Thai Union: Low Tuna Price And Settlement Of Antitrust Lawsuit Positive For The Company

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About: Thai Union Group Public Company Limited (TUFUF), THFRF, TUFBY
by: The Value Pendulum
Summary

Thai Union should maintain its strong earnings growth momentum for 3Q2019 similar to 2Q2019, as tuna prices continued to decline in 2Q2019 and it has 3-4 months of tuna inventories.

The overhang regarding its U.S. subsidiary's antitrust lawsuit has been removed, following a settlement reached with 90% of the plaintiffs and the full financial impact being provided for.

Other positive catalysts for the company include improved profitability at Red Lobster and the listing of its animal feed business.

Thai Union trades at 15.5 times consensus forward FY2019 P/E representing a discount to the stock's historical five-year average forward P/E of approximately 18 times.

Elevator Pitch

Thailand-listed Thai Union Group Public Company Limited (OTC:TUFUF) (OTC:THFRF) (OTCPK:TUFBY) [TU:TB] has underperformed in recent years, largely due to high tuna prices depressing profitability and an ongoing antitrust lawsuit involving its U.S. subsidiary. In the past two years, Thai Union's share price (excluding dividends) has been down -6%, while the Thailand benchmark SET Index was up +5% over the same period.

But things are turning around for Thai Union with tuna prices coming down from mid-2017 highs and a settlement reached with the majority of the plaintiffs in the antitrust lawsuit. Other positive catalysts for the stock include a turnaround of seafood lobster chain Red Lobster and a listing of its animal feeds business.

Thai Union trades at 15.5 times consensus forward FY2019 P/E, representing a discount to the stock's historical five-year average forward P/E of approximately 18 times, based on its share price of THB18.30 as of August 12, 2019.

Company Description

Thai Union is a Thailand-based seafood conglomerate which manufactures and exports frozen and canned seafood and related products; its key products are canned tuna and frozen shrimp. It is the world's largest producer of canned tuna.

The company's three business segments, ambient seafood, frozen, chilled seafood & related, pet care, value added & others contributed 44%, 41% and 15% of its 2Q2019 revenue, respectively. The ambient seafood business relates to the sale of tuna, sardine & mackerel and ambient & pouch salmon; while the frozen, chilled seafood and related business sells shrimp (shrimp, lobster, shrimp feed & value-added shrimp), salmon (frozen, chilled & smoked) and other seafood such as frozen crabs, scallops, shellfish and other fish. Thai Union's pet care, value added & others business includes pet care, ready-to-eat products, local products, bakery products and other snacks.

In terms of geographic breakdown, the U.S., Europe, Japan, Thailand and Other Markets (Asia excluding Thailand and Japan, Australia, Middle East, Canada, Africa, South America and others) accounted for 39%, 29%, 5%, 13% and 14% of Thai Union's 1H2019 top line, respectively.

With respect to the split between self-owned brands and private label products, Thai Union derived 43% of its 1H2019 sales from branded sales, and the other 57% of revenue from private label products manufactured for clients.

Favorable Tuna Prices Drove Earnings Growth

Thai Union grew gross profit by 13.1% YoY to THB5,364 million for 2Q2019, as gross margin improved from 14.0% in 2Q2018 to 16.7% (highest quarterly gross margin since 2015) in 2Q2019. This led to a 10.6% increase in Thai Union's 2Q2019 normalized profit (excluding one-time accruals for U.S. legal settlement elaborated in the next section) to THB1,513 million. Thai Union's improved profitability for the quarter was largely attributable to lower raw material prices for canned tuna (key product for ambient seafood business segment) and frozen shrimp (key product frozen, chilled seafood & related business segment).

Thai Union's Raw Material Price Trends

Source: Thai Union's 2Q2019 Results Presentation

Tuna represents more than half of canned tuna's production cost. With tuna price down -27% YoY and -16% QoQ to $1,217 per ton in 2Q2019 as per the charts above, and Thai Union typically having three to four months' worth of tuna inventories (validated by inventory days of 124 for 2Q2019), the company's 3Q2019 (also the peak business season) should continue to see the positive impact of higher earnings resulting from lower tuna cost. Shrimp and salmon prices have also been relatively stable, based on the price charts above. But tuna price is the most important raw material to watch for Thai Union, as the ambient seafood segment contributes the largest share of revenue for the company at 44% for 2Q2019, and also the fact that frozen shrimp and other frozen & chilled seafood tend to be sold on a marked-up basis (versus ambient seafood), making raw material cost fluctuations less of a concern.

At the company's 1Q2019 earnings call on May 7, 2019, Thai Union affirmed the positive outlook for tuna price, and it does not expect tuna price to be as high as it was in mid-2017:

And in regarding to the key operating impact, we have -- the raw materials remain favorable especially for the tuna price in which why the more recent tuna price has been popped up to about $1,600 as of March. The tuna price again dropped to about $1,450 in April, something that the -- Joerg just mentioned, tuna price are moving in a favorable range and give us breathing room for us to be able to negotiate a balance, negotiation with our supplier and our customer more appropriately...There's a related question on tuna prices. We're now at around $1,450, $1,500, of course, prices will go up again towards Q3. But at least at this stage, we do not have any outlook where prices would make any unprecedented hikes as they did 2 years ago. So I think we hope, we can stay in a much more normalized range below $1,800, maybe even a little bit lower at the lower end of our $1,300, $1,400 ideal range.

Overhang Regarding Antitrust Lawsuit Removed

Thai Union has been affected by an antitrust lawsuit filed against its U.S. subsidiary, Chicken of the Sea International since 2016. Chicken of the Sea International and the two other major suppliers of tuna in the U.S. with a combined 70-80% of the packaged tuna industry were alleged to have been "conspiring to fix the prices of shelf-stable tuna in the United States."

In 2Q2019, Chicken of the Sea International managed to reach a settlement with approximately 90% of the plaintiffs in the above-mentioned antitrust lawsuit. The company recognized an additional accrual of THB 1,858 million for 2Q2019, and it has now guided that "the financial impact of this litigation is now fully provided for by Chicken of the Sea." Thai Union expects to reach a settlement with the other plaintiffs (a minority or about 10% of the plaintiffs) in another six to nine months.

Thai Union provided an update on the financial impact of the antitrust lawsuit involving Chicken of the Sea International at its 2Q2019 results briefing on August 6, 2019:

We believe that the financial impact of this occasion is now fully provided for by Chicken of the Sea. We all know that the process is not over yet, but our belief is now -- Chicken of the Sea belief is that this now leaves the financial impact absolutely behind us. And we can now close out this activity and move on... When will this case be truly finished? I think the legal procedures will still take a little bit. From a financial impact, we believe this is now it. So no more financial effects. But I guess, it will still take another 6 to 9 months to really close down every single case. There are 1 or 2 risks involved, but how long it will take but we believe, 6 to 9 months, the whole thing will be over. Financially, we believe this is now fully appropriately provided for... Is the risk that there could be further accrual expense rate lawsuits? We do not see that there's any material risk for further accruals. There will still be legal expenses of around THB 1.5 million, THB 2 million a quarter for the next 2, 3 quarters until the whole topic is really, really over. We try to limit this as much as we can. Not everything is under our control, though. So accrual are done; some expenses are still ongoing.

Red Lobster Seafood Chain Showing Signs Of Turnaround

Thai Union bought a 25% stake in Red Lobster, a leading U.S. seafood restaurant chain in 2016, as part of its diversification and downstream integration plans. The company recognizes contributions from Red Lobster in the share of income from investment in associates, and Red Lobster has been a drag, remaining loss-making since Thai Union's investment.

In 2Q2019, Thai Union more than doubled the share of income from investment in associates to THB110 million versus THB44 million in 2Q2018, which was largely attributable to the operational recovery at Red Lobster driven by the launch of a new revamped menu, better cost management and higher revenue contribution from home delivery and takeaway (off-premise business). Importantly, Thai Union is guiding for Red Lobster to achieve operating profit break-even within the year.

At the company's 2Q2019 earnings call on August 6, 2019, Thai Union explained in detail the reasons for Red Lobster's improved financial performance:

Quick question on Red Lobster. What is better in Red Lobster? Red Lobster has significantly improved. What has improved will be break even this year. The short answer is, we have budget for the running year that will break even the business. We will earn money, 2 million, 3 million, I think, so the budget is planning to be break even. So that's good. We're running a bit behind budget. So I'm not sure we really make it to above 0, and maybe slightly below 0, but I think at least from a plan for a trajectory business is really on the right track. What has improved? We talked about that quarter, restaurant performance is the key focus of management. Now we'll talk much less about marketing activities, we talk really about 4 walls probability in each of the 700 restaurants. Restaurant operations improve, we took our cost out. We've launched a new menu, we launched a new menu, which is much more affordable. We are trying to shift much more business to the day part consumption. We are attracting a lot of consumers, and get back to the restaurant with affordable day menu items. And last but not least, we have a totally gangbuster off-premise business. So we're now at nearly 8% of revenue off-premise; part of this delivered at home, a lot of them it picked up in the restaurant, but ordered through an app or ordered through phones, 8%. If you recall, 18 months ago, we were around 3.5%. So this is really the growth story in Red Lobster, the off-premise business.

With Red Lobster moving gradually towards profitability, Thai Union wants to drive Red Lobster's international expansion plans. In July 2019, Red Lobster's first restaurant in China opened doors, targeting Chinese students and American expatriates in Beijing.

Unlocking Value And Driving Growth With Listing Of Animal Feed Unit

Thai Union is planning for a listing of its 66.9%-owned Thai Union Feedmill Co., Ltd., or TFM, a manufacturer and distributor of animal feed, more specifically shrimp and fish feed, on the Stock Exchange of Thailand. It is currently in the process of seeking approval from the stock exchange regulators for the listing.

Thai Union shared more details of TFM's planned listing at the company's 1Q2019 earnings call on May 7, 2019:

There's a question around the TFM listing. I've led with this question in my presentation. All those questions, right questions, when will it happen? What's the IPO price? I of course cannot comment on it. And we will -- once the time line is there, we will announce this. We will have an allocation to existing shareholders...I think the objectives for us are that we can much more freely obtain capital to drive an aggressive growth story in this very attractive industry field...And we are now leading this into the Capital Market and opened this into an amazing growth story that is not only about shrimp feed, but about many seafood species made from fish meal, made from soy meal and with a lot of innovation, a lot of growth to drive that.

The planned listing of TFM is positive for Thai Union for a couple of reasons.

Firstly, TFM wants to explore more collaborations with India-listed Avanti Feeds Limited [AVAT:IN], a manufacturer and exporter of animal feeds and shrimp products, which Thai Union has a smaller 15.43% stake in. Proceeds from listing will help to fund TFM's growth plans, such as co-investing in India's animal feed industry with Avanti Feeds Limited. TFM also wishes to diversify away from its core shrimp feed business and explore other types of animal feed which have decent growth prospects as well.

Secondly, being a large seafood conglomerate, the growing businesses within the company tend to be overshadowed by other large businesses or underperforming ones which drag down the entire company's performance. At the recent 2Q2019 earnings call, Thai Union continued to emphasize that TFM "is growing very strongly" and "we're really very encouraged by recent numbers and it will support our IPO effort." Spinning off TFM will allow the market to recognize the value of the fast-growing animal feed business, which also helps with the positive re-rating of Thai Union's valuations.

Thirdly, Thai Union's net gearing remained high at 138% as of end-2Q2019, and IPO proceeds could be used to partially pay down debt and improve the company's financial position. The company has a net gearing target of 100-110%.

Valuation

Thai Union trades at 15.5 times consensus forward FY2019 P/E and 13.9 times consensus forward FY2020 P/E based on its share price of THB18.30 as of August 12, 2019. This represents a discount to the stock's historical five-year average forward P/E of approximately 18 times. Thai Union also offers a 2.2% trailing dividend yield.

Variant View

The key risk factors for Thai Union are a larger-than-expected spike in tuna prices and further complications arising from its U.S. subsidiary's antitrust lawsuit.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.