ArborGen Holdings — Mixed trading, but solid long-term growth outlook

Industrials

ArborGen Holdings

Mixed trading, but solid long-term growth outlook

H124 results

Basic materials

14 December 2023

Price	NZ$0.17
Market cap	NZ$90m
US$0.57/NZ$
Net debt (US$m), excluding leases at 31 September 2023		16.7

Shares in issue	527.0m
Free float	34%
Code	ARB

Primary exchange	NZX
Secondary exchange	N/A

Share price performance

%	1m	3m	12m
Abs	(1.6)	(9.5)	(15.8)
Rel (local)	(0.2)	(2.3)	(16.4)

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

Preliminary results

May 2024

Analysts

Andy Murphy	+44 (0)20 3077 5700
Natalya Davies	+44 (0)20 3077 5700

industrials@edisongroup.com

Edison profile page

ArborGen Holdings is a research client of Edison Investment Research Limited

ArborGen’s H124 results highlighted contrasting trading conditions with challenges in the US offset by a strong performance from Brazil. However, despite the short-term issues, ArborGen remains in prime position to address increasing demand for its seedlings and to continue investment in genetic improvement to drive the switch to sales of higher-value, higher-margin seedlings in both markets. While this process plays out, underlying EBIT is set to increase fivefold in the next two years as we expect gross margins to return to and then exceed historical levels. However, the recent US weakness has led us to trim our DCF valuation from NZ$0.49/share to NZ$0.44, still implying material 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	30.2	16.5
03/23	56.1	9.2	1.6	(0.5)	N/A	17.9
03/24e	64.8	12.0	4.1	(0.3)	N/A	21.3
03/25e	71.3	16.1	8.2	1.0	10.5	12.5

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.

H124 reveals ST US weakness but confirms LT trends

ArborGen’s H124 results highlighted short-term weakness in the US, but continued strength in Brazil. Although volumes in the former are likely to be down this year, prices are rising, driving an increased gross margin contribution. In Brazil, both volumes and prices are buoyant, implying strong revenue growth. This positive trading situation coincides with the appointments of a new CEO and a GM for Brazil and some additional one-off costs, but the underlying outlook for the company remains very promising, which is reflected in our operating earnings forecasts.

Switch to higher-price/margin seedlings ongoing

ArborGen has sold 87% of its budgeted US seedling volumes for the current year, all its eucalyptus and most of its pine seedlings in Brazil. Therefore, on a normalised basis, management is expecting a ‘materially’ improved performance in FY24, supported by higher volumes of higher price mass control pollinated (MCP) seedlings, an improved gross margin from lower MCP seed costs and expansionary activity. These latest-generation MCP seedlings deliver significant step-change gains to forest owners and command price premiums 2–4 times that of earlier-generation open pollinated seedlings. The ongoing switch to higher-priced MCP seedlings and continued strong growth in Brazil is expected to drive margins and profits materially higher.

Valuation: Shaved DCF offers material upside

We have reduced estimates, especially in FY24, to reflect tougher US trading and a series of other factors, which results in a reduction on our DCF valuation, from NZ$0.49/share, to NZ$0.44/share. However, we believe there are a number of drivers of revenue growth that will expand the top line, which will be augmented by margin expansion, thus allowing underlying operating earnings to increase fivefold over the next two years. Furthermore, the business should see cash generation improve as profits rise and a reversal in the build-up in working capital.

US hit and some one-off costs, but Brazil very good

Trading in the US has been affected in recent weeks by order cancellations due to a number of factors outside the control of the company, but Brazil continues to trade very well. This situation coincides with significant management change and some additional one-off costs, but the underlying outlook in both geographies for the company remains very positive. These factors are reflected in our revised operating earnings forecasts, which anticipate a fivefold increase by FY25 over FY23. However, the short-term weakness in the US has led to a reduction in our DCF valuation, from NZ$0.49/share, to NZ$0.44/share, more than twice the current share price.

US headwinds, but Brazil flying

In the US, following the cancellation of some orders due to industry, weather and economic factors, ArborGen is now c 87% sold out of all seedlings it has available, having been c 90% sold around the time of the annual shareholders meeting in September. Low pulp prices have resulted in the closure of several large pulp mills, and a decline in demand for saw timber, notably from the construction market, has prompted some customers to delay harvesting, thus reducing demand for seedlings in the short term. The weather in the summer also hampered clients’ ground preparation plans, adding downward pressure to demand.

In Brazil, the market remains very strong, driving demand for both eucalyptus and softwood seedlings. It follows that seedling prices are also higher. ArborGen is also benefiting from its US$3m investment (to be paid over seven years) in in-house nursery production, which has taken capacity to 80m seedlings pa in H124. The net result is that the company is anticipating strong growth in seedling volumes and prices, which will drive revenue firmly higher. Margins are also expected to expand strongly.

Despite the US headwinds, the company continues to anticipate a year-on-year improvement in earnings in FY24 and beyond, which is reflected in our revised forecasts.

Change of management, but not strategy

In the wake of the disposal of the Australian and New Zealand operations in late 2021, which raised c NZ$22.25m for reinvestment, the company has seen a change in personnel at the CEO level and a new GM appointed to the group’s Brazilian operations in 2023. Firstly, Justin Birch took over as CEO in June from Andrew Baum. Justin was most recently the CFO at Prima Wawona, a leading producer and innovator of fresh fruit production in California. Prior to this he held a number of positions in private equity businesses focused on the food and agriculture industries.

Since he started at ArborGen, Justin has visited almost all of the company’s operations with a view to ‘look under every rock’. That said, we believe that under his stewardship, the company’s strategy is likely to be typified by evolutionary rather than revolutionary change. He has also relocated from California to Ridgeville, South Carolina, where ArborGen is headquartered.

The other significant change was the appointment of Adriano de Almeida as GM of the Brazilian operations. He took over from Gabriela Monnerat, who remains with the company on a consultancy basis to ensure a smooth transition. Adriano has a strong understanding of the Brazilian forestry market, having accumulated a wealth of knowledge and experience in tree improvement and tree breeding in the country.

Other changes are likely in calendar Q124 as ArborGen is actively looking to hire a chief financial officer and a vice president of operations. The company has downsized its New Zealand corporate office and both of these roles will be based in the US.

One-off costs incurred in FY24, but strong underlying growth

Following the H124 results, we have revised our FY24 and FY25 estimates; see Exhibit 1 below. The deferred US orders account for the reduction in revenue growth in FY24, which we have also reflected in FY25, although as some orders appear to be deferred, they may simply be pushed into FY25, implying that our revenue estimates are conservative.

This revenue weakness is the key driver of the decline in EBITDA – US GAAP adjusted, which has been reduced from US$14.4m to US$12.0m, in line with recent guidance of ‘$11.6m to $12.6m’. It is worth noting that our estimate implies year-on-year EBITDA growth of over 30%. EBITDA US GAAP is reduced by a greater proportion as it includes one-off costs, from US$14.4m to US$7.5m, in the middle of the guided range of US$7m to US$8m.

The one-off costs include CEO related charges of US$2.1m (US$1.8m for equity grants, relocation costs and other costs associated, and US$0.3m that relates to shares and other arrangements regarding the previous CEO) and a further US$1.8m that relates to the write down of its US seed inventory. This equates to c 15,000lb out of a total inventory of 75,600lb.

The one-off costs feed into PBT and EPS and are also a major factor in the net debt estimate increase from US$8.9m to US$18.8m in FY24, as is a working capital increase, M&A, growth investment in Brazil and the repurchase of warrants.

Exhibit 1: Revised earnings estimates (US$m)

	FY23	FY24e			FY25e
		Old	New	% change	Old	New	% change
Revenue	56.1	68.0	64.8	-4.7%	74.7	71.3	-4.5%
Y-o-y % change	17.9%	21.2%	15.5%	-	9.9%	10.0%	-
EBITDA - US GAAP, adjusted	9.2	14.4	12.0	-16.7%	17.1	16.1	-5.8%
Y-o-y % change	-8.9%	56.9%	30.4%	-	18.3%	34.3%	-
EBITDA - US GAAP	10.3	14.4	7.5	-48.0%	17.1	16.1	-5.8%
Y-o-y % change	11.2%	40.1%	-27.2%	-	18.3%	115.0%	-
Operating earnings, normalised.	1.6	6.8	4.1	-39.8%	9.5	8.2	-13.6%
Y-o-y % change	-41.0%	327.2%	156.0%	-	38.7%	100.5%	-
PBT	0.9	5.8	(1.5)	-125.2%	8.5	7.2	-15.2%
Y-o-y % change	6.4%	542.0%	-262.7%	-	46.8%	-592.8%	-
EPS from continuing (basic) - diluted, underlying (US cents)	(0.5)	0.8	(0.3)	-133.2%	1.2	1.0	-19.6
Y-o-y % change	N/A	N/A	N/A	-	46.5%	-454.1%	-
DPS (US c)	0.0	0.0	0.0	N/A	0.0	0.0	N/A
Y-o-y % change	0.0%	0.0%	0.0%	-	0.0%	0.0%	-
Net (debt)/cash (pre IFRS 16)	(13.0)	(8.9)	(18.8)	111.3%	(5.1)	(11.2)	118.9%
Y-o-y % change	N/A	-31.3%	44.7%	-	-42.8%	-40.6%	-

Source: ArborGen accounts, Edison Investment Research

Exhibit 2: Financial summary

	US$m	2021 (restated)	FY22	FY23	FY24e	FY25e
Year end 31 March		IFRS	IFRS	IFRS	IFRS	IFRS
PROFIT & LOSS
Revenue		42.8	47.6	56.1	64.8	71.3
Cost of Sales		(27.2)	(29.8)	(37.9)	(40.0)	(42.1)
Gross Profit		15.6	17.8	18.2	24.8	29.2
Operating Expenses		(15.4)	(15.1)	(16.6)	(20.7)	(21.0)
Other Income/(Expense)		0.8	-	-	-	-
EBITDA - US GAAP, Adjusted		7.4	10.1	9.2	12.0	16.1
EBITDA - IFRS - ArborGen		14.0	9.3	13.9	10.9	19.5
D&A		9.8	9.6	10.2	10.5	10.5
Operating Profit (before except.)		1.0	2.7	1.6	4.1	8.2
Exceptionals/Other		1.9	(4.0)	0.6	(4.5)	-
Operating Profit/(Loss) (EBIT)		2.9	(1.3)	2.2	(0.4)	8.2
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	3.0	7.2
Profit Before Tax (IFRS)		0.9	(3.0)	0.9	(1.5)	7.2
Tax		0.6	4.7	(3.4)	-	(2.0)
Profit After Tax (norm)		(0.4)	5.7	(3.1)	3.0	5.2
Profit After Tax (IFRS)		1.5	1.7	(2.5)	(1.5)	5.2
P/(L) from discontinued operations		1.7	-	-	-	-
Net income (IFRS)		3.2	1.7	(2.5)	(1.5)	5.2
Average Number of Shares Outstanding, basic, millions		499.5	500.8	502.4	518.8	527.5
EPS - normalised, cont ops, basic (US cents)		(0.1)	1.1	(0.6)	0.6	1.0
EPS - normalised, cont ops, diluted (US cents)		(0.1)	1.1	(0.6)	0.6	1.0
EPS - IFRS, cont ops, basic (US cents)		0.3	0.3	(0.5)	(0.3)	1.0

Gross Margin (%)		36.4%	37.4%	32.4%	38.3%	40.9%
EBITDA Margin (%)		17.3%	21.2%	16.4%	18.5%	22.6%

BALANCE SHEET
Non-currentAssets		150.4	138.8	141.5	137.0	132.8
Intangible Assets		101.3	97.1	92.9	89.1	85.3
Tangible Assets		43.3	32.9	33.5	35.3	34.9
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	63.3	73.4
Cash and liquid deposits		6.2	15.2	12.7	5.9	12.5
Receivables		12.2	10.8	14.0	14.4	15.8
Inventories		34.5	27.3	31.6	43.0	45.0
Current Liabilities		(15.9)	(10.5)	(20.2)	(23.6)	(24.4)
Trade and other payables		(13.1)	(8.7)	(10.8)	(14.7)	(15.5)
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)	(28.9)	(28.8)
Long term debt		(32.6)	(25.7)	(17.6)	(16.6)	(15.6)
Lease liabilities		(5.1)	(4.2)	(4.1)	(3.7)	(4.6)
Other		(1.5)	(0.3)	(8.6)	(8.6)	(8.6)
Shareholder's Equity		148.2	151.4	149.3	147.8	153.0

CASH FLOW
Operating Cash Flow (before interest, tax, etc.)		8.1	10.8	2.2	3.2	11.0
Financing expense		2.0	1.7	1.3	1.1	1.0
Tax		(0.6)	(4.7)	3.4	-	2.0
FX		0.4	(0.3)	(0.4)	-	-
Capex		(1.0)	(1.5)	(2.2)	(4.4)	(2.2)
Investment in Intellectual Property		(3.7)	(3.1)	(3.4)	(4.1)	(4.1)
Acquisitions/disposals		-	15.2	-	-	-
Lease payments and warrant purchase		(1.3)	(0.9)	(1.1)	(0.5)	09
Interest paid		(2.0)	(1.7)	(1.3)	(1.1)	(1.0)
Change in net cash		1.9	15.5	(1.5)	(5.8)	7.6
Opening net debt/(cash), not incl. leases		29.6	27.4	11.5	13.0	18.8
Exchange rate movements		0.3	0.4	-	-	-
Closing net debt/(cash), not incl. leases		27.4	11.5	13.0	18.8	11.2
Closing net debt/(cash), incl. leases		33.3	16.5	17.9	23.3	16.5

Source: Company accounts, Edison Investment Research

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20 Red Lion Street

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United Kingdom

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