Salmon: It's What's For Dinner

Mar. 22, 2019 2:37 PM ETMowi ASA (MHGVY)BKFKF, GRGSF, LYSFF, SALM17 Comments

Summary

  • Salmon farming companies represent a great long term investment opportunity.
  • Relatively high, if unstable, yields will add to capital gains.
  • Long term trend of increased seafood consumption especially in China supports growth.
  • Mowi is the industry leader with aggressive branding that will drive outsize returns.

If you eat seafood, aquaculture is probably the biggest industry you participate in but don't know anything about. Of Americans' top 10 most consumed seafood products, 5 of them are predominately farmed - shrimp, salmon, tilapia, pangassius, and catfish. While relatively undeveloped in the US, aquaculture is also the fastest growing segment of the agriculture industry.

The aquaculture industry is hugely diverse from small backyard operations growing shrimp in Thailand to multi-national corporations with thousands of employees. The most developed and well-capitalized sector is the salmon farming industry, which is dominated by publicly traded Norwegian companies that operate in all the major salmon producing regions in the world – Norway, Chile, Scotland, Canada, and the Faroe Islands. Key companies include Mowi (OTCPK:MHGVY), Salmar (OTCPK:SALRF), Lerøy (OTCPK:LYSFF), Bakkafrost (OTC:BKFKF), and Grieg Seafood (OTCPK:GRGSF).

Salmon Industry Overview

Raising salmon is not fundamentally different than raising pigs or chickens - there are hatcheries, farms for growing animals to market weight, slaughter, and processing. However, the biology drives a unique economic cycle. A salmon takes 18 months to two years to reach harvest weight, as opposed to 180 days for a pig and only 45 days for a broiler chicken. This requires much more investment per animal, but at the same time salmon commands a much higher value as well. A 5 kilo salmon might be worth $50 when it is pulled from its pen, whereas a chicken is less than $2 when sold to a processor. Clearly working capital needs are significant. Mowi provides a helpful industry handbook updated annually summarizing the industry structure.

Source: Mowi Industry Handbook 2018, page 40.

Industry Growth: Rising Tides in the Salmon Industry

Salmon farming is currently restricted to geographies favorable to the fish. That includes access to cold, clean ocean water and a coast with bays or fjords sheltered from ocean waves. The local communities must also accept the industry, which precludes Alaska and much of the US. These constraints have limited supply growth over the last several years helping drive up salmon prices.

At the same time long term secular trends support continued demand for salmon. While Europe and the US remain the largest markets for salmon with steady demand growth at 4-5%, demand in Asia and the developing world is growing rapidly. In particular, China is currently importing over 100,000 tonnes of farmed salmon per year, which is expected to grow to 240,000 tonnes by 2025, or 12% of global production. Salmon’s position as a premium and celebratory product is well-suited for the Chinese market where seafood is often the centerpiece at banquet dinners or Chinese New Year celebrations.

Source: Mowi Industry Handbook 2018, page 32.

Industry Profitability and Valuations

While increased prices have improved margins, the industry continues to be challenged by animal health issues and associated higher costs at sea. In particular, sea lice, a naturally occurring parasite, are a persistent problem that reduces growth, increases mortality, and hits the bottom line. While disease issues are nothing new for livestock (the US poultry industry has bird flu, and China is currently experiencing an African swine outbreak), the nature of farming in the open ocean makes disease pressures more persistent and costly.

Fortunately for investors, the industry has settled on reporting metrics that are helpful in comparing operational efficiency between companies. Looking at the non-GAAP EBIT per kg gives investors a quick and easily measurable snapshot of how well an individual company is managing disease pressures and salmon price volatility. The Scandinavian tendency toward transparency is very helpful here.

2018 Harvest volume

2018 EBIT per kg

Bakkafrost

44,591

NOK 27.89

Salmar

142,500

NOK 24.29

Leroy

162,039

NOK 19.60

Mowi

375,237

NOK 19.31

Grieg Seafood

74,623

NOK 14.72

Source: Annual and Q4 2018 filings from each company.

Profitability varies considerably! Bakkafrost is clearly an outlier due to reporting EBIT per kg exclusively on its farming business, operating in the Faroe Islands, and earning a small premium in pricing over Norwegian salmon. Even within the Norwegian companies, Salmar is 70% more profitable than Grieg!

Picking a Winner

While I believe in the fundamentals of the industry as a whole, selecting the right company will significantly improve returns. In that vein, I believe Mowi deserves special consideration as an individual stock.

First of all, Mowi remains the largest in the industry by far and is exposed to every major producing region in the world. That fact alone will insulate it from some of the regional risks inherent to less diverse operations. Secondly, Mowi was known as Marine Harvest until recently. This name change was not merely superficial – the company is investing significantly in branding its fish globally. Whether chicken, pork, or beef, branding is common among other proteins. Tyson chicken, Hillshire Farms pork, and Certified Angus beef are all examples of brands that command a premium over equivalent products in the cold case. There is no reason salmon should be any different.

Mowi intends to spend 35M euros over the next two years to promote the Mowi brand, initially in Europe and eventually in North America and Asia as well. I see huge potential in ready-to-eat sushi grade salmon in the cold case, branded smoked salmon, and premium labeling on restaurant menus.

Finally, Mowi expects to see continued growth as it fully digests its latest acquisition of Northern Harvest in Canada and increases its freshwater smolt capacity. 2019 guidance is 430,000 tonnes, or 15% growth year-over-year.

Source: Mowi Capital Markets Day presentation.

Expected Returns

It’s true that Mowi’s higher P/E multiple has priced in some of this growth and profitability, but I still believe the share price has room to run. As long as the company delivers on expected production and keeps costs in line, I expect another 10-15% price appreciation over the next 12-18 months. Combined with a generous 5% dividend yield, Mowi represents an attractive 20% return opportunity in an uncertain economic environment.

Diluted earnings per share (NOK)

Share Price (NOK)

P/E Ratio

Bakkafrost

25.44

439.40

17.3 x

Salmar

31.60

410.60

13.0 x

Leroy

4.90

63.18

12.9 x

Mowi

10.66

201.70

18.9 x

Grieg Seafood

8.58

106.60

12.4 x

A note on dividends: Unlike in the US stock market, there is no stigma to a fluctuating dividend in the salmon industry. Whereas most American companies will sacrifice life and limb to avoid cutting a dividend, the Norwegian salmon companies generally have a stated policy of distributing a set percent of profit, and dividends fluctuate with profitability from year to year.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

This article was written by

Former finance professional working in Silicon Valley

Disclosure: I am/we are long MHGVY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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