Wurst is not over for Devro, says Berenberg
A pioneer in the sausage casings market, Devro now faces major growth challenges, said analysts at Berenberg, beginning coverage of the stock with a 'sell' recommendation.
The €2.2bn artificial sausage casings industry is a niche area within the wider speciality ingredient space, with high entry barriers due to sophisticated production requirements, high investment levels and economies of scale, resulting in attractive profitability.
The casings industry has slowed dramatically since 2014, driven by oversupply of collagen in China that has resulted in heavy discounting and contract losses for some players, while weak macro conditions and FX headwinds in Latin America resulted in a big drop in casings demand in 2016.
Structurally, the casings industry is being affected by the slowing consumption of processed meat products in developed regions, slowing conversion from animal gut to collagen, as well as increasing pricing headwinds from processed meat industry consolidation.
Berenberg forecasts 3% compound industry growth to 2020 – a recovery relative to the previous three years, as cyclical factors abate, but below the historical mid-single-digit levels.
But while Devro pioneered the development of collagen for sausage casings, leading the wave of meat processor conversion, Berenberg believe it is "now in a structurally challenged position for growth, with a relatively unattractive sales exposure to slowing developed markets and weak market positions and a sub-optimal manufacturing footprint in emerging markets".
Having completed an intensive £110m capital investment programme in 2016, the analysts believe that more capital commitment will be necessary in the near term to optimise Devro’s capacity.
"With a high debt profile and growing pension deficit, we expect FCF pressures over the next few years and see significant downside risk to current market forecasts."
The stock trades on 17 times forecast 2018 earnings per share for a 5% three-year EPS compound annual growth rate.