As a well-run, ungeared domestic poultry stock, Astral Foods (code: ARL) has two major variables that largely dictate its fortunes:
- What cost must it pay to raise its chickens?
- What price can it sell its chicken products at?
Firstly, Astral’s long-term track record is superb, proving the underpin of quality in the business. Over the last two decades, the Group has earned an average Return on Capital (c.25%) or nearly double its Cost of Capital (c.12~13%).
Secondly, South Africa’s receding drought pressures and the anticipation of a healthy 2019/2020 maize harvest should see prices remain accommodative. Likewise, the US-Sino Trade War receding has seen soybean prices loosening somewhat globally. Particularly maize–but to a lesser degree also soybean—forms a key input into feed prices that imply that the cost of raising chickens is falling.
Thirdly, following major supply collapses from swine flu in China to the recent appearance of some avian flu in the EU, global protein prices have been quietly ticking upwards. There also remains the potential for anti-dumping tariff protection in South Africa that would be an added positive for domestic poultry prices.
Logically, if Astral’s input costs are dropping while its sales prices are rising, the Group’s gross margins should be expanding. Combined with the positive operating leverage of its overheads, we expect strong performance from Astral going forward.
All this is matched with a reasonable valuation, an ungeared balance sheet and the Group’s quality track record. And, therefore, we are confident that Astral should make an attractive addition to our portfolio.
Originally posted in the January 2020 Alpha Prime Small & Mid Cap Investor Letter (LINK).