Who controls the food chain, business or politicians? That's a question investors in the Tasmanian salmon industry may ask themselves after a Federal Senate Inquiry into the sustainability of the industry was announced last week.
Federal representatives from the Green party of Tasmania are worried about the environmental impacts of salmon farming and in the inquiry's investigative sights is Australia's leading salmon farmer Tassal Group Limited (ASX: TGR)
Since the announcement of an inquiry shares in Tassal have sunk to a 52-week low, while its newly-listed archrival Huon Aquaculture Group Ltd (ASX: HUO) has also been on the nose with investors.
Healthy demand
The investigative problems are set against a backdrop of fast-growing consumer demand for Tasmanian salmon, which has seen the industry publicly state its aim to double production by 2030.
In Australia, harvests of salmon and trout grew at a 10% compound annual growth rate between 2000 and 2013, with Huon mainly selling to high-margin wholesale customers who supply food businesses, fishmongers or sushi and sashimi restaurants.
Tassal primarily sells into the retail space supplying the major supermarkets and other retailers, with both businesses now focused on the domestic market due to strong demand supporting premium prices.
Domestic per capita consumption of salmon has almost doubled over the past seven years and this is a trend supported by immigration patterns and the shift toward healthier diets.
Both businesses also enjoy the natural advantage of Tasmania's cold waters, as nowhere else in Australia is the water temperature suitable to farm salmon.
More traditional barriers to entry are also high, with high costs and risks associated with setting up salmon farming infrastructure, while government issued marine leases are strictly limited.
Disruptive technology
Fish farmers are also beneficiaries of new and disruptive technologies that allow them to modify production methods to cut costs, grow production and potentially super-size fish and profits.
Tassal's ambitious growth plans have potential to improve its return on assets by breeding larger fish through selective breeding programs and diet strategies. It also has significant capital investment programs to support marine lease expansions.
Huon aims to grow its harvest by 10% in the year ahead, investing $200 million over the next four years to grow production alongside shareholders' returns.
The family-run business hit the ASX boards in October 2014 and recent half-year revenues and earnings grew 4.5% and 10% respectively over the prior corresponding period.
The company's prospectus guides for it to earn 33.7 cents per share on a pro-forma basis in 2015, which places it on 14x forward earnings at a recent price of $4.64.
Tassal grew revenues and earnings 12.3% and 28.8% respectively over the prior corresponding period and recently updated the market that it expects strong demand growth over the next 18 months.
After the recent sell down the stock trades on 12x trailing earnings of 28 cents per share at a recent price of $3.40.
Murky waters
On the surface both businesses appear attractive value given the tailwinds and growth outlook, but the looming governmental inquiry is muddying the investment case.
Environmentalists, local people and rival aquaculture business owners have complained about the alleged pollution caused by the salmon farms. In particular they point to falling dissolved oxygen levels at depth in Macquarie Harbour and the pollution caused by fish effluent.
Tassal has protested further scrutiny is unnecessary as it's already a heavily regulated global leader in sustainable environmental practices. Investors will hope the inquiry comes to the same conclusion.
Foolish takeaway
Aquaculture stocks are risky in nature due to the known unknowns of changing seasonal conditions, storms, disease and varying stock mortality rates. Not forgetting the aforementioned potential of regulatory creep to leave investors deep underwater.
Although, as a shareholder I think Tassal and salmon farming remain a reasonable long-term investing bet, based on growing demand, barriers to entry, and the potential for operational improvements to boost profits over the medium term.
