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Fundamental Analysis



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August 16, 2018








Executive Summary

The agricultural industry in Australia has been one of the fundamental components of the economy. Although its relative importance has been decreasing over time, it remains to be significant. GrainCorp Limited and Clean Seas Tuna Limited are two companies in Australia’s agricultural industry listed on the ASX. A top-down analysis of the industry shows that the macroeconomic environment of Australia is favourable for the stocks of the two companies. While fluctuations in some variables have adversely affected the stock prices of the companies, most variables are relatively stable. Likewise, a bottom-up analysis of the two companies’ profitability and leverage ratios reveals that GrainCorp Limited is perforning relatively better than Clean Seas Tuna Limited, translating into better performance in the stocks of the former company.


Introduction to the Australian Agricultural Industry

The Agricultural Industry has been a fundamental component of the economy of Australia for decades. The industry accounted for more than thirty percent of the country’s output and at three quarters of Australian exports in the first quarter of the 20th century(Commission and others, 2006). However, the relative significance of the agricultural industry in the economy has been on a declining trend over the past few decades. In the 2015 fiscal year, for example, the industry accounted for only ten percent of the country’s output. The industry’s share of employment has fallen by more than 50 percent in less than a century. In addition, the country’s reliance on agricultural exports has also declined from over 75 percent in the 1960s to less than 25 percent in the 2015 fiscal year. Projections indicate that the industry will account for as little as 2.3 percent of Australia’s gross domestic product by the year 2020. The decline in the industry’s importance is not due to decrease in output but has rather been caused by higher relative growth in the service-based industry as well as the manufacturing industry(Galariotis, 2016).

While most companies in the Australian agricultural industry operate on small scale basis, the industry is dominated by multinational companies, most of which are listed on the Australian Securities Exchange (ASX). The agricultural industry accounts for about 30 percent of the Australian share market. While a considerable number of large agricultural corporations are largely owned by the government, a significant proportion is owned by private local as well as international investors. The share market for the agricultural industry is one of the most volatile as characterised by large spreads of price shocks occasioned by changes in the economy. Changes in macroeconomic indicators such as inflation rate, interest rate, GDP and the value of the Australian Dollar (AUD) result in changes in the value of the agricultural companies and hence their share prices. Similarly, changes in the specific companies’ financial ratios result in changes in the value of the companies which translates to fluctuations in their share prices in ASX(Baker and Wurgler, 2007).

GrainCorp Limited

GrainCorp Limited is an Australian that deals receives and stores grain and other related commodities. It also provides market and logistics services for these commodities. The firm is a public company listed on the Australian Securities Exchange (ASX). It is among the ASX top 100 companies according to share performance. Founded as Government Grain Elevator in 1917 in New South Wales, the company was formed to offer transportation services for grains from local collection points located throughout NSW grain-producing zones. The company’s name was later changed to the Grain Handling Authority. It was not until 1992 that it was privatised with over 60 percent of its shares being transferred to grain growers. It was then listed on ASX in 1998. The operations of the company has since expanded to other Australian states including Gladstone, Bribane, Newcastle, Mackay, Geelong, Port Kembla, as well as Victoria. Most of the outlets located in these terminals primarily deal with export operations. The company has as of 2012, extended its operations into North America as well as Europe through the purchase of United Malt Holdings and GemanMalt GmbH & Co respectively(Graincorp.com.au, 2016).

Presently, GrainCorp Limited’s shareholding comprises of over 75 percent local and international private investors. It deals with three core grains namely wheat, barley, and canola. Its operations are integrated into three activities namely storage and logistics, marketing, and processing, and are undertaken in three strategic geographical regions, Australia, North America, and Europe(Brewin et al., 2008). The company’s mission encompasses a thrift to become an international leader in agribusiness as well as food ingredients through value creation for both consumers and producers. The company acts as an intermediary connecting the two groups of individuals. In the financial year ended 31st December 2015, the company posted an after-tax profit of AUD 300 million. The profit translated into heavy dividends for shareholders bringing up the company’s share price.(Graincorp.com.au, 2016)

Clean Seas Tuna Limited

Clean Seas Tuna Limited is an Australian company that operates in the aquaculture sector of the country’s agricultural industry. The company is an innovative state-of the-art enterprise primarily operating in South Australia by providing links between the market for tuna fishing and farming industries. The company operates on cumulatively 400 hectare onshore sitesin Fitzgerald Bay, Arno Bay, Port Augusta, and Port Lincoln where most of its operations are situated. Its core business is propagating commercially bred Mulloway, Southern Bluefin Tuna, and Yellowtail Kingfish in both domestic as well as international markets(Longo and Clark, 2012). The company was the first company in the world to undertake a successful transfer of large Southern Bluefin Tuna over long distances. It also operates mature Southern Bluefin Tuna broodstock primarily supported by expertise and skills from The Stehr Group. In addition to the above operations, the company undertakes research and development activities in the production of juveniles of Southern Bluefin Tina. The research and development department of the company is considered to be one of the most successful in the world’s aquaculture industry(Cleanseas.com.au, 2016).

Clean Seas Tuna Limited was incorporated in 2000 and listed on ASX two years later. The company’s main shareholder and parent company is The Stehr Group. The Stehr Group, established in the 1970s is the leader in Australia as well as the international pioneer in tuna ranching, fishing, as well as offshore fish farming(Adams, 2014). The other proportion of the company’s shares are held by local and international private investors, and are traded on the ASX. International private investors cumulatively hold about 15 percent of the company’s shares. Over 60 percent of Clean Seas Tuna Limited’s production is for export purposes. The company’s export market includes countries such as the United States, France, the United Kingdom, Spain, Japan, Italy, Switzerland, Russia, and the Netherlands. The company’s mission is to provide sustainable sea foods in Australia and all over the world. For the past decade, the company has been posting higher profits year on year. However, there was a significant decline in profits in 2008 as a result of the global financial crisis. The company has since recovered as can evidenced by minimal fluctuations in the share price(Cleanseas.com.au, 2016).

Top down Analysis

Top-Down Analysis is a method of fundamental analysis that encompasses looking at the big picture first, and then undertaking an analysis of the details of the components of the big picture. By first undertaking an analysis of the big picture that involves analysing the macroeconomic trend of economic indicators, one is able to narrow down to the implications of such trends on the financial market value of specific companies in a given industry(Böhringer and Rutherford, 2008). The Top-Down analysis in this paper will involve analysing the effects of Australian macroeconomic indicators including interest rate, gross domestic product, and the value of the Australian dollar (AUD), on the market value of the shares of both GrainCorp Limited and Clean Seas Tuna Limited, companies listed on the ASX.

Interest rate

Interest rate refers to the proportion of money charged by a lender to borrower for the use of the lender’s assets. It is usually expressed as a percentage of the principal amount of the asset borrowed. In macroeconomic terms, interest rate refers to the aggregate percentage that borrowers are required to pay to lenders for holding their assets. Interest rate is usually noted on an annual basis, although in most economies it is calculated monthly. In the Australian economy, lenders of credit on which interest is charged include commercial banks and other financial institutions such as investment banks. Borrowers comprise of consumers and investors(Hsing and others, 2011). The decisions of the determination of interest rate in Australia are taken by the Reserve Bank of Australia’s (RBA) Board. The RBA is the authority charged with the responsibility of regulating the flow of money in the Australian economy. As such, it adopts policies aimed at either increasing the amount of money in circulation in the economy or reducing it. It achieves the above objectives by regulating the levels of interest rates. The current rate of interest in Australia is 1.5 percent. The Australia Interest Rate has been on a decreasing trend, having fallen from over 10 percent in 2008 to 1.5 percent in June, 2016 (RBA, 2016).

The reduction in interest rates resulting from reduction in prime rates and inflation rates has shifted the attention of investors to stock markets thereby increasing share prices(Kapsos, 2006). Evidence from the Australian Stock Exchange (ASX) reveals that the stability of interest rates, as well as other macroeconomic indicators, have significantly contributed to the growth of the Australian stock markets. Investors have shifted from investing in risk free financial instruments such as treasury bills as a result of the stable interest rates (RBA, 2016). As a result of the low and relatively stable interest rates, therefore, the price of shares of GrainCorp Limited and Clean Seas Tuna Limited have increased. It is worth noting that the shift of investors from risk-free instruments to stock markets has resulted in oversubscription of the stocks of well-performing companies such as the two mentioned above. The high demand for these stocks has resulted in a higher price.

Exchange Rate (Value of AUD)

Exchange rate refers to the price of the currency of one nation in terms of another nation’s currency, for instance, the value of one Australian dollar in terms of the United States dollar. The exchange rate is used to describe the strength of the local currency relative to the foreign currency. A stronger local currency is desirable. The current exchange rate of AUD to USD is 0.76. That means that 1 AUD dollar is worth USD 0.76. While the current exchange rate may not have a significant impact on the stock prices of companies listed on ASX, the trend in the exchange rate is of the essence. The Australian dollar has, for the past two years, been appreciating. That implies that the value of the Australian dollar relative to other currencies has been increasing. In other words, the Australian dollar has been growing stronger (RBA, 2016).

The appreciating AUD has caused a rise in stock prices because of expectations of lower levels of inflations. An appreciating currency causes investors to expect lower levels of inflation in the future, thereby increasing their demand for stocks. Secondly, since foreign investors, who own a substantial proportion of the stocks of the two companies, will be willing to hold assets in a currency that is appreciating because that will lead to higher returns on their investment, their demand for Australian stocks is high driving the prices for these stocks up(Sornette, 2009). However, since the two companies are net exporters, an appreciating AUD has significantly reduced the earnings of these companies from exports. The effect on share price as a result of the loss in earnings has, however, been neutralised by gains from the appreciating AUD(Hockey, 2013).

Gross Domestic Product (GDP)

Gross Domestic Product (GDP) refers to the monetary value of all the finished goods and services produced within a country’s borders in a specified period of time. Although GDP is typically calculated annually, most countries, including Australia, maintain quarterly GDP estimates. GDP gives an aggregate of all public and private consumption, government spending, investments, and net exports (that is exports minus imports). It is the measure of an economy’s overall economic activity. While the GDP levels of an economy have significant impacts on stock prices, the rate of GDP growth has a stronger relationship with stock prices. The higher the rate of growth of GDP, the better the performance of the stock markets, all other factors held constant (RBA, 2016).

The GDP of Australia has been growing steadily for the last three quarters, with a 3.1 percent growth in the first quarter of 2016. Investors take interest in the economy’s GDP growth reports because the reports give the most comprehensive scorecard about the overall health of the given economy (Vanstone et al., 2004). Given that a healthy economy translates into higher corporate profits, stock performance tends to depict economic performance in the long run. AS such the prices of stocks increase higher rates of GDP growth. The share prices of GrainCorp Limited and Clean Sea Tuna Limited grew steadily in the first quarter of 2016 as a result of the 3.1 percent growth in GDP.

Bottom-Up Analysis

Bottom-Up Analysis is a method of fundamental analysis whose focus is on analyzing individual stocks of a given company as opposed to emphasizing the significance of market cycles as well as economic cycles. In the bottom-up analysis, the investor gives attention to the performance of a specific company as opposed to the industry in which that company operates or even the economy as a whole. The assumption in this approach is that a company can thrive in a non-performing industry(Böhringer and Rutherford, 2008). In this paper, we will undertake to analyze the financial health, financial statements, supply, and demand, as well as the products and services of GrainCorp Limited and Clean Sea Tuna Limited. We will achieve the above objective by analysing the effects of the trends in the financial ratios of these companies on their respective share prices.

In this paper, the bottom-up analysis will involve analyzing two types of financial ratios for each of the two companies namely profitability ratios and leverage ratios. Financial ratios depict a financial analysis in which items of the financial statements of a company are divided by one another with the aim of revealing their logical interrelationships. The two classes of financial ratios give the investor an impression of the financial health of the company by showing the trend in performance as well as projections into the future(Kohansal et al., 2013)

Profitability ratios

Profitability ratios are a class of financial ratios that are used by analysts to make an assessment of the ability of a business to generate earnings relative to its costs and expenses incurred over a given period of time, usually the business’s financial year. The higher the ratio relative to the ratios of competitors, the better the business is taken to be performing. Some of the most widely used profitability ratios in fundamental analysis include return on assets (ROA), profit margin, and return on equity (ROE). For companies in the agricultural industry, profitability ratios play a significant role in shaping investment decisions mainly because the performance of the businesses is highly affected by seasons. As such, businesses that post a relatively high and stable trend of profitability ratios is taken to be safer for investment, and hence its stocks do well in ASX(Baker and Wurgler, 2007).

Profit margins are of different kinds and vary from one industry to another. The net profit margin is the most appropriate profitability ratio for an agricultural company. It is a representation of the ratio between the profits of a company to its revenues. It represents the capacity of the company to translate revenues into profits. Return on assets (ROA) is the profitability ratio that shows the effectiveness with which the company is employing assets to create sales and generate profits. It is usually represented by the net profit after tax(Sornette, 2009). In some cases it also talks into account the asset base of the company in question. Return on equity (ROE) on the other hand is a measure of the ability of the company to generate returns for investors. It is of great importance to investors since it gives them a picture of the probability of earning from their investment(Kohansal et al., 2013).

For GrainCorp Limited, the net profit ratio increased from 65 percent in the FY2014 to 68 percent in the FY2015. The net profit margin ranked second in the agricultural industry in Australia. The ROA for the same period averaged 5.4 percent compared to 3.2 percent average for the industry. The ROE averaged 2.9 percent, 1 percent higher than the industry average.As a result, the share prices of GrainCorp Limited increased by a margin of 0.02 within the same period. There was increased demand for the stocks of the company as a result of posting relatively good profits relative to competitors(Graincorp.com.au, 2016).

For Clean Seas Tuna Limited, the net profit margin remained at 54 percent for the period between 2014 and 2015, an observation that partly explains the little change in the stock prices for the company. The company’s ROA averaged 2.7 percent given the large asset base for the company. The company posted an average of 1.7 percent ROE. The two profitability ratios were close to the industry’s average and therefore did not have large effects on the company’s stock prices(Cleanseas.com.au, 2016).

Leverage ratios

Leverage ratios give the investors an impression of how ale to company is to meet its financial obligations. More specifically, leverage ratios make a comparison of the reliance of the company on owner’s equity versus debt in its operations. The most appropriate leverage ratio is the total debt/total equity. The lower it is the better for the investor. A ratio greater than 2.0 is an indication of a risky scenario. In addition, investors monitor the trend in the ratio over time in making investment decisions(Vanstone et al., 2004).

The total debt/total equity ratio for GrainCorp Limited has averaged 1.2 percent for the last five years while that of Clean Seas Tuna Limited averages 1.4 percent. The observation partly explains the high capitalization for GrainCorp Limited stocks relative to Clean Seas Tuna Limited stocks over the same period(Galariotis, 2010).

Summary and recommendations

The top-down analysis for the agricultural industry in Australia shows that the macroeconomic environment of Australia is favourable. Although there have been fluctuations in some of the macroeconomic variables, they have been relatively stable over time. Changes in the macroeconomic variables result in changes in the ASX as seen in the changes in prices of the stocks of the two companies. GrainCorp Limited and Clean Seas Tuna Limited should take advantage of the favourable economic environment in Australia to position themselves strategically in order to attract investors through stable stock prices.

The bottom-up analysis for the two companies reveals that both profitability and leverage ratios have significant effects on the performance of the stocks of each company. While GraunCorp Limited seems to be on the right track, Clean Seas Tuna Limited falls slightly above the threshold for the industry. The management of the latter should adopt strategies to address the company’s reliance on debt capital for operations.

Reference List

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