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</h2>
Pruning Expectations
Scales (SCL) has provided first time earnings guidance for FY20E, implying a modest downgrade to market expectations. Consequently, we have trimmed our earnings forecasts, with the downgrades captured entirely within the Food Ingredients business on the back of challenging market supply dynamics. We now forecast largely flat earnings growth year on year across SCL’s businesses, with orchard replanting also limiting near term growth in its Horticulture business. Trading on a ~20x forward PE, with limited near term earnings growth and a significant net cash position creating investment uncertainty, we expect the share price to be range bound. NEUTRAL.
What’s changed?
<ul>
<li>Earnings: We revise our underlying NPAT forecasts -5.5%/-4.5% in FY20E/FY21E</li>
<li>Target Price: Lowered -NZ$0.05 to NZ$4.60</li>
<li>Rating: NEUTRAL</li>
</ul>
Guidance update mixed
SCL has reiterated its FY19E underlying NPAT guidance range of NZ$32m to NZ$37m. We have left our FY19E forecast (NZ$34m) unchanged, although note the wide guidance range given the proximity to the end of the financial year may imply some downside risk.
In addition, SCL released a first time FY20E underlying NPAT guidance range of NZ$30m to NZ$36m, implying a downgrade to previous market consensus forecasts. We have lowered our FY20E NPAT to NZ$35m from NZ$37m. We suspect a key driver of the downgrade has been the more challenging market conditions in SCL’s pet food ingredients business, Meateor, driven by a combination of (1) changes in the raw ingredients supply dynamics, such as the increasing demand for use in human consumption, and (2) weaker venison prices. In addition to lower Food Ingredients earnings, we have lowered our interest income assumption with the low interest rate environment impacting SCL’s significant net cash balance (FY19E NZ$84m).
The wide FY20E guidance range appears conservative although prudent given the natural uncertainty associated with annual harvest outcomes. Heading into FY20, we remain comfortable with our Horticulture forecasts given (1) NIWA’s seasonal outlook suggests favourable weather during the key growing period and (2) European apple stocks as of November 2019 are well below average, supportive of FY20 apple pricing in that market.
Signalling higher capex in FY20
SCL highlighted a ‘material increase’ in FY20E capex within its Horticulture division, targeted at creating cost efficiencies. We have lifted our Horticulture growth capex forecast +NZ$6m to NZ$14m. We understand capital projects include further investment into its Croptracker system as well as additional RSE (Recognised Seasonal Employers) worker accommodation. Seasonal labour supply has been tight in recent years, a lift in available RSE workers would be positive for SCL.
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Investment View
SCL is an export focussed company offering investors broad exposure to New Zealand agriculture, with operations in horticulture and meat processing. Although pet food is a growing part of the business, annual apple harvest outcomes and global apple prices will remain key drivers of business performance in the near-term. NEUTRAL.&nbsp;
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Guy Hooper guy.hooper@forsythbarr.co.nz +64 4 495 5255

Scales
Pruning Expectations
Scales (SCL) has provided first time earnings guidance for FY20E, implying a modest downgrade to market expectations. Consequently, we have trimmed our earnings forecasts, with the downgrades captured entirely within the Food Ingredients business on the back of challenging market supply dynamics. We now forecast largely flat earnings growth year on year across SCL’s businesses, with orchard replanting also limiting near term growth in its Horticulture business. Trading on a ~20x forward PE, with limited near term earnings growth and a significant net cash position creating investment uncertainty, we expect the share price to be range bound. NEUTRAL.
What’s changed?

Earnings: We revise our underlying NPAT forecasts -5.5%/-4.5% in FY20E/FY21E
Target Price: Lowered -NZ$0.05 to NZ$4.60
Rating: NEUTRAL

Guidance update mixed
SCL has reiterated its FY19E underlying NPAT guidance range of NZ$32m to NZ$37m. We have left our FY19E forecast (NZ$34m) unchanged, although note the wide guidance range given the proximity to the end of the financial year may imply some downside risk.
In addition, SCL released a first time FY20E underlying NPAT guidance range of NZ$30m to NZ$36m, implying a downgrade to previous market consensus forecasts. We have lowered our FY20E NPAT to NZ$35m from NZ$37m. We suspect a key driver of the downgrade has been the more challenging market conditions in SCL’s pet food ingredients business, Meateor, driven by a combination of (1) changes in the raw ingredients supply dynamics, such as the increasing demand for use in human consumption, and (2) weaker venison prices. In addition to lower Food Ingredients earnings, we have lowered our interest income assumption with the low interest rate environment impacting SCL’s significant net cash balance (FY19E NZ$84m).
The wide FY20E guidance range appears conservative although prudent given the natural uncertainty associated with annual harvest outcomes. Heading into FY20, we remain comfortable with our Horticulture forecasts given (1) NIWA’s seasonal outlook suggests favourable weather during the key growing period and (2) European apple stocks as of November 2019 are well below average, supportive of FY20 apple pricing in that market.
Signalling higher capex in FY20
SCL highlighted a ‘material increase’ in FY20E capex within its Horticulture division, targeted at creating cost efficiencies. We have lifted our Horticulture growth capex forecast +NZ$6m to NZ$14m. We understand capital projects include further investment into its Croptracker system as well as additional RSE (Recognised Seasonal Employers) worker accommodation. Seasonal labour supply has been tight in recent years, a lift in available RSE workers would be positive for SCL.

Investment View
SCL is an export focussed company offering investors broad exposure to New Zealand agriculture, with operations in horticulture and meat processing. Although pet food is a growing part of the business, annual apple harvest outcomes and global apple prices will remain key drivers of business performance in the near-term. NEUTRAL.&nbsp;

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

Scales Corp Ltd

Scales: Pruning Expectations