New Zealand Professional Investment Services Firm

Forsyth Barr

We are proud to be a New Zealand owned firm, with 21 offices throughout the country and over 300 employees. We assist personal, institutional and corporate clients providing a full range of investment services.

Forsyth Barr is a foundation New Zealand Exchange firm (NZX) and accredited market participant. We have been confirmed by the Financial Markets Authority as a Qualifying Financial Entity (QFE).

Research is the cornerstone of our advice. We have one of New Zealand's leading teams of analysts. Our global affiliations ensure comprehensive research coverage of all major investment markets.

New Zealand Professional Investment Services Firm, Forsyth Barr

Equity Bottom-Up

<h2>Scales<br>1H20 Result&nbsp;— A Bite out of Horticulture</h2>
<div></div>
<p><strong>NEUTRAL</strong></p>
<p>Scales (SCL) reported a soft 1H20 result in line, at a group level, with recently lowered expectations. Earnings mix shifted from historic levels with strong Food Ingredients growth effectively offsetting a weak period for the Mr Apple business. SCL reaffirmed its FY20 underlying NPAT guidance at the lower end of NZ$30m to NZ$36m (Forsyth Barr NZ$30m). We view 1H20 Horticulture disruption as being largely one-off in nature and expect earnings to normalise, although rising labour cost pressures have muted our view of long term EBIT margins. Providing an earnings offset is a higher Food Ingredients earnings base following impressive volume growth. Our target price increases +NZ$0.70 (+15%) to NZ$5.30 on the back of cost of capital changes. SCL is trading broadly in line with our view of fair value. NEUTRAL.</p>
<figure class="editor-figure mceNonEditable"><img src="https://static-prod.smartkarma.com/images/media/000/155/264/original/image_62463876451598490490408.png?1598490493" class="editor-image img-responsive" data-smartkarma-image-id="155264"></figure>
<div>
<h3>Earnings mix changes larger than expected</h3>
</div>
<div>
<p>1H20 earnings mix change was larger than expected with weaker Horticulture earnings and a stronger Food Ingredients result. A combination of a large China domestic crop and the timing of&nbsp;lockdown&nbsp;restrictions in market&nbsp;negatively impacted price realisation for Mr Apple. Whilst harvest sizes vary from year to year, the delayed sales window due to&nbsp;COVID-19 restrictions significantly exacerbated any price impact, and as such we view the impact as largely one off in nature. Conversely,&nbsp;lockdown&nbsp;policies resulted in a level of consumer stock piling&nbsp;of pet food, leading to increased demand for&nbsp;SCL's&nbsp;raw ingredients products as its customers looked to shore up their supply chain. Although a degree of demand is likely to normalise, we suspect&nbsp;SCL&nbsp;has gained market share and therefore expect the earnings change to be more enduring on a go forward basis.&nbsp;</p>
</div>
<div>
<h3>What's implied for the 2H&nbsp;— continuation of apple price trends</h3>
</div>
<div>
<p>SCL&nbsp;maintained its FY20 guidance. 1H20 horticulture earnings are based on the assumption that apples not sold at balance date (49% of expected sales volume) achieve prices in line with suppressed levels experienced to date.&nbsp;As of today&nbsp;SCL&nbsp;has sold c. 80% of its expected volumes, and we, therefore, see limited further risk to FY20 earnings. Despite commentary suggesting trading at its Food Ingredients business has remained strong into 2H20, we estimate earnings guidance implies a marginal slow down in growth. We view this as prudent given what appears to be a level of pull forward demand captured in 1H20.</p>
</div>
<div>
<h3>Cost pressures limit Horticulture margin expansion; Growth in Food Ingredients encouraging</h3>
</div>
<div>
<p>SCL provided first time EBIT margin guidance for its Mr Apple business out to FY25, lower than our prior expectations. Guidance highlighted that despite investments into operational efficiencies and varietal mix improvements, rising cost pressures are expected to limit any margin expansion beyond a normalisation in FY21. Providing an earnings offset, Food Ingredients delivered impressive growth in 1H20, with an additional US factory contracted (currently using 9 factories) set to contribute from FY21. We make limited net changes to our earnings forecasts but recalibrate earnings mix, lifting Food Ingredients and lowering Horticulture.</p>
</div>
<div>
<div>
<div>
<div><strong>Guy Hooper</strong></div>
<div><a href="mailto:guy.hooper@forsythbarr.co.nz" target="_blank" rel="noopener">guy.hooper@forsythbarr.co.nz</a></div>
<div>+64 4 495 5255</div>
</div>
</div>
</div>

Scales 1H20 Result&nbsp;— A Bite out of Horticulture

NEUTRAL
Scales (SCL) reported a soft 1H20 result in line, at a group level, with recently lowered expectations. Earnings mix shifted from historic levels with strong Food Ingredients growth effectively offsetting a weak period for the Mr Apple business. SCL reaffirmed its FY20 underlying NPAT guidance at the lower end of NZ$30m to NZ$36m (Forsyth Barr NZ$30m). We view 1H20 Horticulture disruption as being largely one-off in nature and expect earnings to normalise, although rising labour cost pressures have muted our view of long term EBIT margins. Providing an earnings offset is a higher Food Ingredients earnings base following impressive volume growth. Our target price increases +NZ$0.70 (+15%) to NZ$5.30 on the back of cost of capital changes. SCL is trading broadly in line with our view of fair value. NEUTRAL.


Earnings mix changes larger than expected


1H20 earnings mix change was larger than expected with weaker Horticulture earnings and a stronger Food Ingredients result. A combination of a large China domestic crop and the timing of&nbsp;lockdown&nbsp;restrictions in market&nbsp;negatively impacted price realisation for Mr Apple. Whilst harvest sizes vary from year to year, the delayed sales window due to&nbsp;COVID-19 restrictions significantly exacerbated any price impact, and as such we view the impact as largely one off in nature. Conversely,&nbsp;lockdown&nbsp;policies resulted in a level of consumer stock piling&nbsp;of pet food, leading to increased demand for&nbsp;SCL's&nbsp;raw ingredients products as its customers looked to shore up their supply chain. Although a degree of demand is likely to normalise, we suspect&nbsp;SCL&nbsp;has gained market share and therefore expect the earnings change to be more enduring on a go forward basis.&nbsp;


What's implied for the 2H&nbsp;— continuation of apple price trends


SCL&nbsp;maintained its FY20 guidance. 1H20 horticulture earnings are based on the assumption that apples not sold at balance date (49% of expected sales volume) achieve prices in line with suppressed levels experienced to date.&nbsp;As of today&nbsp;SCL&nbsp;has sold c. 80% of its expected volumes, and we, therefore, see limited further risk to FY20 earnings. Despite commentary suggesting trading at its Food Ingredients business has remained strong into 2H20, we estimate earnings guidance implies a marginal slow down in growth. We view this as prudent given what appears to be a level of pull forward demand captured in 1H20.


Cost pressures limit Horticulture margin expansion; Growth in Food Ingredients encouraging


SCL provided first time EBIT margin guidance for its Mr Apple business out to FY25, lower than our prior expectations. Guidance highlighted that despite investments into operational efficiencies and varietal mix improvements, rising cost pressures are expected to limit any margin expansion beyond a normalisation in FY21. Providing an earnings offset, Food Ingredients delivered impressive growth in 1H20, with an additional US factory contracted (currently using 9 factories) set to contribute from FY21. We make limited net changes to our earnings forecasts but recalibrate earnings mix, lifting Food Ingredients and lowering Horticulture.




Guy Hooper
guy.hooper@forsythbarr.co.nz
+64 4 495 5255




Scales: 1H20 Result — A Bite Out of Horticulture

Scales Corp Ltd

Scales: 1H20 Result — A Bite Out of Horticulture