ArborGen Holdings — Seedling supplier’s long-term future looks green

Industrials

ArborGen Holdings

Seedling supplier’s long-term future looks green

H123 interims

Basic materials

7 December 2022

Price	NZ$0.22
Market cap	NZ$111m
US$0.64/NZ$
Net debt (US$m) as of 30 September 2022 (includes lease obligations)		22.4

Shares in issue	502.8m
Free float	33%
Code	ARB

Primary exchange	NZX
Secondary exchange	N/A

Share price performance

%	1m	3m	12m
Abs	(6.7)	(6.7)	(17.7)
Rel (local)	(9.7)	(5.7)	(8.3)

52-week high/low

NZ$0.3

NZ$0.2

Business description

ArborGen Holdings is an NZX-listed investment company and is the world’s largest integrated developer, commercial manufacturer and supplier of advanced forestry seedlings, with operations in the United States and Brazil.

Next events

FY23 results

May 2023

Analysts

Ken Mestemacher, CFA	+44 (0)20 3077 5700
Andy Murphy	+44 (0)20 3077 5700

industrials@edisongroup.com

Edison profile page

ArborGen Holdings is a research client of Edison Investment Research Limited

Reflecting ArborGen Holdings’ (ARB’s) strategic shift to focus on Brazil and the United States, the company reported mixed H123 results: growth from Brazil boosted overall revenues by 61% over the prior comparable period, although US challenges and a higher amortisation charge led normalised operating earnings to fall US$1.2m y-o-y to a loss of US$0.6m. ARB made investments in Brazilian and US nurseries, adding capacity for about 38m seedlings. While H223 could be affected by ongoing inflationary pressures and US yields, ARB’s long-term prospects appear solid, benefiting from recent record Mass Control Pollinated (MCP) cone harvests, capacity expansion and the potential for margin recovery from future price increases and a favourable mix shift. We are reviewing our estimates.

Year end	Revenue (US$m)	EBITDA* (US$m)	EBIT** (US$m)	EPS (c)	EV/revenue (x)	Net debt *** (US$m)
03/21 (restated)	42.8	7.4	1.0	0.3	3.1	33.3
03/22	47.6	10.1	2.7	0.3	2.8	16.5

Note: FY21 numbers have been restated to reflect the divestment. *EBITDA is US GAAP, adjusting for investments in intellectual property, government grants, inventory adjustments, etc. **EBIT excludes strategic review costs, grants, etc. ***Includes capitalised leases.

H123: Strong demand from Brazil drives results

ARB reported revenue growth of 61% over the prior comparable period to US$7.4m for H123, boosted by strong growth in Brazil. Gross margins rose 13.5pp to 24.3% in H123, driven by three factors from Brazil: a tight supply situation from rising demand, price increases and a move to more in-house pine seedling production. However, inflationary pressures, lower than expected (particularly non-loblolly) US yields and a higher amortisation rate affected profits, with normalised operating earnings shifting from a profit of US$0.6m in H122 to a loss of US$0.6m in H123.

Expanding container capacity in Brazil and the US

With demand outpacing supply in the Brazilian market, ArborGen added seedling capacity by acquiring a 10m seedling pine nursery in Canoinhas and entering a long-term lease agreement for a 20m seedling eucalyptus nursery in Martinho Campos. These should support sales of c 20m pine seedlings and over 70m eucalyptus seedlings in FY23. Nearly 50m seedlings pa will now be internally produced in Brazil. ArborGen also added 8m of container seedling capacity across its Bellville and Bullard facilities. Management estimates this added capacity should start producing seedlings in about FY24, helping boost US revenues and margins.

Valuation: Record harvest and margin recovery

At NZ$0.22, ARB is down 17% year-to-date. Long-term, we believe ArborGen should benefit from multiple tailwinds, including record US MCP harvests, increased container capacity and potential US margin recovery. However, over the rest of FY23, inventory issues and demand shifts in the United States will likely continue to affect results, leading management to expect US seedling sales to be c 5% lower than FY22’s 284m. Brazil looks promising, with the potential for volume and price increases, leading management to guide to FY23e US-GAAP EBITDA of US$10.0–10.5m (including US$2m in expected one-off payroll credits).

H123: Strong Brazilian demand drives results

ArborGen’s H123 results reflected the company’s recent strategic shift to focus on the high-growth US South and Brazil markets (see Exhibit 1); in both markets it is one of the leading commercial suppliers of seedlings. Revenues were up 61% over the prior comparable period to US$7.4m, boosted by strong growth in Brazil. Gross margins also rose to 24.3% or 13.5pp over H122 due to margin growth in Brazil, driven by three factors: (1) prices can be adjusted up more frequently than in the United States to account for cost increases; (2) there is a tight supply situation with very strong demand; and (3) the shift to producing more pine seedlings in-house (rather than outsourcing, where margins are lower) following the recent acquisition of the 10m seedling pine nursery in Canoinhas, Santa Catarina, Brazil.

Despite the rising sales, ArborGen’s normalised IFRS operating earnings shifted from a US$0.6m profit in H122 to a US$0.6m loss in H123. ARB’s operating results were affected by:

■

a smaller change in the fair value of biological assets in the US (primarily due to inflationary pressures in the US), lower than expected seedling yields (especially non-loblolly species), seedling sales mix and higher historical MCP seed costs from pollination activity two years ago (when yields from younger orchards were lower than optimal), and

■

a higher intellectual property (IP) amortisation charge (the reduction in the useful life of IP from 20 years to 17 years).

Adjusted US-GAAP EBITDA from continuing operations, which strips out various one-off costs (eg strategic review) and other non-cash adjustments (eg fair value adjustments for biological assets), improved to a US$2.9m loss versus a US$3.4m loss in H122. Net debt grew slightly to US$22.4m (including lease liabilities of US$4.9m) from US$16.5m in FY22, which is normal for ArborGen given the cyclical nature of US seedling sales, which all occur in the second half of the fiscal year.

Exhibit 1: Financial performance (continuing operations)

US$m	H122	H123	Change
Revenue	4.6	7.4	60.9%
Gross profit	0.5	1.8	260.0%
Gross margins	10.9%	24.3%	13.5pp
Operating earnings (loss), normalized*	0.6	(0.6)	N/A
Net earnings (loss) from continuing operations	(0.5)	(1.6)	220.0%
Net earnings from discontinued operations	0.6	-	N/A
EPS (loss) per share (cents)	(0.10)	(0.32)	218.9%
Net debt (including financial leases)	34.9	22.4	(35.8)%
Net cash from operations	0.1	(2.4)	60.9%

Adjusted US-GAAP EBITDA reconciliation
Net earnings (loss) after taxation, continuing operations, forestry genetics segment	1.0	(1.2)	N/A
Net earnings (loss) after taxation, corporate	(1.5)	(0.4)	(73.3%)
Net earnings (loss) from continuing operations	(0.5)	(1.6)	220.0%
Less tax benefit	(0.4)	-	N/A
Plus financing expense	0.9	0.7	(22.2)%
Plus D&A	3.8	4.4	15.8%
Plus corporate costs	-	-
NZ IFRS EBITDA – ArborGen	5.3	3.9	(26.4)%
Investments in intellectual property	(1.4)	(1.3)	(7.1)%
Change in Fair Value of biological assets	(7.2)	(5.9)	(18.1)%
Other IFRS adjustments	(0.2)	0.1	N/A
Other significant items	0.1	0.3	200.0%
Adjusted US-GAAP EBITDA	(3.4)	(2.9)	(14.7)%

Source: ArborGen, Edison Investment Research. Note: *Before government grant income, strategic review costs, etc.

Outlook: Record harvest and capacity expansion boost long-term prospects

In the near term (FY23), ArborGen could face a temporary margin reduction in the United States, though accelerating demand and margin growth in Brazil should somewhat offset those issues. In the United States, results could continue to be affected by the aforementioned cost inflation, reduced seedling yield in H123, supply chain issues and short-term demand shifts from large national accounts, leading management to expect US FY23 seedling sales to be about 5% lower than FY22’s 284m. In contrast, Brazil’s outlook appears promising, benefiting from rising domestic demand in both eucalyptus and softwood, and ArborGen should likely see both volume and price increases in this important region. Moreover, management expects Brazil’s profitability to be materially higher than FY22’s breakeven, with Brazil already generating US$1m of US GAAP EBITDA in H123. Consequently, ArborGen is guiding to consolidated US GAAP EBITDA of US$10.0–10.5m for FY23e (including US$2m in expected Employee Retention Credits under the US CARES Act, but excluding NZ public company costs and strategic review costs).

With its strategic review completed and a new focus on the US South and Brazil markets, which show high growth and strong demand longer term, ArborGen’s prospects appear solid. As it is the leading commercial supplier of advanced genetics loblolly seedlings in the US South and leading commercial supplier of advanced pine and eucalyptus seedlings in Brazil, we see ARB’s sales and margins benefiting from several tailwinds:

■

Record cone harvest lifts US MCP supply. In November 2022, the company harvested the highest ever MCP cones, as orchards planted in 2011 and 2012 matured into full production. Over the next couple of months, seed should be extracted from those cones, which management expects to be equivalent to over 200m MCP seedlings. Notably, about 60% of those seeds are expected to come from the recently supply constrained Eastern provinces (30% of the total from the Coastal region). Seeds from this FY23 harvest will be partially used to produce MCP seedlings for sale in FY24 as well as for building up seed inventory, where ArborGen is targeting having two to three years of MCP inventory on hand to lessen dependence upon single-year harvests. Importantly, this harvest should affect the overall mix of seedling sales, shifting some production from Open Pollinated (OP) seedlings to higher-value MCP seedlings in FY24.

We can estimate the impact of this record harvest and mix shift from OP to MCP. If we assume an extra US$0.10 in margin per unit of MCP seedlings versus OP seedlings, then for every 10m in mix shift to MCP, ARB would generate an incremental US$1m of revenue. For instance, if management is able to sell 20m more MCP (instead of OP) seedlings over the next year or two, then it could generate an extra US$2m of sales, holding all other variables constant (eg margin, total volume).

■

Container expansion in the United States. The company is in the process of expanding its container capacity by increasing the capacity of its container facility in Bellville, Georgia from 13m to 16m, and constructing a new 5m unit container facility in Bullard, Texas, which is on track for the first phase of container production in the Western regions. Management expects these sites to begin producing containerised seedlings in about FY24, which should help boost revenues and margins from the key US market.

■

Larger footprint to meet rising demand in Brazil. Seedling demand in Brazil is exceeding supply, with hardwood and softwood markets driving much of the growth. To meet this demand, ArborGen uses both in-house and outsourced production, with the former providing a higher margin at the company’s three eucalyptus nurseries and one pine nursery. To meet the rising demand, ArborGen recently made two key investments to increase its footprint in Brazil: (1) the acquisition of a 10m seedling pine nursery in Canoinhas; and (2) a long-term lease agreement starting on 1 December 2022 at a 20m eucalyptus seedling nursery in Martinho Campos, which should boost internally produced seedlings from 30% to 50% of total requirements. These should support sales of c 20m pine seedlings and more than 70m eucalyptus seedlings in FY23. Nearly 50m seedlings pa will now be internally produced in Brazil and we note that all ArborGen Brazilian seedlings are containerised. Moreover, the company is evaluating an opportunity to further expand internal eucalyptus capacity by about 10m in FY24.

■

Margin recovery. As mentioned earlier, inflationary conditions and supply chain issues have pressured margins in the US. We see this trend reversing in the next two to three years for several reasons. First, US average selling prices (ASPs) should reset early next calendar year (late FY23) to reflect the higher costs ArborGen is experiencing, helping FY24 margins. Moreover, ArborGen’s ability to more frequently reset Brazil’s ASPs should also help it to pass on the impact of inflation. We also see margins improve by the mix shift from OP to MCP (from the record MCP cone harvest discussed above) and the move to about 50% in-house production of eucalyptus in Brazil. Finally, ARB benefits from operating leverage too, as a large proportion of the nursery and harvesting costs are fixed. As the company brings the added capacity (discussed above) online, we anticipate that there should be further margin expansion as incremental volume benefits from fixed cost infrastructure. We are reviewing our estimates at this time, which will likely reflect these margin dynamics.

■

Carbon opportunity. As discussed in our previous note, ArborGen is exploring opportunities for providing seedlings to forest-based carbon projects and large-scale afforestation and reforestation efforts. In H123, the company began supplying hardwood and pine seedlings to two leading carbon companies in the US South, executing a long-term supply agreement with one and currently negotiating a comparable agreement with the other. While the timing and potential seedling quantities of these two companies are not clear at the moment, these opportunities could provide incremental value in the long term.

Finally, management recently announced that the CEO, Andrew Baum, will be stepping down from his role with the company once a successor has been recruited. While we are reviewing our estimates, we do not see this as having a negative effect on ARB’s long-term prospects as once a new CEO has been appointed, Andrew will remain in a consulting role to the business to ensure a smooth leadership transition. The board is in the process of recruiting a new CEO.

Exhibit 1: Financial summary

	US$m	FY21 (restated)	FY22 (restated)
Year end 31 March		IFRS	IFRS
PROFIT & LOSS
Revenue		42.8	47.6
Cost of Sales		(27.2)	(29.8)
Gross Profit		15.6	17.8
Operating Expenses		(15.4)	(15.1)
Other Income/(Expense)		0.8	-
EBITDA - US GAAP, Adjusted		7.4	10.1
EBITDA - IFRS - ArborGen		14.0	9.3
D&A		9.8	9.6
Operating Profit (before except.)		1.0	2.7
Exceptionals/Other		1.9	(4.0)
Operating Profit/(Loss) (EBIT)		2.9	(1.3)
Net Interest and financial expense		(2.0)	(1.7)
Profit Before Tax (norm)		(1.0)	1.0
Profit Before Tax (IFRS)		0.9	(3.0)
Tax		0.6	4.7
Profit After Tax (norm)		(0.4)	5.7
Profit After Tax (IFRS)		1.5	1.7
Profit/(loss) from discontinued operations		1.7	-
Net income (IFRS)		3.2	1.7
Average Number of Shares Outstanding, basic, millions		499.5	500.8
EPS - normalised, continuing operations, basic (US cents)		(0.1)	1.1
EPS - normalised, continuing operations, diluted (US cents)		(0.1)	1.1
EPS - IFRS, continuing operations, basic (US cents)		0.3	0.3

Gross Margin (%)		36.4%	37.4%
EBITDA Margin (%)		17.3%	21.2%

BALANCE SHEET
Fixed Assets		150.4	138.8
Intangible Assets		101.3	97.1
Tangible Assets		43.3	32.9
Right of Use Assets		5.8	4.7
Other		-	4.1
Current Assets		52.9	53.3
Cash and liquid deposits		6.2	15.2
Receivables		12.2	10.8
Inventories		34.5	27.3
Current Liabilities		(15.9)	(10.5)
Trade and other payables		(13.1)	(8.7)
Current Debt		(1.0)	(1.0)
Lease liabilities		(0.8)	(0.8)
Other		(1.0)	-
Long Term Liabilities		(39.2)	(30.2)
Long term debt		(32.6)	(25.7)
Lease liabilities		(5.1)	(4.2)
Other		(1.5)	(0.3)
Shareholder's Equity		148.2	151.4

CASH FLOW
Operating Cash Flow (before interest, tax, etc.)		8.1	10.8
Financing expense		2.0	1.7
Tax		(0.6)	(4.7)
FX		0.4	(0.3)
Capex		(1.0)	(1.5)
Investment in Intellectual Property		(3.7)	(3.1)
Acquisitions/disposals		-	15.2
Lease payments		(1.3)	(0.9)
Interest paid		(2.0)	(1.7)
Change in net cash		1.9	15.5
Opening net debt/(cash), not incl. leases		29.6	27.4
Exchange rate movements		0.3	0.4
Closing net debt/(cash), not incl. leases		27.4	11.5
Closing net debt/(cash), incl. leases		33.3	16.5

Source: ArborGen, Edison Investment Research

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