Bega Cheese: COVID challenges + competitive milk environment

About the author:

Belinda Moore
Author name:
By Belinda Moore
Job title:
Senior Analyst
Date posted:
14 January 2022, 9:30 AM
Sectors Covered:
Agriculture, Food & Beverage, Travel and Chemicals

  • Bega Cheese's (ASX:BGA) FY22 EBITDA guidance was 2-11% below consensus estimates. The lower than expected guidance reflects significant COVID costs and supply chain disruption and a highly competitive milk procurement environment. Importantly, the Lion Dairy and Drinks (LD&D) integration and synergies are on target.
  • We have revised our forecasts.
  • While we can look through short-term COVID impacts, we remain concerned about the industry structure which has resulted in the continual need to pay improved returns back to farmers at the expense of shareholders. For the company to rerate, this needs to change.
  • We move to a Hold rating with a new price target of (login to view). 

Event: disappointing trading update with FY22 guidance below consensus

BGA has provided FY22 underlying EBITDA guidance of A$195-215m.

This was 2-11% below Factset consensus of A$219.3m and Morgans previous forecast of A$217.0m.

FY22 EBITDA is well up from A$141.7m in FY21 given the Lion Dairy and Drinks (LD&D) acquisition and the associated synergy benefits. 

Dairy and Drinks (LD&D) acquisition and the associated synergy benefits.

The lower than expected guidance reflects significant COVID costs and supply chain disruption and a highly competitive milk procurement environment. These factors have resulted in margin pressure, however demand for BGA’s products remains strong.

Specifically, BGA noted market disruption in Australian food service channels as a result of lockdowns, structural change in the Chinese infant and toddler dairy nutritional market, significant operational disruption including factory shutdowns, major changes to operations and logistics scheduling, increased safety and testing regimes, major cost increases and shortages across the entire supply chain.

Given Australian milk supply is down (it has been too wet) and the competitive environment amongst the processors for milk remains fierce (there is excess processing capacity in Australia), BGA is expected to increase its already record high farmgate milk price further. This also reflects the fact that global dairy prices have been strong.

Importantly, the LD&D integration and synergies are on track. BGA continues to target FY22 synergies of A$36m, with the full A$41m of benefits in FY23.

Once COVID challenges lesson, we expect there are additional synergies beyond its base case from better utilising its chilled distribution network, plant rationalisation and new product development (NPD). 

We downgrade our forecast

Reflecting BGA’s weaker than expected guidance, we have downgraded our FY22/23/24 EBITDA forecasts by 5.5%/4.6%/4.1%. The downgrades at the NPAT level are greater at 10.9%/8.6%/7.3% given the group’s large D&A.

BGA will report its 1H22 result in late February. BGA’s earnings are usually seasonally skewed to the 1H.

However this year, given the increased costs and disruption to its operations from COVID, we expect that earnings will be marginally skewed to the 2H. The 2H will also benefit from price rises, higher global dairy prices and greater synergy benefits with LD&D. 

Investment view - downgrade to Hold rating 

Until Australian processing capacity rationalises or the Australian milk pool materially grows, the competitive environment for milk is likely to remain fierce and result in dairy processors effectively overpaying for milk.

This means that upside from favourable operating conditions is likely to be partially paid away to the dairy farmers as opposed to shareholders benefiting from the earnings upside. For this reason, despite its growing branded business (~80% of sales), BGA is likely to trade at a discount to its FMCG peers.

With a lack of share price catalysts in the absence of further accretive M&A, we move to a Hold recommendation.

Following earnings downgrades, our valuation has (login to view)

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Disclaimer: The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.

Solid top-line outcome: BAP’s 1Q22 revenue was flat on the pcp, an extremely resilient result given the extent of lockdowns in the period (~70% of stores impacted) and the strength of the pcp (cycling 27% growth). Composition comprised: Trade +2%; NZ -10%; Retail -12%; and Specialist Wholesale +7%. Overall, BAP stated that non-lockdown areas are outperforming expectations. ▪ 1Q22 trade & retail: Trade/Burson revenue was up +2% on the pcp (LFL sales - 1%; cycling 8% pcp); NZ/BNT revenue was down -10% (LFL sales -15%; cycling +4%); and Retail/Autobarn revenue was down -12% (LFL sales -16%; cycling +36%). Within the Retail segment, online sales were +80% on the pcp. Stores percentages impacted by lockdown were: Trade 70%; NZ 100%; and Retail 50%. ▪ Specialist segment results: Specialist wholesale revenue is up 7% on pcp, with Auto electrical/Truckline divisions ‘performing strongly’; and WANO underperforming. ▪ GM pressure expected to be temporary: BAP stated GM was stable across Wholesale and NZ (45% of FY21 revenue); and down ~50bps Trade and Retail (~55% of FY21 revenue), driven by promotional and online pricing in lockdown areas (we assume no margin pressure witnessed in non-lockdown areas). BAP expect margins to revert once lockdowns ease. ▪ The cost base has increased vs pcp, a function of duplicated DC costs (commencement of new VIC DC), and higher group and team member support (covid related) costs. BAP noted FY22 store rollouts and refurbs are on track.

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