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Date : 06/04/2022

United Malt Group

ASX :

UMG

Market Cap : $1.13 Billion

Dividend Per Share : $0.055

Dividend Yield : 1.45 %

Buy

52 Week Range : $3.76 - $4.76

Share Price : $3.85

UMG is the world's 4th largest commercial maltster with a sticky customer base and a clearly laid out growth plan. A 'Buy' from us.

Company Analysis

United Malt Group (ASX: UMG) is an Australia-based commercial maltster company. It supplies malt and other brewing ingredients/products to global brewers, craft brewers and distillers. The Company operates an international distribution business, which provides a full-service offering for craft brewers and distillers, including malt, hops, yeast, adjuncts, and related products. The Company offers malting houses in Canada, the United States, Australia, and the United Kingdom in the craft brewing and Scotch whisky sectors. It is also a craft malt distributor in North America.

United Malt is the fourth largest commercial maltster globally, which provides vertically integrated brewing; United Malt has been operating as a network of companies spanning North America, the UK and Australia since the early 1990s when Canada Malting purchased Great Western Malting and Bairds Malt. In 1995 the companies and Barrett Burston Malting in Australia were purchased to form the ConAgra Malt Group.

Since the formation of the Group, the craft beer industry has exploded. With the acquisition of North Country Malt in the United States, United Malt expanded into the warehouse and distribution business to support Commercial craft breweries.

Today, United Malt serves users worldwide, brewers, distillers, and other malt and craft ingredients. The Group’s international reach includes an extended network of distribution partners who locally deliver UMG’s malts and products.

Source: Tradingview.com

a long history of established brands

We recommended United Malt for the first time last year on the 3rd of March 2021, whilst the Company’s share was traded at $3.41 apiece. It was an excellent stock for a post-pandemic world. Despite a relatively flat rolling 12-month performance, we believe UMG comes with sheer dominance in its space and lots of growth in its pipeline and that the recent pullback can be an opportunity to get some more shares whilst they are still cheap.

Timeline

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Source: UMG

UMG reported solid FY21 earnings backed by a strong year of operation

FY21 was once again a challenging period for United Malt. COVID-19-related extended lockdowns in many of its key markets adversely impacted on-premise beer consumption and disrupted global supply chains and the Company’s ability to ship products to customers. However, UMG’s management team and its employees across the Group adapted well to these challenges and have demonstrated their agility, ingenuity and continued focus on serving its customers. We have witnessed that UMG’s management has done a commendable job anticipating and responding to their challenges.

Notwithstanding the lingering effect of the pandemic, we have cause for optimism about United Malt’s future. High vaccination rates in its key markets and hopefully reduced restrictions should support increased demand for malt products. Hence, the Company is well-positioned to benefit from improving market conditions, and we have seen UMG making good progress in implementing its strategy for medium-term growth.

Another solid achievement during the period was how UMG dealt with the risk that presented the pandemic. Hence, in response to COVID-19, we have seen the Company diligently focus on its employees’ health and well-being and the safe operations of its sites. Furthermore, UMG not only implemented initiatives to keep its people safe and support them during the pandemic, but it also made good progress in developing its longer-term safety strategy.

Pleasingly, COVID-related constraints did not slow UMG’s internal improvement initiatives. The Company announced a transformation program to renew its organisational and technology platforms during the year to create a simplified, more efficient and effective organisation. This program aims to keep its customer at the centre of everything UMG can offer. More importantly, UMG aims to reshape its business to drive growth, enhance its customer experience and increase efficiency by improving its systems and processes and streamlining its organisational structure.

Despite being launched against the backdrop of significant disruption caused by the pandemic, UMG achieved to date solid progress. We are confident that these measures will position the business to capitalise on the expected improvements in market conditions as UMG’s core markets enter the recovery phase, return to growth, and generate enhanced shareholder returns over the medium term.

While UMG’s last year’s results were adversely affected by these evolving COVID-related disruptions across the Group’s markets, relaxed lockdown restrictions in the second half of FY21 in North America and the UK spanning the northern hemisphere summer resulted in improved operating performance. This improvement was reflected in an 18% increase in EBITDA in the Warehouse and Distribution business, a solid 27% on a constant currency basis. Pleasingly, this momentum appears to be continuing into FY22. However, the arrival of the COVID Delta variant in Australia and Asia resulted in curfews and extended lockdowns in those markets in the second half, which softened sales, as did ocean freight disruption and significant increases in shipping rates. The Group EBITDA was $123.3 million, down 21% year-on-year. The FY21’s EBITDA was affected by the one-off costs of the Grantham site closure, the transformation, and the new IFRIC accounting pronouncement, which required costs incurred for the Company’s new ERP and Transport Management systems to be expensed when incurred rather than capitalised.

UMG’s Statutory Net Profit After Tax (NPAT) was $13.8 million compared to $45.6 million for FY20. Underlying Net Profit After Tax was $34.0 million compared to $57.4 million for FY20. We expect UMG’s gross profit margin to consistently remain stable above 25% whilst the Company significantly improves its net profit margin from 1% to above 12%, in line with a return to normal.

United Malt allocates approximately 60% of its underlying NPAT for the dividends. Consistent with this policy, and notwithstanding the challenges experienced during FY21, the Board resolved to pay a final dividend of 3.5 cents per share, unfranked, bringing the full-year dividend to 5.5 cents per share. The dividend payout in FY21 totalled 48% of the underlying NPAT, a remarkable 40% increase year-on-year.

Furthermore, United Malt has clearly stated that the Company aims to provide shareholders with a steady increase in dividends as profits grow.

Company Updates

FY22 onward outlook: United Malt braces for the global reopening

While we now see welcome improvements in sales outlook in UMG’s major markets and “green shoots” in some Asian countries, the effect of COVID-19 continues to create unexpected challenges across some of UMG’s markets. However, we are encouraged by the increasing vaccination rates globally and government commitments to removing lockdowns.

Moreover, United Malt has demonstrated its ability to adapt to these challenges to provide quality products and services to its strong and diversified customer base. We continue to see UMG focuses on optimising its core business by upgrading its capabilities and footprint to target growth in the craft beer and distilling markets.

As market conditions improve, we believe UMG is well-placed to take full advantage of rebounding malt demand. In the meantime, UMG stated that it continues to implement its transformation strategy to deliver approximately $30 million in net benefits in EBITDA by FY24.

UK operation

In the UK, United Malt remains well-placed to service the Scottish whisky market, which requires malt to meet the long-term requirements of distillers to produce aged whisky. The expansion at the Arbroath facility is now complete and has delivered an additional 22,000 tonnes of production capacity. Meanwhile, the new facility in Inverness will provide an additional 57,000 tonnes of capacity to service the distilling market. The site is expected to be operational by July or August 2022, slightly behind schedule due to ongoing social distancing requirements on-site. However, we remain optimistic that UMG will meet the deadline. The revised overall cost to complete the Scottish project is approximately $127 million. The higher cost estimate is driven by construction delays, higher material and supply chain costs, a tight labour market resulting from the COVID-19 environment, and some adverse foreign exchange movements. Notwithstanding increased project costs, the 79,000-tonne capacity expansion is underpinned by expanded contracts with major customers and based on the current forward orders secured; project return rates will be preserved. The Grantham facility in England was closed in March 2021, with customers’ orders now being supplied from UMG’s Witham facility and the additional volume coming online at the Arbroath facility.

Australia operation

In Australia, UMG continues to steadily progress on its 27-million-dollar project to replace the existing kiln at its Welshpool facility with a new and indirect heating source kiln. This renewal provides operating efficiencies and safer technology. We expect UMG to achieve a 10% reduction in gas and electricity usage. This upgrade also allows for expanding the facility’s capacity with further capital investment. The new 9,100 sqm craft Warehouse and Distribution Centre in Derrimut, Victoria, is now operational and provides an expanded range of ingredients and a “one-stop-shop” experience for UMG’s customers.

Central America operation

UMG has expanded its partnership with its Mexican distribution partner to grow its penetration capabilities into the region further. UMG’s partner opened its third warehouse in October 2021. During FY21, the Company announced its transformation program, which efforts are on renewing the processes and policies and technology platforms to create a simplified, more efficient and effective organisation. This project is expected to deliver circa $30 million of net benefits in EBITDA by FY24. One-off costs of $4.3 million were incurred in FY21 as part of the project.

UMG has also commenced the development of its new ERP and implemented a Transport Management System to enhance its data analysis and process improvement. Total expense on these systems is expected to be around $20 million over three years, with $6.5 million incurred in FY21.

Overall, we are convinced that United Malt is well-positioned to continue navigating through the near-term challenges. We believe that UMG is entering FY22 with optimism based on the opening up across key geographies with governments’ desire to limit future lockdowns and the continuing recovery in beer consumption. We are also confident in UMG’s implementation of its strategy to set the business up for a return to growth by investing in its capability, delivering on its strategic initiatives and capitalising on the improving market trends.

Industry Analysis

We have recognised three global trends that could continue to drive UMG’s performance in the future:

Drought in Canada: Crop conditions in Canada have deteriorated due to the drought, which has impacted the size and quality of the barley crop and has elevated global barley prices. We believe this issue would not severely impact United Malt as we have seen the Company taking proactive sourcing barley from Denmark and Australia to supplement its locally-sourced supply. The imported barley will support the requirements to meet UMG’s customers’ demands in both quality and supply. We expect the Company to continue to receive its first cargo throughout this calendar 2022.

Ease of COVID restriction worldwide: As vaccination rates increase and lockdown restrictions ease, we expect to see UMG capitalising on increased on-premise consumption with a corresponding improvement in product mix and demand for speciality malts.

UMG’s strategic initiative to streamline its operation: We think UMG is well-placed to return to growth supported by its strong market positions. Hence, UMG has quite an edge vis-à-vis its competition. It has strategically located malting assets and a market-leading distribution platform that services customers’ ingredient requirements. Additionally, we believe that United Malt’s growth will be further enhanced by the strategic initiatives the Company is implementing to equip its business with capabilities to operate more sustainably and create a more streamlined and efficient operating model to generate higher returns soon.

Investment Thesis

UMG is a unique opportunity to get exposure to a well-established pure-play malting business

Why do we like UMG? United Malt is the fourth largest commercial maltster globally, producing ingredients for the brewing, distilling, and food markets. They have an extremely sticky user base that is not going anywhere. In the alcohol industry, ingredients define how a product tastes and smells. Therefore, customers of UMG are not susceptible to jumping ship on their raw material partners. Additionally, the Company also exhibits traits of a business that has some room for growth further.

United Malt is supported by a distribution network comprising 25 warehouses, both Company-operated and through third-party logistics providers, and international craft distribution partnerships throughout North America, South America, Europe, Asia and Australia.

Source: UMG

We like the fact that UMG is well-diversified, and its customer base is well-diversified in different product categories, end-market, geography, and comprises a range of high-quality customers, including global brewers, craft brewers, distillers and food companies. UMG sell into domestic and export markets. Export markets, particularly in Asia, are an important source of demand for malt produced in Australia. The largest revenue comes from the North American region, accounting for 61% of UMG’s total sales. Europe is the second-largest market for UMG, contributing to 19% of the Company’s revenue. Micro Brewers represents the largest category in terms of clients, contributing 35% to UMG’s total earnings.

UMG has a strong market position and owns malting assets that are strategically located

United Malt owns malting assets strategically located near barley growing regions and customer demand. The Group generates profit from two business segments, Warehouse and Distribution and Processing.

Warehouse and Distribution: UMG’s Warehouse and Distribution segment generates revenue from the sales and distribution of bagged malt, hops, yeast, adjunctions, and related products. International craft distribution partners support the Company-owned distribution network focused on regions exhibiting growth in craft. United Malt’s competitive advantage is its ability to deliver all ingredients to the brewer on a just-in-time basis.

Processing business: United Malt has approximately 1.25Mtpa of capacity across twelve processing plants in Canada, the United States, Australia, and the United Kingdom. The Processing division services over 600 customers, including major brewers, national craft brewers, distillers, and food companies, with high earnings visibility underpinned by long-term contracts. UMG’s malting assets are strategically located across major barley growing regions providing access to high-quality barley and near-critical transport infrastructure, offering better access to customers.

Source: UMG

A solid growth strategy focused on high-value end markets where growth is expected to continue

United Malt continues to optimise its asset footprint, including upgrading capacity to create best in class operations enhancing customer experience.

Since last year, UMG has worked on a program to transform its business and renew its organisational and technology platform to create a simplified, more efficient, and effective global business. The specific areas of focus and initiatives that form part of the transformation include the organisational redesign, the transitioning to a simplified operation to create an organisational design reflecting a standalone malting company, and process changes. Through this program, UMG is also working on improving its capabilities by implementing simplified and standard processes, skills, and systems, enabling United Malt to become more data-informed. Overall, UMG aims to harness its network of malting production facilities and warehouse and distribution centres as one global network to deliver better outcomes for its customers, hence improving the Group’s revenue stream. The transformation program is being delivered over the coming periods and will deliver about $30 million in annualised net benefits by FY24. Ongoing work:

UK: The Scottish Expansion

The expansion has an objective of capital growth, and the completion is targeted for mid-CY22. UMG aims to increase capacity to 79,000 tonnes over the two Scottish facilities. The global demand for aged whisky continues to grow. United Malt is well-positioned to support the Scottish distilling industry supplying Scottish malt. Long term customer agreements underpin the capacity expansion.

The project’s first stage was completed in March 2021, with 22,000 tonnes of additional capacity commissioned in Arbroath. The expansion at United Malt’s Inverness site is underway, with the addition of a new malting tower of 57,000 tonnes per annum expected to be completed in July or August 2022. In addition to increasing production capacity, sustainability has been at the forefront of this project. The plant control system has been designed to incorporate energy monitoring technology and process control that allows consistent production quality and data-led analysis of energy consumption. The kilning equipment uses the best available technology to limit gas and electricity consumption. In addition, the installation of an anaerobic digestion module that treats effluent from both malting facilities at the site will significantly reduce the strength of effluent flows by 80% and reduce suspended solids by 50%.

Australia: Perth Kiln

United Malt’s Australian-based business replaces the existing kiln at its Welshpool facility with a new and indirect heating source kiln. This renewal provides operating efficiencies and safer technology. The project replaced the site’s ageing direct-fired, double floor kiln with an indirect fired single deck kiln, which will remove reliability and inefficiency issues and reduce maintenance costs and plant emissions. The Welshpool facility is near Western Australia’s high-quality barley growing region and is well situated to meet domestic demand and export to Asia.

Australia: Melbourne Warehouse

In June 2021, United Malt opened a new distribution facility in the greater Melbourne area. Its first Company operated a distribution centre in Australia. The 9,100 square metre distribution centre leverages the experience of the Company run distribution centre network across North America, providing an expanding range of ingredients and a “one-stop-shop” experience for customers. The new distribution centre allows United Malt to work more closely with its customers as their key partner in providing the finest brewing and distilling ingredients, creating excellent beer and whiskey foundations. The site has the capability for both cold and ambient storage on one site, offering customers all key beverage ingredients: malt, hops, yeast and an expanded range of adjuncts. The new facility results from numerous years of planning and has significantly strengthened United Malt’s distribution network and supports its strategy of being easy to do business with. This enables the Group to better serve its customers through faster dispatch and an expanded range of ingredients.

Mexico Warehouses

In FY20, United Malt announced its intention to expand its presence in Mexico. Mexico is an emerging craft market with demographics to support craft proliferation. Demand for reliable and readily available craft brewing ingredients is increasing. UMG has expanded its distribution partnership to grow further the Company’s brand presence and the “one-stop-shop” service offering in the Mexican craft market. With its local partner Beermex, UMG provides the growing craft market in Mexico with a wider product offering, enhanced customer experience and more efficient logistics. Three warehouses are now operational in Mexico. Merida, Guadalajara, and Tijuana. Guadalajara will serve as the primary supply hub for Tijuana and other satellite distribution points as the Company expands its presence in Mexico’s Northern and Central areas.

UMG is a resilient business: The Company reported FY21 results consistent with the market guidance

FY21 Earnings in line with previous years: EBITDA declined by 21%, however, to $123.3 million, consistent with the market guidance provided by UMG in September last year. It is important to note that this amount includes one-off items totalling $13.9 million. These include costs related to the Grantham site closure and the transformation program. The new IFRS accounting pronouncement required costs incurred to develop the new ERP and Transport Management systems to be expensed when incurred rather than capitalised amortised over the expected life of these investments. Underlying EBITDA excluding these one-off items was $137.2 million, a decline of 11% from the prior year. On a constant currency basis, removing the effect of the higher Australian dollar compared to the prior year, the underlying EBITDA was down 6%. The Company incurred two Significant Items, which reduced UMG’s reported result for FY21. These included write-downs on debts owed by a longstanding Asian customer and on grain stored at a UK warehouse that went into administration.

Consistent Dividends: As a business that, in normal times, should produce reasonably stable earnings, UMG’s dividend policy is to distribute to shareholders approximately 60% of its Net Profit After Tax. Consistent with this policy, while recognising the challenges experienced during the past year, the Company declared a final dividend of 3.5 cents per share, unfranked, bringing the full-year dividend to 5.5 cents per share. This represented 48% of FY21 Underlying NPAT.

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United Malt maintains a strong balance sheet, and the Company continues to operate comfortably within banking covenants. UMG has no significant near‐term refinancing commitments, with the maturity date of the term debt facilities extended to November 2024. Furthermore, the Group’s terms of the debt remain materially unchanged.

UMG has a clear strategy and targets its expansion in high-value markets

The fundamentals for malting remain positive. Beer remains a significant beverage category and is expected to grow further while seeing continued growth in craft beer and ancillary products. Of course, distilling continues uninterrupted, with UMG’s customers laying down spirits for ten-plus years for aged whisky.

We believe that United Malt clearly defined strategy, with its completing capital projects and its business transformation program, will deliver a material earnings uplift over the next two years. Thus, the outlook is improving in North America for beer consumption, in particular with the craft market. Furthermore, the Asian malt export demand is recovering over the medium term. We are also witnessing increases in vaccination rates and easing restrictions. Although, supply chain constraints remain.

Craft brewers are expanding into new channels through packaged products. Thus, we expect volumes to approach FY19 pre-covid levels onward to FY23, with gradual improvement in product mix and margins as the northern hemisphere’s summer season progresses.

During FY21, we have seen the worst drought in North America in over 17 years, with a 37% reduction in the barley crop. Subsequently, UMG experienced the barley and malt prices double for a few months. However, we are pleased that the Company has secured the supply and quality of barley required to meet its customer commitments this financial year and protect its market share. Hence, UMG arranged barley import via bulk vessel from Denmark and Australia to be delivered through FY22. The Group continues to anticipate a cost impact of $8 to 12 million in FY22, reflecting the additional cost of importing barley into North America.

United Malt remains in a strong financial position. We expect UMG’s gearing to be slightly above its target range approximately three times. Notwithstanding this temporary increase, the Company will maintain a comfortable headroom within its facilities. We expect it to be within its target range of 2.0 to 2.5 times by the end of the full year.

In FY22, we expect UMG’s capital expenditure to be $72 million for growth and sustainability projects, mainly related to completing its Scottish capacity expansion and $38 million for safety-related investment. Capital expenditure will be weighted to the second half of the year.

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FY22 represents the peak of the Company’s capital expenditure cycle, with growth projects delivering earnings uplift from FY23, including the $18 million from the Scottish project. While we believe UMG will have to manage a few complexities in the short term, we remain confident of the Company’s full-year performance. We expect earnings to align with its historical seasonal earnings split of 40% first half and 60% second half.

Considering these operational aspects, we forecast UMG’s earnings to remain stable at above $1.2 Billion from FY22 to FY24.

Technical Analysis

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Trend

Over the last twelve months, UMG price action has remained relatively flat. Throughout CY21, UMG has been trading sideways in the $3.6 and $4.6 range. These two levels are key levels. The $3.5 and $3.6 price range is UMG’s floor. We believe that UMG will be consolidating around this price area before its next rally towards the $4.6 multi-year resistance level. Once a clear breakout occurs of the $4.6 level, there will be a great possibility of a rebound and a bull run towards $6 per share, our primary target.

Key price levels

There are two important levels to watch:

  1. The $3.6 level: UMG’s actual floor.
  2. The $4.6 level: UMG’s multi-year resistance.

Volume and momentum

Volume increased over the last 200-day with the 20-day volume average up by 111%. The price action remains neutral in the near term, evolving between $3.6 and $4.0 per share.

Trade consideration

  • Market participants might be interested in entering at key support levels: $3.6 and $3.7 per share.
  • Primary target price above $6.0 per share
  • Secondary target price at $6.7 per share
  • Consider reducing exposure below $3.5 per share
  • It is recommended to exit the trade below $3.0 per share

Recommendation

UMG is a pure-play malting business with an extremely sticky user base and one that is leveraging strong growth fundamentals. United Malt exhibits all the traits of long-term growth stocks, which is relatively safe. Hence, UMG is well established in an attractive and unique market. The Company owns malting assets strategically located and leads the craft brewing distribution platform. Another aspect of the business we like is the Company’s integrated supply chain with strong barley sourcing capabilities. UMG launched its transformation program during FY21, expected to bring $30 million in net benefits delivered by 2024. As market conditions improve, we believe UMG is well-placed to take full advantage of rebounding malt demand. With current customers not going anywhere and future growth plans well underway, we recommend a “Buy”.

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