Is Inghams a moat-worthy investment?

Nicholas Grove  |   02/11/2016 Text size  Decrease  Increase   |  
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Nicholas Grove: I'm Nick Grove from Morningstar. And today I am joined by equity analyst Ravi Reddy, to discuss the upcoming IPO of poultry producer Inghams.

Ravi, thanks for your time today.

Ravi Reddy: Thanks, Nick. It's good to be with you.

Grove: So, Ravi any Australian shopper who has ever walk down the freezer aisle of the supermarket is familiar with the brand Inghams. But before we discuss whether or not investors should apply for shares in the IPO. Does Inghams possess any kind of competitive advantages and is it a moat-worthy investment?

Reddy: Short answer, no. In our view poultry producers have two sources of competitive advantage, cost advantage and intangible assets or brand. We don't think Inghams has sustainable competitive advantages from either of these sources. We think Inghams is going to get margin improvements from these productivity initiatives they have got underway. But over time we think these will be eroded, because of the concentrated customer base, the commoditized nature of the products and that competitors can replicate these product initiatives. In terms of brand Inghams is a well-known brand, but we don't think it's strong enough to give them any pricing power. Essentially Inghams is selling a commoditized product.

Grove: In the pre-IPO report that Morningstar published, you said that despite some opportunities for growth at Inghams you do have some concerns about some medium-term issues. What are these issues?

Reddy: These include pricing pressure and relaxation of import rules. We are concerned about pricing pressure given the concentrated nature of Inghams customer base. Inghams top five customers account for about 55 per cent of sales. The customer base is concentrated towards the major Australian supermarkets and these supermarkets have a history of putting pricing pressure on suppliers. They have even done this to global brands like Heinz and Coke. So, we expect Inghams to feel this similar sort of pressure over time. In terms of import rules, in August this year the import rules were changed. So, now partly cooked chicken and uncooked chicken can be imported from New Zealand into Australia. Now Tegel, which is New Zealand's largest producer, will have greater access to the Australian market. We think there'll be sort of minimal issues for Inghams from these in the near term. But in the longer term further changes to these rules possess some challenges for the company.

Grove: Finally, Ravi are retail investors being given a raw deal in being asked apply for shares in the IPO, before the final price is determined by the institutional bookbuild. And should they still apply for shares in the IPO?

Reddy: We're very disappointed that the offer price is going to be announced after the offer closes. We think retail investors should have been treated better. We do not recommend investors subscribe for the Inghams IPO. Our fair value estimate is $3.50 a share and this is below the bottom of the indicative pricing range which is $3.57 to $4.15 a share. So, it's priced fairly at the bottom end and is expensive at the top end. We've also compared it to some US-listed peers that Morningstar covers and our valuation stacks up reasonably against these. We've also looked at Tegel, which is listed in New Zealand--it floated in May this year. That listed at the bottom end of the indicative pricing range and that pricing was also at a lower valuation multiple than Inghams. Tegel shares are now trading just below their listing price at the moment.

Grove: Ravi, thanks for your time today.

Reddy: Thanks, Nick.

Grove: I'm Nick Grove from Morningstar. Thanks for watching.

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