Thai Union Frozen Products

Thai Union Frozen Products Plc (TUF)

Thai Union Frozen Products (TUF) is a leading producer and exporter of frozen and canned seafood. It has 20 subsidiaries—13 domestic and 7 overseas—and six affiliates to cater to its expansion and integration plans. Its product range includes tuna loin, canned tuna, frozen shrimp, canned pet food, canned seafood, cephalopod, canned sardines and mackerel and shrimp feed. As of 1H11, canned tuna and frozen shrimp represented the largest contributors—51% and 17%, respectively, of consolidated sales.

Investment thesis: We remain bullish about TUF's 2H11-FY12 earnings profile. Strong 2H11 profitability is underpinned by the kicking-in of synergistic benefits from MWB in 3Q11, a more stable raw material price environment, more frequent sales price increases, MWB and TUF sales expansion and a better COSI bottom-line with the easing of price-led competition in the US. In FY12, we expect greater synergistic benefits from MWB, the kicking-in of its US pet food revenue, and interest cost savings as a result of debt refinancing to lead earnings growth. Despite concerns over baht appreciation and weak US and EU economies, we believe the downside risk is negligible—TUF is hedging more actively and tuna consumption in developed markets isn't impacted by recessions. Our BUY rating stands with a YE12 target price of Bt78 (pegged to a PER of 15x). TUF is our sector top pick.

Less volatile raw material prices in 2H11: We believe raw material price volatility will ease HoH in 2H11. The domestic shrimp price will dip a little, due to increased production in 2H11, then sustain at that level until YE11. We expect a sustained high tuna price through 2H11, buoyed by a tightening global tuna supply because of warmer weather and more bans on fishing. Although 2H11 is high-catch season, the price decline will be insignificant. In a more stable raw material pricing environment, TUF's margin will rise.

Full-year synergies with MWB in FY12: We estimate about €3m (or Bt130m) in synergistic benefits with MWB in 2H11 and €15m (or Bt640m) in FY12. In 2H11, we expect some cost savings with the start-ups of MWB canning operations in the Seychelles and Ghana, some scope for yield improvement and more optimal fleet management. Next year's highlights will be revenue from fishmeal, other value-added products and the penetration of new markets—Germany, Russia/CIS, Scandinavia and North Africa.

US pet food—a new sales growth driver: TUF is entering the American pet food market and has an ambitious FY15 sales target of US$200m. We expect commercial launch in 4Q11. The firm already has distribution for its seafood products across the US, so has a client base already. Good pet food numbers would mean upside to our FY12 sales forecast.  

Outlook

Strong operations to be sustained in 2H11: Baht appreciation notwithstanding, we expect TUF to sustain the strong earnings it posted for 2Q11 through 2H11, supported by gross margin (GM) of 16.5-17%, the kicking-in of synergistic benefits from the MWB consolidation in 3Q11, sales expansion for both MWB and TUF's stand-alone operation and interest expense savings brought about by debt refinancing. The solid GM will be underpinned by more stable pricing environment for raw tuna and shrimp and more regular sales prices adjustments for finished products—both tuna (every 1-2 months) and shrimp (every 2-3 months)—in response to changes in the costs of raw materials. This is despite the anticipation of stronger Baht against US$ and Baht against Euro in 2H11. The contribution from Chicken of the Sea International (COSI) should also increase with the easing of price-led competition in the US.

Raw materials prices to stabilize in 2H11: We believe raw material price volatility will ease HoH in 2H11. The domestic shrimp price will dip a little, due to increased production in 2H11 (5-6 months after flooding in the southern provinces of Thailand in March 2011), perhaps 5-10% HoH and stay at that level in 2H11. The mean domestic shrimp price—50-60 pieces/kg—has already dropped 16% from its peak of Bt155/kg in April. The YTD mean is Bt143/kg, up 21% YoY.

With regard to tuna, warmer global weather and a fishing ban on EPO (July 29-Sept 28) have brought on a tightening of supply, so we expect sustained high tuna prices through 2H11. Although 2H11 is high-catch season, the price decline will be insignificant—US$1,400-$1,800/tonne range during the period. The raw tuna price peaked at $1,905/tonne in June before dropping to $1,620/tonne in July, then bounced back to $1,700/tonne in August-to-date. Given a more stable tuna price, tuna margin should be sustained high in 2H11. The YTD mean is $1,666/tonne, up 26% YoY.

Risks

High business resilience to weak US and EU economies: We believe that the unfavorable economic situations in the EU and US will have little or no effect on tuna consumption and demand in those markets. Demand for canned tuna in developed economy markets isn't affected by the vagaries of the economic cycle, but by the relative cost of close substitutes, such as chicken (which is about twice the price and substantially more expensive than it was a year ago).

Baht appreciation against US$ and Euro in 2H11: About 91% of consolidated revenue and 67% of consolidated costs are in foreign currencies, so there is about 75% natural hedging in the cost-to-revenue structure. In any case, TUF hedges more actively than it used to before. Based on our sensitivity analysis, for every one baht of appreciation against the US dollar, TUF's consolidated profit would be squeezed by about 1%.  

Recommendation and valuation

Our top pick in the sector: We remain bullish about TUF's 2H11-FY12 earnings profile. Strong 2H11 profitability is underpinned by the kicking-in of synergistic benefits from MWB in 3Q11, a more stable raw material price environment, more frequent sales price increases, MWB and TUF sales expansion and a better COSI bottom-line with the easing of price-led competition in the US. In FY12, we expect greater synergistic benefits from MWB, the kicking-in of its US pet food revenue and interest cost savings as a result of debt refinancing to lead earnings growth. Despite concerns over baht appreciation and weak US and EU economies, we believe the downside risk is negligible—TUF is hedging more actively and tuna consumption in developed markets isn't impacted by recessions. Our BUY rating stands with a YE12 target price of Bt78 (pegged to a PER of 15x). TUF is our sector top pick