Royal Bank Column – Sowing the seeds for success

Highlights Turnover up 213% from $2 056 billion in prior comparable period to $6,43 billion for the six months to August 31.


Gross profit increased 320% from $741

million in the prior period to $3 111 billion for the first half of the trading year.


Headline EPS rose 2 264% from $0,95 in the prior period to $22,45 for the first six months of the trading year.


Inventories up 425% from $2 894 billion in the prior comparable period to $15 208 billion for the six months to the end of August.


Nature of business


Seed Co is in the business of developing and marketing certified crop seeds.


The majority of sales are in the form of its hybrid maize seed as well as significant sales of wheat, soyabean, barley, sorghum and groundnut seed.


The company is heavily invested in research and development from which it develops its own seeds through various research stations.


The group holds a dominant position in the Zimbabwean market with an approximate 85% market share.


They also have an Export Processing Zone (EPZ) processing and packaging plant specifically for export.


The group has extensive operations throughout the region where it does a significant proportion of its business. The group has operations in Botswana, (established to drive the African expansion), Zambia, Malawi and South Africa (in the form of a joint venture with Syngenta Seed Co).


Results commentary


The group produced an excellent set of results for its half year as evidenced by the 2 464% increase in profit after tax from $142,9 million in the prior comparable period to $3 665 billion for their first half, significantly ahead of inflation for the period.


This coincided with an increase in operating margins from 36% in the prior period to 48% for this period.


The rise in profit was largely driven by a huge increase in other operating income up 1 772% from $346,5 million in the previous comparable period to $6 485 billion derived mostly from net exchange gains of $5,9 billion, the sustainability of these earnings has to be questioned.


Cost of sales as a percentage of turnover 48% for the current set of results represents an improvement on the prior comparable period where the figure was at 64% an indication that the group is watching its costs.


However, a major concern was the sharp rise in overheads which grew by 411% from $862,8 million in the prior comparable period to $4 413 billion.

With local overheads rising 315% ahead of the rate of inflation, while regional overheads were up 480% this management attributed to the devaluation of the local currency and increased production in these markets.


The percentage of turnover derived from the region declined as compared to the prior period from 74% to 69%.


Local turnover was affected by 33% decline in local winter cereal sales while the region experienced a 6% decline in real volumes due to last season’s stockout.


There was a notable increase in Return on Shareholders Equity (ROE) from 5% in the prior comparable period to 62% for the first six months to the end of August, indicating a great deal of value created for shareholders.


This has been accompanied by an increase in Return on Assets (ROA) from 4% in the prior period to 10%, indicating an improvement of the use of their assets.


Inventories increased 425% from $2 894 billion in the prior comparable period to $15 208 billion for the first six months of their trading year.


This indicates that the group is in a strong stock position for the upcoming season, the added effect of this will be control future costs.


There has been a significant increase in bank borrowings from $1 445 billion in the prior period to $14,13 billion for the first six months to August, most of which was for the purchase of seed for the upcoming season.


Consequently, the current ratio is at a less than comfortable 1.04 compared to the prior period where the ratio was 1.68.


Operational review


The majority of sales in the first half came in the form of cereals in the Zimbabwean market which represented approximately $2 billion of the turnover while the remaining $4 billion emanated from Zambia and Malawi mainly in maize seed.


There has been a notable improvement in margins regarding this season’s current prices.


In the previous season seed was bought for $100 000 a tonne and sold at $170 000 a tonne a margin of 70% while this season they were purchasing at $1 million a tonne and selling at $2,5 million a tonne, a margin of 150%.


In the region the group was buying at US$400 and selling at US$1 100.


The company had not released any seed until the new prices had been set, unlike the previous year where the company sold 30% of their produce at lower prices.


Local seed supply has been slow primarily due to late planting and a dry spell experienced in January.


The group’s regional operations all performed well save for the Mozambique operations which however, saw its losses narrowing.


Outlook


Prospects for the upcoming season remain low with the group expecting 40% of its normal local deliveries.


However, overall deliveries should be 90% of those last year with the slack taken up by the regional operations.


On the right is a chart showing the breakdown in estimated production by region for the upcoming season.


An average of management’s projected estimates


While Zimbabwe, as said earlier, is going to be severely affected, it still represents the largest supplier to the group with an estimated 28 000 tonnes.


Management is expecting Zambia to supply between 18 000 and 20 000 tonnes for the upcoming season with Malawi expected to produce 7 000 tonnes.


South Africa and Mozambique should both supply 3 000 tonnes each.

As the company is unable to export any of its Zimbabwean supply, the group is likely to sell the majority of its regional supply on the regional markets, which represents 54% of total supply.


On the research and development front the Zimbabwean research team is nearing the release of seven new maize hybrid seeds with improved disease resistance and yield.


Also in the pipeline are new strains of wheat, soyabean and groundnuts.

Regionally the new research site at Mpongwe in northern Zambia is now up and running, and the research site south of Maputo is also making progress in producing varieties suitable for the south eastern coastal belt from Mozambique to Kenya.


Recommendation and valuation


We believe the stock to have excellent prospects for the medium to long-term. Traditionally, the group transacts 80% of its business in the second half of its trading year and management indicates this year should be no different.


With a possible long overdue devaluation, the group may be poised for additional windfall exchange rate gains.


The stock is currently trading on a rolling PE of 7.49x.


We have revised our forecasts upward to forecast $110 EPS for their full year to the end of February, which gives the group a cheap forward PE of 2.9x.


We recommend the stock to be a strong buy for the medium to long-term.


This article has been issued and prepared by Barnfords Securities (Pvt) Ltd (Barnfords). The company is a financial consultant to the Royal Bank of Zimbabwe Ltd (Royal).

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