to the prices it achieves for both its OP and MCP seedlings. Lower-priced OP seedlings are slowly being phased down in favour of the higher-value and faster-growing MCP seedlings. Clearly, in an inflationary environment, ArborGen’s own costs are rising, but revenue growth, operational improvements, lower seed costs and expansionary activity are all expected to allow for gross margin expansion. Transportation and fertiliser costs can also fluctuate. Clearly, ArborGen has risks, which include adverse weather that can damage orchards and seedlings, as well as disease and parasites, which could affect output. Interest rates can also have an impact but, with relatively modest debt levels, this sensitivity is manageable. We are not aware of any technical or regulatory issues that could affect the stock or its ability to trade.

Leader in expanding forestry seedling markets

ArborGen has evolved into one of the most advanced developers and suppliers of pine and eucalyptus seedlings in the US South and Brazil, and is increasingly looking to develop a presence in the high-growth carbon markets. Its technology-driven genetic development programmes are now producing seedlings that are significantly more productive (tons/acre) and valuable (higher % of sawtimber) versus lower gen trees. These latest-generation MCP seedlings deliver significant step-change gains to forest owners and command price premiums, 2–4 times that of earlier-generation OP seedlings. Volume growth in the US and Brazil and increased MCP seedling sales growth in the US is expected to drive c 15% pa revenue growth on average and is expected to drive margins and profits materially higher over the medium to long term. We expect FY24 to be a record year for ArborGen, with further growth thereafter.

Expansion strategy in US South and Brazil

ArborGen is one of the largest commercial global seedling suppliers and a leading provider of advanced genetics seedlings for the forest industry. Its operations are focused on the high-growth markets in the US South and Brazil, as well as on the new and emerging high-growth carbon markets.

US South (FY23: 73% of volumes, 70% of group revenue)

In the US, ArborGen is focusing on converting customers from lower value OP seedlings to much higher-value, advanced genetic loblolly (pine) MCP seedlings, which yield materially greater volumes of higher-value wood at an earlier stage in the growth cycle and are therefore generating step-change value gains for forest-owning clients. ArborGen is building its MCP seed inventory to meet anticipated future demand and mitigate supply risks. Furthermore, it is looking to leverage its recent expansion of container production facilities and is evaluating other expansion opportunities. The benefits of the expansion projects are expected to be seen in the current financial year, including increased sales, cost savings from increased production efficiencies and incremental margins from the additional volumes sold.

Brazil (FY23: 27% of volumes, 30% of group revenue)

In Brazil, ArborGen is looking to build on its market-leading position in eucalyptus and loblolly pine seedlings and leverage its ‘best-in-class products’ to drive profitability. It is also integrating its recently acquired and leased nurseries, while also continuing to investigate other potential production expansion opportunities.

Carbon markets

Planting trees for high-growth carbon markets is an emerging expansion opportunity for ArborGen. Carbon project developers are actively pursuing large-scale afforestation and reforestation projects in the Southern US. ArborGen is actively engaged with several of these companies to provide both advanced genetics pine seedlings and hardwood seedlings; it has executed a long-term seedling supply agreement with one such company and is working to execute others.

ArborGen driving advanced genetics

ArborGen is one of the largest commercial global seedling suppliers and a leading provider of advanced genetics seedlings for the forest industry. OP seedlings are produced by taking seeds from the best available mother plant and fertilising them naturally with pollen from an unknown father tree. ArborGen sells different grades of OP seedlings ranging from advanced to elite, and MCP seedlings ranging from Advanced to 2.0, each more productive and more valuable than the previous grade.

MCP seed is produced from crossing specific elite mother and father parent trees to generate seeds with the highest genetic potential. The process involves pollen from ArborGen’s highest performing father trees being applied to flowers of ArborGen’s best mother trees in a controlled manner. MCP seed is more expensive to develop and produce but generates significantly more value to the forest owner and hence commands higher pricing. This continuous development of seedlings to produce bigger, faster growing and more disease resistant seedlings is how ArborGen hopes to retain its leading position in the field of loblolly genetics.

Exhibit 1: Advantages of advanced genetic seedlings

Source: ArborGen Holdings, report and accounts 2023

Exhibit 2 highlights the attractions of advanced genetic seedlings in terms of the shorter duration of time to first thinning, the higher yield at that point and the significantly higher yield at final harvest. As well as developing seedlings that develop greater sawtimber percentages, the phenotypic (relating to the observable characteristics of an individual resulting from the interaction of its genotype with the environment) variation is much reduced, which means that the size and characteristics of the trees are similar, which helps with processing the sawn timber at harvest and results in reduced waste and increased yield.

Exhibit 2: Comparison of performance of advanced genetic seedlings.

Source: ArborGen Holdings, from 2023 Annual Report and Accounts

More productive seedlings command premium prices

The increase in anticipated timber volume per seedling is reflected in the average price per seedling. The average price of OP bareroot seedlings in FY23 was c US$0.07/seedling, while the average price for MCP bareroot seedlings was c US$0.20, nearly three times as much. Over the last four years, ArborGen has been switching from OP to MCP volumes. In FY20, MCP and Varietal accounted for c 30% of loblolly sales by volume, and this has since grown to c 41%. The company expects the proportion of MCP seedlings to increase over the medium term. While seed production costs are higher for MCP seed, due in part to the increase in manual labour required, seedling production costs are the same for both OP and MCP.

In terms of overall US seedling revenue over the same period, loblolly OP revenue has declined from c 42% of total US seedling revenue to c 31%, with the percentage expected to continue to decline over the medium term as MCP volumes and revenues increase.

Progress on US initiatives continues apace

ArborGen has three strategic growth initiatives: the United States, Brazil and the emerging carbon markets. Some of its initiatives relate to growth, while others relate to reducing external risks as well as maintaining ArborGen’s leading proprietary genetics advantage.

In the United States, ArborGen’s core growth initiative is driving increased adoption of advanced genetics across the US South as the leading commercial supplier of advanced genetics loblolly seedlings, leveraging years of investment in developing best-in-class proprietary MCP products and growing the supply of proprietary genetics. In order to achieve this ArborGen is:

Building MCP seed inventory: ArborGen has vast seed orchards in the US South spanning c 1,200 acres (85% of which are loblolly pine), across five genetic provenances. To ensure that it has adequate seed each year to produce the volume of advanced genetics seedlings required to meet demand and desired sales growth, ArborGen is targeting to build at least two years of ‘buffer’ MCP seed inventory for each provenance, thereby minimising its reliance on single-year cone harvests. ArborGen expects to reach the two-year target for all regions by 2028 and has already met the target in Texas, with two other regions likely to hit targets in the next two years.

Diversifying its orchard by geography and age class: to lower the risk of an extreme weather event, or the spread of disease, ArborGen is addressing provenances that lack sufficient geographic distribution by establishing orchards in additional locations, especially towards its western regions and further away from the risk of a major hurricane in the east. It also recycles older trees with younger trees that can better withstand tropical force winds, again reducing external risks to seed production.

Incorporating new genetics: new genetics are essential to maintain a competitive advantage and industry-leading orchards. The traditional establishment of orchards using backward selections will be modified to give ArborGen the opportunity to incorporate forward selections directly into new orchards. Backward selections are parents whose seedlings have been tested in the field and performance is confirmed in progeny trials. Forward selections are predicted to be good parents, but their seed has not been tested in trials. Forward selection was previously viewed as too risky, but new analytical methods and breeding approaches offer ArborGen a much greater degree of confidence, saving up to 12 years in a cycle (see Exhibit 4).

Exhibit 3: Backward and forward selection time scale

Source: ArborGen Holdings

In addition to the drive to grow MCP adoption, ArborGen is expanding container seedling capacity where appropriate: in FY23, ArborGen successfully completed the commissioning of a new container facility at its Bullard nursery in Texas, and the expansion of its existing container facility in Bellville, Georgia. The benefits from these projects are expected to be seen in the current financial year, including increased sales, cost savings from increased production efficiencies and incremental margins from the additional volumes sold.

In Brazil, the eucalyptus pulp market has become very well established and the market has collectively announced plans to expand total pulp production by c 30%, which implies annual demand for eucalyptus seedlings of c 1.2bn pa. ArborGen estimates that c 500m seedlings will be supplied by the integrated pulp companies, and a further 500m+ will be supplied by a network of seedling suppliers. This leaves an imbalance of c 100–200m seedlings pa, which ArborGen could address. In FY23, ArborGen sold 80m seedlings into the Brazilian market, implying material potential for growth. Furthermore, the domestic supply market has been shrinking for several years due to a weak market, poor management and weak capitalisation of independent nurseries, and yields have fallen. ArborGen’s genetically superior seedlings, which produce higher yields, should be in high demand in these circumstances.

In order to address this opportunity, ArborGen has already rolled out its successful US strategy in the Brazilian market, which has seen it develop best-in-class products, establish a network of both in-house and contract nurseries and establish operating and logistical systems that allow it to offer reliable service and high-quality products across several regions and production sites. This implies that ArborGen has established itself as the preferred partner to both suppliers and customers.

To address the growth opportunities, over the last 18 months, ArborGen has acquired a 10m seedling pine nursery in Santa Catarina and leased a fourth eucalyptus nursery at the end of FY23, bringing the total internal capacity up to nearly 50m seedlings pa, and in H124 it leased a fifth eucalyptus nursery adding c 5m seedling capacity. FY24 has started well, with the company having already sold all of its budgeted eucalyptus seedlings for the current year and 80% of its budgeted pine seedling sales.

As the role that trees can play in the capture of greenhouse gases becomes increasingly accepted, global carbon markets are emerging and ArborGen is uniquely positioned to take advantage by supplying its genetically advanced pine and hardwood seedlings to carbon project developers. ArborGen is already engaged with various carbon registries and carbon companies with a view to supplying seedlings to large-scale afforestation projects, particularly in the Southern US. It has already agreed one long-term supply agreement and is hopeful that others will be forthcoming.

FY23 results show good revenue growth

FY23 group revenue increased 17.9% to US$56.1m, principally driven by strong revenue growth in Brazil. Revenue from the US was down slightly versus the previous year. Gross profit edged up 2.2% to US$18.2m, which implied a 500bp drop in the gross margin driven largely by some volume production losses and higher one-off MCP seed production costs. The increase in administration costs, largely due to the inclusion of an FX gain of $1m in FY22 relating to the disposal of the New Zealand operations, also led to a lower underlying operating earnings (ie profit before exceptionals and therefore a measure of underlying profits) figure of US$1.6m, down from US$2.7m in FY22. ArborGen reported an operating profit before financial expenses of US$2.2m, compared to a loss of US$1.3m in FY22, primarily due to net exceptional expenses in FY22 of US$4m, compared to an exceptional income of US$0.6m included in FY23.

These one-off costs account for the increase in EBITDA (US GAAP) from US$7.6m to US$10.3m, and a decline in adjusted US GAAP EBITDA from US$10.1m to US$9.2m. Net debt in the period increased from US$11.5m to US$13.0m for several reasons, including the late receipt of US$2.4m of COVID-19 related grant payments (received since FY23 year end.), higher costs associated with the US container expansion project (partly due to greater than expected capacity), a working capital increase in Brazil due to the expansion of nurseries and lower earnings in the US.

Exhibit 4: FY23 results summary

US$m

FY22

FY23

Change (%)

Revenue

47.6

56.1

17.9%

Gross profit

17.8

18.2

2.2%

Gross profit margin (%)

37.4%

32.4%

-5.0%

Operating earnings (before other significant items)

2.7

1.6

-40.7%

Operating profit before financial expenses

(1.3)

2.2

N/A

EBITDA – US GAAP

7.6

10.3

35.5%

EBITDA – adjusted US GAAP

10.1

9.2

-8.9%

Net cash/(debt) (ex-leases)

(11.5)

(13.0)

13.0%

Source: ArborGen Holdings, Edison Investment Research

The volumes of seedling sales in the US and Brazil took materially different paths in FY23. In the US, the total volume of seedlings sold fell 3.9%, from 284m to 273m, for two reasons: 1) production losses at agriculture sites (due to yield issues with hardwood species and some operational issues with loblolly on a nursery site where ArborGen had not grown pine but chose to do so in FY23; this has been stopped); and 2) lower sales in National Accounts year-on-year because of customer specific issues but this was largely offset by private landowner sales. It is worth noting here that ArborGen has been successful in raising average selling prices in each of the last three years, and we anticipate that this trend to continue as it sells a greater proportion of high value seedlings.

In Brazil, the volume of seedlings sold rose 35% to 102m and included 80m eucalyptus seedlings and 22m pine seedlings. The volume increase was driven by increased production capacity and increased sales of advanced genetics volumes and pricing was positively supported by a strong demand profile. It is also benefiting from an increased proportion of sales from its internal production capacity.

Exhibit 5: Seedling sales volumes (m) by country/year

Exhibit 6: Average seedling price by country/yr (US$)

Source: ArborGen Holdings actuals, Edison Investment Research, estimates

Source: ArborGen Holdings actuals, Edison Investment Research estimates

Exhibit 5: Seedling sales volumes (m) by country/year

Source: ArborGen Holdings actuals, Edison Investment Research, estimates

Exhibit 6: Average seedling price by country/yr (US$)

Source: ArborGen Holdings actuals, Edison Investment Research estimates

Revenue in the US has been fairly static at c US$40m in each of the last four years, largely due to the impact of the COVID-19 pandemic. This highlights the resilience of the markets in which ArborGen operates. In Brazil though, growth in FY23 has been material and especially so in the most recent period. This reflects the operation of newly leased nurseries and a return to better pricing following an extended recessionary period, exacerbated by the effects of the pandemic. The outlook for both geographies is encouraging, as illustrated in Exhibit 8 below, reflecting our estimates.

Exhibit 7: Revenue by country (US$m)

Source: ArborGen Holdings actuals, Edison Investment Research estimates

Despite the increase in both revenue and gross profit over the last two years, gross margins came under significant pressure in FY23 due to some lost production and increased production costs. Management believes that this is a temporary phenomenon and that the anticipated increase in volumes and prices in both regions will lead to a recovery in gross margins in FY24. We believe that these trends are reflected in the material increase in EBITDA (adjusted US GAAP) in both FY24 and FY25 in our estimates.

Exhibit 8: Profit and margin measures (US$m and %)

Source: ArborGen Holdings, actuals, Edison Investment Research, estimates

Outlook improving for volumes and mix

Management is expecting a ‘materially’ improved performance in FY24, driven by increased volumes of seedling sales in the US (including MCP seedlings) and in Brazil from sales of eucalyptus and pine seedlings, higher seedling sales in carbon markets and improved gross margins from lower MCP seed costs and recent expansionary activity. This confidence is based on the knowledge that despite being in the early stages of the current financial year, ArborGen has already sold over 70% of its budgeted seeding volumes (including c 85% of budgeted MCP volumes) in the US and in Brazil it has sold all its budgeted eucalyptus seedings and c 80% of its budgeted pine seedlings.

ArborGen does not expect the overall market in the US to grow this year due to the tightening monetary policy, but it does expect internal actions such as the increase in internal container seedling production and higher sales into carbon markets to boost sales, and that lower MCP seed costs and other cost initiatives will combine with higher selling prices to boost the gross margin and overall earnings.

In Brazil, ArborGen anticipates that the strong underlying market will persist, driving stronger sales of both eucalyptus and pine seedlings. Successful integration of a 10 million capacity pine nursery located in Canoinhas, Santa Catarina, and of ArborGen’s fourth eucalyptus nursery in Brazil, which brings ArborGen’s internal eucalyptus production capacity in Brazil to nearly 50 million seedlings per year, will drive volumes. It also anticipates higher sales prices and better margins.

These trends are reflected in our forecasts, which show revenue increasing c 21.2% to US$68m in FY24 and to US$75m in FY25, and operating profit increasing five-fold from US$1.6m in FY23 to US$9.5m in FY25.

Financials sound, valuation offers material upside

We believe there are a number of drivers of revenue growth that will push the top line in a positive direction, which in turn will be amplified by margin expansion, thus allowing underlying EBIT to increase five-fold over the next two years. Furthermore, the business should see cash generation improve as profits rise and the build-up in working capital eases. This should result in reduced net debt, such that balance sheet capacity increases offering increased optionality in future years. These characteristics are reflected in our DCF valuation, which implies a value for ArborGen of NZ$0.49, which is comfortably above the current share price.

Earnings: Positive trends cloaked

Our financial model reflects a number of positive trends in both the US and Brazil that we expect will drive revenue growth, but also drive up gross margins and should result in rapidly increasing earnings.

Firstly in the US, management is concentrating on pushing sales of MCP seedlings rather than OP and we therefore expect the sales volumes of lower-price and lower-margin OP seedlings to decline at c 2% pa. We expect MCP volumes to grow at c 5–7% pa, resulting in modest growth in total volumes. However, because the MCP seedlings are on average c 3–4x the price of OP, we expect double-digit revenue growth.

In Brazil, given the positive market trends and the expansion of the nurseries discussed earlier, we anticipate double-digit volume growth of both eucalyptus and pine seedlings, as well as c 5–6% pa price growth. We estimate that these two trends will drive revenue growth of c 20% pa in Brazil. Overall, we anticipate group revenue growth of c 15% pa in FY24 and FY25, from the US$56.1m reported in FY23, to US$74.7m in FY25.

Furthermore, we anticipate that the cost of goods sold per seedling will rise at a more modest rate (ie c 1% pa) as inflationary pressures recede and volumes increase. Therefore, we forecast that gross profits will rise c 60%, from US$18.2m in FY23 to US$29.7m in FY25. The implied gross margin will increase from 32.4% in FY23 to 39.7% in FY25, ahead of the margin achieved in FY21 and FY22. We expect normalised operating earnings (ie underlying EBIT) to increase five-fold from US$1.6m in FY23 to US$9.5m in FY25.

Cash flow set to recover in future years

Over the last three years, ArborGen has generated c US$23.9m of net cash from operating activities. The latest full year was held back as receivables reversed from an inflow of US$1.4m in FY22 to an outflow of US$3.2m, while there was also a deliberate inventory build-up to protect future revenues.

We are forecasting a recovery in operating cash flow to c US$9–11m pa (before interest tax, principal repayment and capex) in FY24 and FY25 as sales and profits increase and the build in working capital reduces. We also expect ArborGen to continue to invest in c US$5–6m pa in capital investment (including c US$3–4m on R&D expenditure) to ensure that its genetics research continues to develop improving MCP and Varietal seedlings for future generations.

Balance sheet: Capacity to invest for the future

Over the last two years, ArborGen’s net debt (excluding finance leases) has reduced from US$27.4m to US$13.0m, largely due to the receipt of disposal proceeds following the sale of its Australian and New Zealand operations. This implies that it exited FY23 with a net debt to adjusted US GAAP EBITDA of 1.5x. Given the increase in profitability in FY24 and FY25, we expect this ratio to fall to 0.6x in the current year and to c 0.3x in the following year.

This provides ArborGen with the potential to increase investment or to make modest acquisitions or lease additional nurseries in future years if the opportunities were to arise. ArborGen does not have a debt target, preferring to assess opportunities on merit.

It is worth noting that our profit and net debt forecasts only partially reflect the costs of the change in CEO, due to yet-to-be-agreed accounting treatment. Links to the relevant public statements are here and here.

Valuation points to material upside

Our DCF valuation points to a value of US$0.296/share, which at an exchange rate of US$0.61/NZ$, translates to NZ$0.49/share, versus the current share price of NZ$0.19, implying material upside.

Our key assumptions beyond our forecast period include:

Total revenue growth of 7.5% in years 4 and 5, slowing to 5% pa in years 6 to 10.

A terminal value revenue growth rate of 3%, which is quite low considering the underlying growth nature of the markets in which ArborGen operates.

A WACC of 9.9%, which includes a risk-free rate of 5% and is held down by the company’s reported beta of 0.7.

The sensitivity table below is priced in US cents and gives an indication of the potential upside should the cost of capital fall from the 9.9% we have in our DCF model, or if the terminal growth rate was to edge up from the 3%, we have assumed to, say, 5%.

Exhibit 9: Value per share (US cents) sensitivity table

Terminal growth rate (%)

0.0%

2.5%

5.0%

7.5%

10.0%

WACC (%)

12.0%

1.8

8.6

11.0

16.0

33.6

11.0%

2.1

10.3

13.7

21.8

70.7

10.0%

2.5

12.5

17.5

32.3

N/A

9.0%

2.8

15.4

23.1

56.7

N/A

8.0%

3.3

19.3

32.5

178.2

N/A

Source: Edison Investment Research

Exhibit 10: Financial summary

US$m

2021 (restated)

FY22

FY23

FY24E

FY25E

March year end

IFRS

IFRS

IFRS

IFRS

IFRS

PROFIT & LOSS

Revenue

 

42.8

47.6

56.1

68.0

74.7

Cost of Sales

(27.2)

(29.8)

(37.9)

(42.8)

(45.1)

Gross Profit

15.6

17.8

18.2

25.2

29.7

Operating Expenses

(15.4)

(15.1)

(16.6)

(18.4)

(20.2)

Other Income/(Expense)

0.8

-

-

-

-

EBITDA - US GAAP, Adjusted

 

7.4

10.1

9.2

14.4

17.1

EBITDA - IFRS – ArborGen

 

14.0

9.3

13.9

17.8

20.5

D&A

9.8

9.6

9.8

10.2

10.2

Operating Profit (before except.)

 

1.0

2.7

1.6

6.8

9.5

Exceptionals/Other

1.9

(4.0)

0.6

-

-

Operating Profit/(Loss) (EBIT)

 

2.9

(1.3)

2.2

6.8

9.5

Net Interest and financial expense

(2.0)

(1.7)

(1.3)

(1.1)

(1.0)

Profit Before Tax (norm)

 

(1.0)

1.0

0.3

5.8

8.5

Profit Before Tax (IFRS)

 

0.9

(3.0)

0.9

5.8

8.5

Tax

0.6

4.7

(3.4)

(1.6)

(2.4)

Profit After Tax (norm)

 

(0.4)

5.7

(3.1)

4.2

6.1

Profit After Tax (IFRS)

 

1.5

1.7

(2.5)

4.2

6.1

P/(L) from discontinued operations

1.7

-

-

-

-

Net income (IFRS)

 

3.2

1.7

(2.5)

4.2

6.1

Average Number of Shares Outstanding, basic, millions

499.5

500.8

502.4

503.5

504.0

EPS - normalised, cont ops, basic (UScents)

 

(0.1)

1.1

(0.6)

0.8

1.21

EPS - normalised, cont ops, diluted (UScents)

 

(0.1)

1.1

(0.6)

0.8

1.20

EPS - IFRS, cont ops, basic (UScents)

 

0.3

0.3

(0.5)

0.8

1.21

Gross Margin (%)

36.4%

37.4%

32.4%

37.0%

39.7%

EBITDA Margin (%)

17.3%

21.2%

16.4%

21.2%

22.8%

BALANCE SHEET

Fixed Assets

 

150.4

138.8

141.5

135.0

131.6

Intangible Assets

101.3

97.1

92.9

88.7

84.5

Tangible Assets

43.3

32.9

33.5

33.7

34.5

Right of Use Assets

5.8

4.7

4.9

2.4

2.4

Other

-

4.1

10.2

10.2

10.2

Current Assets

 

52.9

53.3

58.3

71.3

79.5

Cash and liquid deposits

6.2

15.2

12.7

17.1

19.9

Receivables

12.2

10.8

14.0

15.1

16.6

Inventories

34.5

27.3

31.6

39.1

43.0

Current Liabilities

 

(15.9)

(10.5)

(20.2)

(24.6)

(25.4)

Trade and other payables

(13.1)

(8.7)

(10.8)

(15.7)

(16.5)

Current Debt

(1.0)

(1.0)

(8.1)

(8.1)

(8.1)

Lease liabilities

(0.8)

(0.8)

(0.8)

(0.8)

(0.8)

Other

(1.0)

-

(0.5)

-

-

Long Term Liabilities

 

(39.2)

(30.2)

(30.3)

(28.2)

(26.1)

Long term debt

(32.6)

(25.7)

(17.6)

(16.6)

(15.6)

Lease liabilities

(5.1)

(4.2)

(4.1)

(3.0)

(1.9)

Other

(1.5)

(0.3)

(8.6)

(8.6)

(8.6)

Shareholder's Equity

 

148.2

151.4

149.3

153.5

159.6

CASH FLOW

Operating Cash Flow (before interest, tax, etc.)

8.1

10.8

2.2

11.0

9.4

Financing expense

2.0

1.7

1.3

1.1

1.0

Tax

(0.6)

(4.7)

3.4

1.6

2.4

FX

0.4

(0.3)

(0.4)

-

-

Capex

(1.0)

(1.5)

(2.2)

(2.8)

(3.4)

Investment in Intellectual Property

(3.7)

(3.1)

(3.4)

(3.4)

(3.4)

Acquisitions/disposals

-

15.2

-

-

-

Lease payments and warrant purchase

(1.3)

(0.9)

(1.1)

(2.5)

(1.1)

Interest paid

(2.0)

(1.7)

(1.3)

(1.1)

(1.0)

Change in net cash

1.9

15.5

(1.5)

4.1

3.8

Opening net debt/(cash), not incl. leases

 

29.6

27.4

11.5

13.0

8.9

Exchange rate movements

0.3

0.4

-

-

-

Closing net debt/(cash), not incl. leases

 

27.4

11.5

13.0

8.9

5.1

Closing net debt/(cash), incl. leases

 

33.3

16.5

17.9

11.4

6.5

Source: company accounts, Edison Investment Research

Contact details

Revenue by geography

ArborGen Holdings
Suite 107
100 Parnell Road
Auckland 1052
New Zealand
+64 9 356 9800
ArborGenholdings.com

Contact details

ArborGen Holdings
Suite 107
100 Parnell Road
Auckland 1052
New Zealand
+64 9 356 9800
ArborGenholdings.com

Revenue by geography

Management team

Chair: Dave Knott, Jr

President and CEO: Justin Birch

Dave was appointed to the board in February 2017 and assumed the role of chairman in August 2021. He is the executive managing member of Knott Partners, ArborGen’s largest shareholder. Dave is also a board member of Daida and sits on the advisory board of The HiGro Group.

Justin was appointed to the board on 25 April 2023. Previously, he worked at Prima Wawona in various roles including CFO. Before that, Justin worked for various private equity groups, mainly focused on food and agriculture.

Management team

Chair: Dave Knott, Jr

Dave was appointed to the board in February 2017 and assumed the role of chairman in August 2021. He is the executive managing member of Knott Partners, ArborGen’s largest shareholder. Dave is also a board member of Daida and sits on the advisory board of The HiGro Group.

President and CEO: Justin Birch

Justin was appointed to the board on 25 April 2023. Previously, he worked at Prima Wawona in various roles including CFO. Before that, Justin worked for various private equity groups, mainly focused on food and agriculture.

Principal shareholders

(%)

Dave Knott

28.3

Libra Fund LP/Ranjan Tandon

17.6

Accident Compensation Corporation

6.8

Irvin Kessler

5.1

Sky Hill Limited

4.0

JPMorgan Chase Bank NA, New Zealand branch

1.9

Public Trust

1.3

General disclaimer and copyright

This report has been commissioned by ArborGen Holdings and prepared and issued by Edison, in consideration of a fee payable by ArborGen Holdings. Edison Investment Research standard fees are £60,000 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

Accuracy of content: All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report and have not sought for this information to be independently verified. Opinions contained in this report represent those of the research department of Edison at the time of publication. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations.

Exclusion of Liability: To the fullest extent allowed by law, Edison shall not be liable for any direct, indirect or consequential losses, loss of profits, damages, costs or expenses incurred or suffered by you arising out or in connection with the access to, use of or reliance on any information contained on this note.

No personalised advice: The information that we provide should not be construed in any manner whatsoever as, personalised advice. Also, the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The securities described in the report may not be eligible for sale in all jurisdictions or to certain categories of investors.

Investment in securities mentioned: Edison has a restrictive policy relating to personal dealing and conflicts of interest. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report, subject to Edison's policies on personal dealing and conflicts of interest.

Copyright: Copyright 2023 Edison Investment Research Limited (Edison).

Australia

Edison Investment Research Pty Ltd (Edison AU) is the Australian subsidiary of Edison. Edison AU is a Corporate Authorised Representative (1252501) of Crown Wealth Group Pty Ltd who holds an Australian Financial Services Licence (Number: 494274). This research is issued in Australia by Edison AU and any access to it, is intended only for "wholesale clients" within the meaning of the Corporations Act 2001 of Australia. Any advice given by Edison AU is general advice only and does not take into account your personal circumstances, needs or objectives. You should, before acting on this advice, consider the appropriateness of the advice, having regard to your objectives, financial situation and needs. If our advice relates to the acquisition, or possible acquisition, of a particular financial product you should read any relevant Product Disclosure Statement or like instrument.

New Zealand

The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a “personalised service” and, to the extent that it contains any financial advice, is intended only as a “class service” provided by Edison within the meaning of the FAA (i.e. without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision.

United Kingdom

This document is prepared and provided by Edison for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.

This Communication is being distributed in the United Kingdom and is directed only at (i) persons having professional experience in matters relating to investments, i.e. investment professionals within the meaning of Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005, as amended (the "FPO") (ii) high net-worth companies, unincorporated associations or other bodies within the meaning of Article 49 of the FPO and (iii) persons to whom it is otherwise lawful to distribute it. The investment or investment activity to which this document relates is available only to such persons. It is not intended that this document be distributed or passed on, directly or indirectly, to any other class of persons and in any event and under no circumstances should persons of any other description rely on or act upon the contents of this document.

This Communication is being supplied to you solely for your information and may not be reproduced by, further distributed to or published in whole or in part by, any other person.

United States

Edison relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. This report is a bona fide publication of general and regular circulation offering impersonal investment-related advice, not tailored to a specific investment portfolio or the needs of current and/or prospective subscribers. As such, Edison does not offer or provide personal advice and the research provided is for informational purposes only. No mention of a particular security in this report constitutes a recommendation to buy, sell or hold that or any security, or that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person.

London │ New York │ Frankfurt

20 Red Lion Street

London, WC1R 4PS

United Kingdom

London │ New York │ Frankfurt

20 Red Lion Street

London, WC1R 4PS

United Kingdom

General disclaimer and copyright

This report has been commissioned by ArborGen Holdings and prepared and issued by Edison, in consideration of a fee payable by ArborGen Holdings. Edison Investment Research standard fees are £60,000 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

Accuracy of content: All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report and have not sought for this information to be independently verified. Opinions contained in this report represent those of the research department of Edison at the time of publication. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations.

Exclusion of Liability: To the fullest extent allowed by law, Edison shall not be liable for any direct, indirect or consequential losses, loss of profits, damages, costs or expenses incurred or suffered by you arising out or in connection with the access to, use of or reliance on any information contained on this note.

No personalised advice: The information that we provide should not be construed in any manner whatsoever as, personalised advice. Also, the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The securities described in the report may not be eligible for sale in all jurisdictions or to certain categories of investors.

Investment in securities mentioned: Edison has a restrictive policy relating to personal dealing and conflicts of interest. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report, subject to Edison's policies on personal dealing and conflicts of interest.

Copyright: Copyright 2023 Edison Investment Research Limited (Edison).

Australia

Edison Investment Research Pty Ltd (Edison AU) is the Australian subsidiary of Edison. Edison AU is a Corporate Authorised Representative (1252501) of Crown Wealth Group Pty Ltd who holds an Australian Financial Services Licence (Number: 494274). This research is issued in Australia by Edison AU and any access to it, is intended only for "wholesale clients" within the meaning of the Corporations Act 2001 of Australia. Any advice given by Edison AU is general advice only and does not take into account your personal circumstances, needs or objectives. You should, before acting on this advice, consider the appropriateness of the advice, having regard to your objectives, financial situation and needs. If our advice relates to the acquisition, or possible acquisition, of a particular financial product you should read any relevant Product Disclosure Statement or like instrument.

New Zealand

The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a “personalised service” and, to the extent that it contains any financial advice, is intended only as a “class service” provided by Edison within the meaning of the FAA (i.e. without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision.

United Kingdom

This document is prepared and provided by Edison for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.

This Communication is being distributed in the United Kingdom and is directed only at (i) persons having professional experience in matters relating to investments, i.e. investment professionals within the meaning of Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005, as amended (the "FPO") (ii) high net-worth companies, unincorporated associations or other bodies within the meaning of Article 49 of the FPO and (iii) persons to whom it is otherwise lawful to distribute it. The investment or investment activity to which this document relates is available only to such persons. It is not intended that this document be distributed or passed on, directly or indirectly, to any other class of persons and in any event and under no circumstances should persons of any other description rely on or act upon the contents of this document.

This Communication is being supplied to you solely for your information and may not be reproduced by, further distributed to or published in whole or in part by, any other person.

United States

Edison relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. This report is a bona fide publication of general and regular circulation offering impersonal investment-related advice, not tailored to a specific investment portfolio or the needs of current and/or prospective subscribers. As such, Edison does not offer or provide personal advice and the research provided is for informational purposes only. No mention of a particular security in this report constitutes a recommendation to buy, sell or hold that or any security, or that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person.

London │ New York │ Frankfurt

20 Red Lion Street

London, WC1R 4PS

United Kingdom

London │ New York │ Frankfurt

20 Red Lion Street

London, WC1R 4PS

United Kingdom

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