Key investment thesis

We think Grieg equity is highly impaired as the company will most likely be faced with a significantly dilutive equity raise in 2h 2021. Should the company raise NOK2bn of equity in a rights issue with a 30% discount in order to improve its cash position, Grieg share count would increase by 35m shares or 30% dilution to existing shareholders. We assume that Grieg’s EBIT/kg improves from a low of NOK2/kg in 2021 to NOK8/kg in 2022 and does not recover to 2018-2019 levels of 14-15NOK/kg due to the significant biological issues the company continues to have and the recent increased feed cost. Thus, Grieg could generate 640m of EBIT in 2022, using its previous average EV/EBIT multiple of 8x, this gets us an EV of NOK5.2bn, an equity value of NOK3bn and a share value of NOK20 75% downside assuming 2.2bn net debt (post equity raise) and 148m shares. 

Company and sector history

The salmon farming sector is a highly attractive industry thanks to the structural growth in demand for salmon and limited supply growth due to regulation in Norway and biological limitations. Since 2011, salmon farmers have faced an almost “goldilocks” period as they were able to marginally increase volumes every year during a decade of sustained salmon price appreciation (Salmon price went form ~NOK30/kg to ~NOK60+). The result is an explosion in margins and free cash flow at pretty much every listed salmon business over the last decade. For example, Marine Harvest or Mowi as it is now known, was able to increase Free cash flow from €70m in 2011 to €400m in 2019, and the stock has increased 10x accordingly over the same period.

Knowing this dynamic it seems strange that we are pitching a short in Grieg Seafood as those structural drivers of growth continue to be present in the industry. However, we would also like to highlight that salmon farming is an extremely difficult process and it is clear from analysing the consistency of results across the players that 1) some companies have a structural knowledge advantage over others in the industry and 2) salmon farming is hyper local; companies positioned in the right geographies have a structural cost advantage over their peers. 

Thus, we come to the core tenet of our thesis and why we believe Grieg is a fantastic short idea. First, Grieg is well known to be the worst operator in the salmon farming sector and has a history of underperforming its peers, even those positioned in the exact same regions. We believe this is mostly due to Grieg’s ownership structure; it is 50.2% owned by the Grieg family represented by Per Grieg Jr. Our checks have led us to conclude that the Grieg family do not have a strong understanding of salmon farming, yet they apply significant influence on the direction of the business and its operations. The management team at Grieg have very little control over decision making at Grieg and are there just to follow orders brought to them by the family. Comparing Grieg to any other listed salmon business in Norway shows a stark disparity between the consistency of growth and free cash flow. For example, during the same period of 2011-2019 Grieg has shown negative to quasi 0 free cash flow 50% of the time. Additionally, due to the family’s need for cash, Grieg has been paying out dividends in excess of its free cash flow.

In terms of catalysts for the short, we believe that there are several factors which have led to a significant deterioration in Grieg’s balance sheet. Net debt in the last 2 years has exploded from NOK2.4bn in 2018 to NOK4.2bn in 2020. The company was in breach of its bank convents in 2020 which had to be renegotiated. We feel that there is a high risk of a significant and dilutive capital raise coming in the second half of the year as the business runs out of cash and its RCF dries up.

The centre of Grieg’s recent issues- A massive, related party transaction and an ambitious growth plan based off it.

·         In Feb 2020 Grieg bought Grieg NF in Canada for NOK620m + an earn out structure of another NOK930m if Grieg NF hits 33kt of volumes. We find this transaction to be highly questionable. Grieg paid an exorbitant ~185NOK/kg for Grieg NF, way above market rates in similar areas. Grieg NF is controlled by the Grieg family; thus, we believe this transaction was essentially a way for the Grieg family to cash out of Grieg Seafood without selling down their stake and losing control.

·         The earn out is also highly problematic and presents even more conflicts of interest. Firstly, the Grieg family is now highly incentivised to get Grieg NF to 33ktn of volume at all costs; it does not matter if that volume is profitable, they receive the earn out (in cash!) regardless at the expense of minority shareholders of Grieg Seafood.

·         In order to reach these volume targets, Grieg management have presented a monumental capex plan + working capital build over the next 5 years. This year alone Grieg will spend NOK1.2bn of capex (font end loaded) + an additional NOK350m of wc. With the purchase price made in cash + the additional capex needed the company has taken on significant additional debt at a time when its operations in Norway and Scotland have started to deteriorate due to biological issues. With only 26m euros of cash on the balance sheet, this leaves little room for the company to manoeuvre a difficult time and could lead to a cash crunch in Q3 this year as the business continues to burn money and draw down further debt from its revolving credit facility.

·         We believe the investment that is being made in Canada is highly unlikely to produce any significant returns for Grieg Seafood shareholders and has a negative NPV. Marine Harvest have stated that the areas that Grieg are growing in Canada are some of the hardest places in the world to farm salmon. Cermaq, a large multinational salmon farmer, has pulled out of a project to farm salmon in the exact same region Grieg is expanding into. Knowing that Grieg struggles to operate in Norway, we doubt they will manage in a much more unforgiving environment. 

Operational issues + Coronavirus

1.       Although potentially temporary, COVID has impacted the foodservice demand for salmon and therefore putting pressure on the short-term salmon price. The drop in the salmon price drops straight to Grieg’s bottom line and led to a drop in Grieg’s EBIT of over NOK320m. We do not see a rapid recovery in the salmon price as a likely option in the short term, especially as lockdowns continue in Europe and supply in 1H 2021 is growing in the double digits.

2.       Grieg’s Norwegian salmon operations have significantly deteriorated due to increasingly problematic biological issues. These include new issues with “winter ulcers” on the fish which are essentially infected wounds that are caused by sea lice treatment. 40-50% of Grieg’s fish have been impacted by issues which cause significant downgrades to achieved prices as high as 50%. Grieg faces a catch twenty-two when dealing with these issues as if they don’t treat the fish for sea lice, the lice will eventually kill or severely harm the fish. We do not see any short-term resolution to these biological issues and therefore assume that Grieg’s cost per kg in Norway and Scotland continue to be elevated.

3.       Scottish operations continue to show negative revisions and poor performance and negative EBIT. We understand that close to 50% of Grieg’s salmon operations in Scotland are in undesirable locations. As the Scottish operations have continued to deteriorate the company has decided to put the company for sale and has stopped reporting results in Scotland as the asset is “held for sale”. However, due to lockdowns in the UK, competitors have not been able to view the asset or do any due diligence. We therefore think that it will take much longer for Grieg to sell Scotland than they are letting on, especially due to the poor quality of the assets and its deteriorating nature. Consensus does not include ~200-400m of negative EBIT a year from Scotland in their estimates and if the asset is not sold it could lead to further negative revisions.

4.       The poor quality of the Scottish assets was highlighted on 18th September 2020 when Grieg stated they would be completely mothballing their operations in the Isle of Skye following an incident with high mortalities in the region.

5.      The cost of feed which is 40% of Grieg’s COGS has increased in the last 12 months by ~25% yoy, this is putting pressure on the costs/kg at a time where Grieg is guiding the market to lower costs/kg.

The resulting situation and conclusion

Grieg is significantly indebted and continues to burn cash each quarter due to capex obligations it has in Canada coupled with poor operating performance in its core Norwegian and Scottish business. Even at current relatively strong prices of NOK55/kg Grieg produces no EBIT and negative FCF. The company has 1.2bn left on its RCF, however our estimates suggest Grieg will eat through this RCF by Q3 this year. This cash crunch will coincide with the end of the renegotiated covenant period that Grieg agreed with its banks in 2020. We believe that for the banks to feel comfortable with extending credit to Grieg, the company will be forced raise capital in the equity markets in the order of NOK2bn+ to bring the net debt back down to NOK2-3bn. We think the company is employing an extremely risky strategy by thinking the salmon price will save them by 2h 2021. Consensus estimates of the business reflect an unrealistic improvement in costs/kg due to ongoing biological issues in Grieg’s operations, a highly optimistic sale of the Scottish operations and a bullish short-term view of the salmon price, and a profitable medium-term outcome to the operations acquired in a related party transaction in a highly questionable region.