Description

Leroy is the the second-largest salmon fish farmer in the world based out of Bergen, Norway with a market cap of $5bn+.   Leroy traces its history back to 1899, with the company listed in June 2002 - it entered the farming industry ~20 years ago via acquisitions.  Company’s controlling shareholder with 52%+ control is Laco AS, a private Nowregian holding company owned by the Mogster family, a family with a long history in the Norwegian fishing industry.  

Quick backdrop on the industry - on the supply side, Norway accounts for ~50% of global farmed supply with EU and North America being the key consumption end-markets. Rising costs and relatively high entry barriers due to the capital-intensive nature of three-year production cycles have led to significant consolidation in coastal farmed salmon industry supply over the past decade, with the total number of scale suppliers in the three largest countries of Norway, Chile and Scotland falling by 75%.  In 1997, there were ~110 companies farming salmon vs. less than 45 today.  The three largest players (Mowi, Leroy & Salmar) in Norway represent ~45% of global salmon farming volume and have a combined EV of > €26bn.  The overall industry has grown at a top line CAGR of ~10% over the past 15 yrs, driven by combination of volume + pricing.   Given the concentrated and consolidating global salmon supplier base with relatively high entry barriers, large industry players have been able to generate  mid-teens average EBIT margins and mid-teens industry ROIC profile over the past decade.

On the demand side - biggest secular driver is population growth and increase in per capita consumption of protein with salmon taking increasing share.  Based on UN estimates, global population will grow to ~9.7bn by 2050 - if per capita consumption of protein remains the same, this would result in 28% increase in demand for protein. Given health benefits of seafood being promoted by health authorities, per capita consumption of fish is expected to grow 21kg in 2029 from 20.6kg.  

Salmon is viewed as a relatively healthy source of protein, given that it is rich in micronutrients, minerals, marine omega-3 fatty acids, high-quality protein and several vitamins.  Despite the health benefits, salmon within total fish consumption remains relatively niche, at <5% by weight.  Despite the small share, salmon market has been able to grow at a CAGR of 10% between 2011-2020, driven by a combination of volume growth (~6-7%) and price inflation (~3-4%).

Salmon is, however, a relative expensive protein source vs. pork (5x price), chicken (2.5x), beef (1.3x) and lamb (2.5x). This premium price positioning of salmon vs. other proteins also reflects a relatively high proportion of demand coming from the hospitality channels (hotels, restaurants, catering) which represent ~40% of the end markets.  As a result, 2020 was a significant hit for the industry due to Covid related closures in the hospitality sector - demand fell 80%+ within that sub-sector.  Another hit was on pricing - with pricing falling ~15% vs. pre-pandemic levels.  Given the pandemic induced effect on demand + volumes, the sector underperformed as market is ascribing a high probability that the earnings deceleration is not temporary.  

One underappreciated factor on the current environment is that the current supply chain issues we are experiencing will benefit the industry via increase in salmon pricing.  But we believe the supply/demand shortfall will actually last more than a few months given the industry production cycle, biological factors, as well as regulatory constraints limiting significant rapid capacity additions in the short term.  First, the production of farmed salmon from egg to fish takes ~3 years - simplistically, the whole process starts with fertilization of salmon eggs, raising the fish into smolts in a controlled freshwater environment (~1 yr), transferring fish to seawater pen cages that are grown to 4-5kg (12-24 months). The grown fish are then transferred to processing plants where they are prepped for sale.  And the cycle restarts with the site being “harvested” for a new generation to be placed in the same location (2-6 months).  Another constraint for salmon raising is the temperature of seawater (making only certain locations feasible for salmon raising) as well as the need for a specific amount of current into the farm - these conditions are usually only found in protected waters such as fjords.

In addition to the farming cycle and biological factors that constrain coastal farmed salmon production to certain regions, regulations in each jurisdiction require salmon farming licenses that ultimately restrict the total production for each company and the overall industry.  For example, in Norway, production limitations are regulated as ‘maximum allowed biomass’ (MAB), which is the defined maximum volume of fish a company can hold at sea at any one point in time. Typically, one licence sets a MAB of 780 tonnes and the total maximum allowed biomass for commercial use at end of 2020 was 973,530 tonnes of Atlantic salmon and trout. Average utilisation of the MAB was 86% in 2020.  Total Norwegian Atlantic salmon and trout in seawater licences were limited to 1,087 in 2020.

Despite the structural tailwinds we see, the license restriction leads us to choose Leroy over the other industry players.  License restrictions in Norway do not apply for freshwater smolt production licences, which can be applied for at any time.  Over the past few years, Leroy laid out a capital plan to invest in growing its capacity for smelt product (fish grown onshore in tanks before they are released to seawater in the ocean).  By employing this strategy, Leroy can release a larger amount of smelt into the ocean farms, which result in higher yield per license and growth in volume. As a result of this improved utilization strategy vs. peers, we believe Leroy can grow its volume at a mid to high single digit rate for at least the next 5 years, which is above the rate of growth expected from peers.  Another advantage we think Leroy has vs. its peers is that its production is fully integrated upstream to downstream.  Their downstream production facilities are already built-out to provide value-added services such as fileting + packaging.  This we believe allows Leroy opportunity to improve margins vs. competitors as Leroy can trace their products from beginning to end, an increasing focus and competitive advantage in in a growing ESG aware world.

Consensus has Leroy’s EPS coming at 4.8 NOK in 2022.  Given the rebound in volume + strong pricing environment, we believe EPS will come out much stronger at closer to 5.5 NOK, which would make current valuations at 14.5x P/E, a significant discount to peers who trade in the high teens range.  

Catalyst

Demand rebound from Covid lows + supply/demand imbalance + better utilization per license will lead to increased volume/pricing resulting in earnings acceleration