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Why I think this cheap agriculture stock could be a winner

Agriculture stocks often trade relatively cheaply, largely because of significant climate, disease or seasonality risks that companies in this sector invariably face. Huon Aquaculture Group Ltd (ASX: HUO) operates Atlantic Salmon farms in Tasmania and is also susceptible to those risks, though I believe the stock could outperform in the long-term.

Huon was established in 1986 and is the second largest salmon producer in Tasmania, with three major marine sites in the state’s south. Salmon farming is a capital-intensive business, and there are major barriers to entry for potential competitors in the form of strict regulation and environmental controls as well as limited regions where the fish can be produced.

Due to the industry risks I highlighted earlier, Huon and its larger competitor Tassal Group Limited (ASX: TGR) are cheap relative to the overall market, currently trading around 10x trailing earnings per share. Such a low market valuation suggests Huon’s prospects are weak, when in fact the opposite appears to be the case and the company’s balance sheet looks fairly strong.

Huon had statutory earnings of $42 million in FY2017, representing an almost 15% return on equity. Revenues of $260 million were produced from sales of 18,500 tonnes of fish, and management estimates this will rise to 24,500 tonnes in FY2018, an increase of 32.5%. At its AGM held on 30 November, Chairman Mr. Neil Kearney stated earnings were projected to be higher in both FY2018 and FY2019.

Huon believes Australian demand for salmon will grow at around 10% per annum, while maintaining pricing above the long-term average due to supply constraints. Additionally, Huon expects to increase sales in Japan as part of its intended strategy to export to high-performing Asian markets.

Returning to the financial statements, Huon has significant Biological Assets as you’d expect, but pleasingly, a relatively small amount of interest-bearing debt. For FY2017, EBITDA covered interest expense 23x.

Huon generated operating cash flows of a healthy $54 million in FY2017, which are required to pay for the business’ substantial ongoing capital expenditures. Cash payments for capex totalled $35 million last financial year and management expects this figure will be more than $65 million in FY2018, due to production expansion at existing and recently-approved locations.

Another reason why I like Huon is that it is still majority owned by founder, current CEO and Managing Director Mr. Peter Bender. He and his wife and Executive Director, Ms. Frances Bender, own around 66% of Huon, meaning management is likely to be highly motivated with interests closely aligned with other shareholders.

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Motley Fool contributor Ian Crane has no financial interest in any company mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. 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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