Bega teeters lower on sour guidance

The market gave Bega Cheese (ASX: BGA) a masterclass in what it thinks of profit downgrades, with the share price down -11.92% two hours into the day’s trading.

The share price fall followed the company’s warning due to the "short-term impacts of COVID-19 and a "highly competitive milk procurement environment".

Based on the short-term impacts of covid and a highly competitive milk procurement environment, the company is guiding to FY22 earnings (EBITDA) in the range of $195 to $215m.

Meantime, management noted that markets in both Australia and internationally remain strong particularly in dairy ingredients with both short and medium-term positive demand.

Tilt towards more resilient end-markets

Bega, owner of the Vegemite brand, acquired brewing giant Lion’s Dairy and Drinks business for $560m in late 2020, and generated underlying earnings (EBITDA) of $141.7m in FY2021 - 38% higher than the prior year and reported a net debt $324.9m.

While Bega believes the Lion’s milk portfolio was acquired on the cheap, management raised doubts over infant formula markets in China ever recovering to pre-covid levels.

Management previously pointed to above-expectation earnings from the acquisition for the five months of trading, with strong FY22 momentum. 

Despite current challenges, UBS is encouraged by Bega’s significant revenue tilt towards more resilient and higher value grocery end-markets – following the Lion Dairy & Drinks acquisition and had forecast three-year compound earnings growth of 29% from FY21.

Key broker concerns

The broker expects FY22 to be challenging for Bega, with a step-up in the farm gate milk price to $7.14 from $6.50 in FY21. 

Morgans notes, branded sales are now over 73% of group sales, up from 59% in FY20. With a full year of Lion’s dairy and drinks business, the broker expects branded sales to represent over 80% of group sales in FY22.

However, the broker also echoed similar concerns around competition for milk, unprecedented farmgate milk prices, and covid lockdowns undermining the higher margin convenience and food service channels.

Bega shares appear to be consolidating within a longer-term downtrend. The Average Directional Index is below 20, which is indicating that shares have traded sideways recently.

Consensus on Bega prior to today’s profit downgrade was Moderate Buy.

Based on Morningstar’s fair value of $6.25 prior to the announcement, the stock looked undervalued.