Since delivering impressive half-year results, Australian salmon producer Tassal Group Limited (ASX: TGR) has seen its share price fall from a high of $4.15 to a low of $3.15. Several short-term factors have weighed heavily on the share price since the announcement.
The first, and probably the most significant, is the announcement of a Federal government inquiry into the sustainability and environmental impacts of aquaculture in Tasmania. Tassal Group Limited is the largest aquaculture company in Tasmania and any further regulations or restrictions as a result of the inquiry will obviously impact its operations.
There is speculation that Tassal Group will be purchasing De Costi Seafoods, which is also weighing on the stock. To date, there has not been much information about the potential deal, although the company has advised that any deal would have to be in the best interests of shareholders. Although this could be a positive for the company and shareholders, the uncertainty is putting more pressure on the stock price.
Most recently, ASX-listed salmon producer Huon Aquaculture Group Limited (ASX: HUO) has also seen its share price plummet based on a profit downgrade. This was attributed to lower salmon export prices and cheaper foreign imports reducing the domestic wholesale price. Although wholesale and export markets make up less than 30% of Tassal's revenue, this factor is also a headwind for the company.
Both companies produce a commodity with relatively high capital costs, and they aren't able to completely determine the export price they receive for their salmon. Tassal does possess some advantages as a result of operating in the retail segment, including more predictable pricing, long-term contracts and a better understanding of supply volumes.
Are these factors enough to warrant a 24% reduction in the share price after half-year profits increased 25% from the previous corresponding period?
Only time will tell, but I think there are some features about the company that make it a good long-term investment. Tassal Group is a global leader in sustainable aquaculture practices and in 2014, the company was rated the world's leading salmon farmer for Corporate, Social & Environmental Reporting.
The company is also the largest employer in Tasmania outside of government bodies, contributing significantly to the local economy. It has been proactive in working with the government bodies since the announcement of the inquiry and believes it will be an opportunity to present its environmental and social credentials. This gives me confidence the company will prosper following the inquiry.
Tassal has also improved its return on assets through cost efficiencies and strong fish biomass growth coupled with excellent feed conversion performance. This results in larger salmon with higher survival rates for the same cost, allowing the company to increase profits faster than sales. Gearing is conservative at around 17% and the company has a strong balance sheet with biological assets increasing significantly due to the factors previously mentioned.
Domestic consumption of salmon has increased substantially over recent years and the trend toward healthier food options is set to continue. Tassal wants to increase per capita consumption of salmon in the domestic market while also increasing the price it receives for its product. In addition, the company is working to move beyond just salmon to salmon and seafood, which could provide enormous opportunity in a $4.3 billion industry. The De Costi transaction may be a big step forward on that front.
At the current $3.30 share price, the company is trading at approximately 9x FY15 earnings and based on dividend forecasts, it has a yield of about 4% (50% franked). With a payout ratio of around 40%, the dividend is conservative and leaves the company with an increased margin for safety if unforeseen circumstances were to arise. These figures are certainly attractive for investors who are willing to embrace moderate risk.
Foolish takeaway
While the company faces some short-term headwinds, which likely have already been factored into the share price, the underlying fundamentals look positive. In my view, the share price may not recover until market sentiment improves, but there is good long-term value for investors who are willing to take on risk and hold for several years.
