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IPO: 5 Key Risks Facing Inghams Group Limited Investors

Photo: Cowgirl Jules

Investors look set to flock towards the shares of Inghams Group Limited (ASX: ING). As one of Australia’s biggest chicken companies, the company will list its shares on the ASX on 7 November in what will be one of the most anticipated initial public offers (IPOs) of 2016.

If you’re peckish for more, you can read more about the IPO, here.

But speculation and bad puns aside, an investment in Inghams Group is not without risk. While investors should read the prospectus if they are seriously considering buying shares in the business, I thought I’d highlight five of the biggest risks facing Inghams Group:

Price Reductions

Just over half of Inghams’ revenue came from retail customers, with “all major retailers” in Australia and New Zealand counted as customers. While that gives Inghams Group great access to consumer markets, it does make it susceptible to pricing pressures from the likes of Woolworths Limited (ASX: WOW) and Coles, owned by Wesfarmers Ltd (ASX: WES).

Inghams Group provided a sensitivity analysis on its pro forma forecast net profit of $98.8 million for FY17. The table showed that a mere 1% decrease in average selling price could impact its NPAT result by $16.7 million, a reduction of nearly 17%. Of course, an increase in selling price would likely be beneficial, provided that it didn’t impact volumes too greatly.

Source: Inghams Group prospectus

Source: Inghams Group prospectus

Customer Reliance

The company noted in its prospectus that 55% to 60% of its revenue was generated by its top five customers in financial year 2016 (FY16). The loss of any one of those customers could prove damaging to the bottom line.

Competition

According to the company, it enjoys #1 and #2 market positions in Australia and New Zealand, respectively. It estimates it has a 40% share of the chicken market locally and 34% of the chicken market in New Zealand, compared to 33% and 48% respectively for its closest rivals in those markets.

Source: Inghams Group prospectus

Source: Inghams Group prospectus

Although it is clearly a dominant player, that doesn’t make it immune to pressures from its competitors, including both Baiada in Australia and Tegel in New Zealand. All three will be gunning for an even greater control over the market, and Inghams isn’t guaranteed to come out on top.

Contamination or Disease

This risk isn’t specific to Inghams, but rather all businesses in the poultry or agriculture industries. Contamination to poultry products is possible at any stage along the supply chain, and could cause a reduction in demand, costly recalls or reputational damage. Disease outbreaks such as the avian influenza could also force Inghams Group to destroy poultry or limit its ability to get products to the market.

Increase in Costs

Inghams Group operates on relatively thin margins, with just over 4% of sales expected to reach its bottom line in the current financial year (FY17) on a pro forma basis. The vast majority of the group’s costs are at an operational level, with cost of sales expected to be more than $1.9 billion, compared to $2.38 billion in sales.

Notably, cost of sales includes feed costs and direct labour costs, among other things. If the cost of raw ingredients used at its feedmills (e.g. grains and other legumes, vegetables and animal protein meals) were to rise a significant amount, Inghams’ profitability would take a hit.

Referring to the Sensitivity Table again (see above), Inghams Group estimates that a 5% increase in feed costs would impact net profits by around 2.5%.

Should You Buy?

Many of the worst performing shares from recent years have been those which recently listed their shares on the market, including Dick Smith, Spotless Group Holdings Ltd (ASX: SPO), McAleese and Vocation.

It might seem unfair to highlight those companies in an article about Inghams Group, and I’m not suggesting Inghams Group is headed down the same path. What I am highlighting is that IPOs are not guaranteed to make investors money – not all of them turn out as profitable for early investors as Bapcor Ltd (ASX: BAP) or oOh!Media Ltd (ASX: OML).

If you’re planning to invest in Inghams Group, make sure you do so without the hope of making a quick buck. Read through the prospectus thoroughly, understand the investment thesis and the risks, and only then can you make an informed decision.

Of course, if you are considering buying shares in Inghams Group, you may need to free up some cash in order to do so. Our top analysts have outlined three rotten shares they believe are a sell today, which could be a great starting point to look at.

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Motley Fool contributor Ryan Newman owns shares of Bapcor. The Motley Fool Australia owns shares of Bapcor. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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