This year Bega Cheese Ltd (ASX: BGA) shares had been on fire… until last month.
Starting the year off at $5.21, the food manufacturer completed its acquisition of Lion Dairy & Drinks in January then climbed 25% to be as high as $6.51 in April.
But the stock tumbled in May to end up as low as $5.75 to start this month.
So is the current dip a time to buy, or are there long-term issues with the company?
Fairmont Equities managing director Michael Gable thinks the former.
He said in his blog this week that Bega shares were currently selling on a 1-year forward price-to-earnings ratio of 20, which wasn't any higher than when the business faced more margin pressure.
"The current multiple is not demanding in the context of a 3-year EPS growth of ~35% on a CAGR basis over the medium term (FY21-24)," said Gable.
"The strong overall EPS growth profile underpinned by a near-doubling of EPS in FY22 to reflect the full-year earnings contribution (and synergies) from the LD&D acquisition. The latter is expected to improve Bega's earnings visibility and growth profile over the medium term."
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Bega's financial outlook looks good
Despite it falling out of favour with investors, Gables reckons Bega is in better financial shape than ever.
"Results for the six months to 31 December 2021 showed evidence of operating leverage, with group EBITDA margin improving from 6.5% in 1H20 to 10.3%," Gables wrote on his blog.
He added that operating leverage will be further boosted with "attractive returns" from a new lactoferrin facility.
"The rationale for expansion into lactoferrin is supported by the fact that lactoferrin prices are strengthening on the back of higher levels of demand for Infant Milk Formula from new and existing nutritionals customers."
Lion acquisition improves the business
According to Gable, the buyout of Lion Dairy & Drinks has "the potential to improve overall margin" in the medium term.
"LD&D is considered a good strategic fit for Bega, as it diversifies Bega's dairy exposure, increases scale, and accelerates the shift towards branded products.
"The significance here is that branded products offer stronger organic growth rates, higher margins and higher returns."
Already the new arm is a big contributor.
"Including the first full year of contribution from the LD&D acquisition, LD&D is expected to account for ~47% of overall sales and ~39% of overall EBITDA in FY22."
Bega's gearing expected to reduce
The food business' debts are forecast to decrease in proportion to its earnings.
This had occurred even before Bega completed a $400 million equity raising to fund the Lion acquisition, according to Gable.
"Gearing — on a net debt to EBITDA basis — had reduced from 2.9x to 2.0x, despite the seasonal working capital build, which is typical of the 1st half," he said.
"Given that part of the purchase price for the LD&D acquisition was funded by debt, the gearing level is expected to increase above ~2.0x in FY21, but remain below the leverage covenant of 3.0x. Importantly, gearing is expected to fall in FY22/23 to reflect the contribution from the LD&D acquisition and the potential divestment of some non-core LD&D operations."
Bega shares were up 2.48% at Friday's close, trading at $6.19.
