Description

Quick Case 

I would buy Salmar, the second-largest Norwegian salmon producer, controlled by Kverva, a private investment company focused on aquaculture. I actually prefer Bakkafrost as an investment here, as I see it as a slightly higher quality company that has sold off more over the market correction, while it has slightly more fundamental upside, but it has already been written up and discussed quite a bit on here, and I think that Salmar is broadly exposed to the same dynamics and has ample upside, too. 

Over the last couple of months, the salmon price has taken a hit, down about 32% in NOK from a peak of 80 NOK/kg to the current 54 NOK/kg. The shares of Salmar have fallen in sympathy, from a high of 488 NOK to a low of 320 NOK and the current 405 NOK. Assuming no recovery in the salmon price for the rest of the year, followed by a modest recovery back up to 60 NOK/kg in 2021 and modest yearly increases thereafter, I think that the company will be able to earn EPS of 23 NOK this year, 26 NOK next year and then steadily increasing from there. I think that earnings weakness should not be that pronounced this year as volume recovery and NOK weakness offset underlying demand weakness. I also think that it is not overly optimistic to expect that, in the long-term, salmon prices should be quite well-supported, as the supply/demand dynamics are favourable, with relatively limited supply growth and strong structural demand, so my forecasts of a modest recovery may even prove to be conservative (though I do not need this to be the case for the investment to work from here). 

The company is well-capitalised, with about 3.5bn NOK of net debt, about 1x EBITDA, which would take about 18 months of normalised FCF to clear. The generous ~2.6bn NOK of yearly dividend has recently been cancelled, which also will allow them to conserve cash. A cancellation of the dividend is obviously not a positive, but I see It being reinstated once the economic situation improves, and anyway I don’t really think that many investors are really in the salmon stocks entirely for the dividend, it is more of a structural earnings growth play. 

I think that once the economic situation stabilises and investors get comfortable that 1. The company is more than adequately capitalised to weather the storm; 2. A return to the pre-2015 lower average level of salmon prices is not likely to happen, the focus will return to valuation, and investors will realise that the stock still looks attractive based on reasonable medium-term assumptions for salmon prices and the associated earnings power of the company. 

In terms of what the shares could be worth, I look at it in a few different ways.  

On a simple P/E basis, I have the company earning 23 NOK in 2020, 27 NOK in 2021, 29 NOK in 2022, and 31 NOK in 2023 (hope these numbers don’t come back to haunt me). The forward P/E has ranged between 10x-18x over the last three years; I think that, given the mid-20’s ROE, a reasonable multiple is towards the higher end of that range, but if we use 14x, that multiple on 2023 EPS gets you to a year end 2022 FV of 435 NOK; on top of that, they will likely have reinstated the dividend well before then, and I think you will also have received about 50-55 NOK of dividends, getting you to a total fair value of about 490 NOK, +20%. 

On a fair EV/IC basis, I think that the company’s ~22% ROIC merits an EV/IC multiple of about 3.7x. Again, I am using my 2023 estimates to get to a year end 2022 fair value, and 3.7x EV/IC gets me to about 540 NOK of fair value, about 35% upside. 

Finally, investors in the sector tend to focus on EV per kg of production. Over the last three years, Salmar’s EV/kg has ranged from 200 NOK to 400 NOK – using the midpoint of that range and my volume assumptions gets me to a fair value of 520 NOK by the end of 2022, about 30% upside. 

The average of these methodologies gets me to a fair value about 520 NOK, around 30% upside.

Salmon Market 

I think that the longer-term top down bull case on salmon has been discussed on VIC previously, so I will not spend too much time going over old ground. 

Briefly, on the supply side, 2019 supply was about 2.6m gwt, the majority of which came from Norway (~1.35m gwt) and Chile (700k gwt). Supply in both of those markets is quite constrained – Norway is reaching limits in terms of permitted biomass (which is closely regulated) barring contributions from unconventional sources such as deep sea and onshore, which are anyway relatively limited and have been discussed in prior writeups. Chile is also limiting supply following some very negative events in the past relating to heavy losses from disease due to excessive biomass and poor regulation of how the fish could move around. The new supply limiting regulations appear to be working, with flat smolt growth in 2019 and low single digit growth so far in 2020. Other areas of the world such as Scotland, Canada, Tasmania and Russia form a much smaller part of the global supply and will be constrained in adding to it meaningfully. Over the past five years, global supply has grown at about 3% per annum, which over the longer-term, since 2008 the growth has been about 5%. Market expectations over the next three years are at 5%.  

On the demand side, again it has been discussed before, but as salmon is largely a fresh product and is consumed in line with what supply happens to be in a given period, it is hard to precisely estimate what demand is, however I would note that supply growth has averaged about 3%-5% per year, depending on the length of the lookback, while in the 2009-2018 period, prices have risen from 28 NOK/kg to 65 NOK/kg (about 55 NOK/kg currently with covid), while in euros, prices have risen from 3.5 EUR/kg to 6.5 EUR/kg (about 4.8 EUR/kg currently due to covid – was 6.5 EUR/kg in early March) – I think that this suggests strong underlying demand. The drivers for this are well understood – as GDP per capita improves, diets tend to become more protein-rich (global per capita protein consumption has risen from 16kg in 2000 to 21kg in 2018). Salmon is relatively more healthy than other proteins, is more efficient to produce in terms of feed conversion into edible yield, consumes less fresh water and carbon, and is still a very small part of the global protein pie. Demand growth is most likely to GDP-plus for quite a few years to come. 

Over the last couple of months, salmon prices haven’t been immune to covid – a significant part of the market goes to hotels and restaurants, where demand has been impacted, and will continue to be so. There is probably some demand replacement from take home, particularly in markets ex-North America, but not enough to offset hotel and restaurant demand going to zero. The impact so far has been that pricing has declined about 40% in EUR from the peak in January; due to depreciation in NOK, the peak to trough price declines in NOK, the reporting currency of Salmar, have been a more modest 32%. If we factor in some seasonality and instead look at YoY declines, the numbers would be a still more modest 32% in EUR, 20% in NOK. Current spot pricing is about 54 NOK/kg, while forward pricing out to year end is around 49-53 NOK/kg.  

While earnings estimates have come down from about 28 NOK to about 25 NOK, the good news is that the company should still be very profitable if prices do not dip much below here – historical analysis shows that a spot price of 55 would be consistent with an EBIT level of about 19-20 NOK/kg, while if spot prices fell to 45 NOK/kg, they would still have historically managed to produce about 15 NOK/kg of EBIT.   

Company 

Looking at Salmar in a bit more detail, they are the second-largest producer in Norway behind Mowi, with 142,500 gwt of production in 2018, far behind Mowi at over 350,000 gwt all in. Their assets are mainly in Norway, in the Central and Northern regions, with some smaller assets outside of Norway (Iceland and Scotland). Volumes in Norway have generally been growing steadily except for 2016, where some biological challenges drove volumes down. They have since recovered from this setback, but 2019 saw another modest decline as the company faced a sea lice issue which meant that they needed to harvest early, meaning lower average fish weight. Across the whole of the Norwegian business, though, volumes were up.Revenue in 2019 stood at 12.2bn NOK, with operating income of 3.1bn. Relatively low biomass adjustments last year means that earnings were not meaningfully distorted by this measure, and the company generated an EPS of 22 NOK. The longer-term earnings history, along with my forecasts, are as follows:

Over the much longer-term, the company probably has the most consistent level of earnings delivery, along with Bakkafrost, and is second only to Bakkafrost in terms of over the cycle average returns.

Cash conversion in terms of free cash flow to net income has been at around 70% on average since 2014, but has been burdened by relatively high capex, which should decline from 1.3bn NOK in 2019 back down to about 750m NOK by 2023, which should in turn see cash conversion improve to over 90%, and would improve the prospective FCF yield from 4% this year to 7% in 2023. 

Apologies for the formatting of this table, just could not get paste image to work, even with Google Docs. 

As noted above, their balance sheet is quite strong, with a limited amount of net debt, and should be further supported by their announcement not to pay a dividend this year.

Catalyst

There's a CMD upcoming in a couple of months, but not sure it will be a major catalyst. Think that the passing of time and the salmon price hopefully not collapsing should see the earnings resilience displayed, and the market cap should just grow into the earnings.