Aquaculture is one of our favorite investment themes for the medium to long term investment horizon. Along with population growth, higher living standards and healthier diets that support greater consumption of fish protein, several countries around the world are also investing in aquaculture. addressing food security as well as supporting climate change initiatives.
Previous episodes of foodborne virus outbreaks and food contamination have disproportionately affected land-based sources of animal protein. Thus, investors may consider adding aquaculture to their portfolio to diversify the risks associated with investing in the food industry.
In this paper, we assess the long-term return drivers for aquaculture, as well as the potential impact of the newly proposed ‘resource rent tax’ in Norway.
Demand for healthy fish protein to sustain population growth and long-term growth
Investors are often unimpressed by analysts who point to population growth as a long-term investment theme. This is understandable given that world population growth rates have been steadily declining and will continue to decline from 0.84% per year to just 0.64% by 2040, according to the latest projections published by the United Nations. Most of the world’s population growth will be in developing countries, as a number of developed countries are already experiencing population decline.
However, the positive impact of population growth on demand for fish protein for aquaculture is exacerbated by other factors such as increased affluence and healthier eating habits in emerging markets. Simply put, population growth not only leads to an increase in base demand, but also increases fish consumption in proportion to other sources of protein for a balanced diet, thus fueling aggregate demand growth.
In addition, declining fish stocks in the oceans also mean that the world will have to rely more on aquaculture production to meet the growing demand for fish protein.
Mowi is a Leader in Salmon Aquaculture with a Vertically Integrated Model
For investors looking to add portfolio exposure to this theme, we select Mowi ASA ( OTCPK:MHGVY ) as a top-tier company to fulfill our high view of the aquaculture theme.
Mowi is currently the largest producer of farmed salmon in the world by volume. The company’s products are sold in more than 70 countries, representative offices operate in 25 countries. Mowi operates in three main business areas including feed, farming and sales and marketing, of which salmon dominates a large share of its business.
In addition to leveraging significant advantages in economies of scale, we particularly like how Mowin has successfully integrated its operations vertically across the value chain over the years. Mowi is the only salmon producer in the world with a fully vertically integrated business model, which highlights the company’s many competitive advantages over its peers. Due to the unique challenges of salmon production, Mowin’s ability to control the entire value chain is absolutely critical.
Mowi is uniquely positioned to coordinate and apply research and development efforts with full control over the entire value chain from genetics, feed, farming operations, harvesting, processing, logistics, sales and marketing. In comparison, other salmon producers (even at scale) rely on off-the-shelf solutions for either genetics or feed, and have limited control over the quality and development of their suppliers.
Aquaculture is in a Constant Technological Race
Interestingly, aquaculture is one of the most technologically complex industries today. And Mowi has been a pioneer and leader in aquaculture technology for many years, creating a significant technological gap between the company and its peers.
Mowi has also been developing the same type of salmon since the company first started in 1964. Having complete control over breeding, genetics and feed means Mowi is able to produce superior products compared to its competitors. By producing its own eggs and chick stocks, Mowi is able to ensure and select the best genetic traits for future generations of salmon. The company continues to invest aggressively in improving the disease resistance and other biological qualities of salmon.
Other areas of R&D that we believe will further enhance Mowin’s competitive edge include Smart Farming technologies. These projects have been in development at Mowi for several years, and some are already being implemented in real-world salmon farming environments. The diagram below, extracted from Mowin’s 2021 Annual Report, demonstrates some of these innovative R&D projects in action.
Salmon fishing is environmentally friendly, important in an increasingly carbon-conscious world.
The table below shows the amount of greenhouse gas emissions for different food products. As we have seen, animal protein production is responsible for some of the highest levels of greenhouse gas emissions. Farmed fish, which is part of the animal protein group, is actually one of the more environmentally sustainable food sources (highlighted in green).
However, due to the variety of different fish species that are farmed, this still presents a high overall picture. Taking a closer look at the specific fish species farmed, we highlight that farmed salmon (highlighted in green) is among the lowest in greenhouse gas emissions at just 5.1 kilograms per kilogram of seafood. This makes farmed salmon one of the most environmentally sustainable and scalable sources of animal protein in the world today.
Qualitative factors aside, Mowi has also performed well financially over the years, providing investors with a TTM ROE of 22.4% and a 5-year average ROE of 15.8%. The company also averages a stable gross margin of 46% and an EBITDA margin of 20% over the last 5 years with a dividend yield of 4.2%.
In terms of valuation, we note that Mowi almost never trades at deep discounts due to the relatively stable nature of its profitability and earnings. The stock currently trades at just 11.3x TTM GAAP P/E, but we note that this is due to the recent 22% decline in Mowi’s share price following the announcement of a newly proposed 40% “resource rent tax” in Norway. Including corporate tax, this would amount to a 62% tax on income from salmon producers. Thus, current P/E ratios do not take into account the potential reduction in EPS, which most analysts expect would fall by a third if the new proposed tax were to be implemented.
Awaiting Resource Rent Tax Result
The Norwegian government’s announced proposal to increase taxes on goldfish production is likely to present significant downside risks to the aquaculture industry in Norway. Major salmon producers, including Mowi, have halted investment in Norwegian production in anticipation of reduced cash flows in 2023. We further note that reduced investment means production volumes could potentially stagnate, presenting downside risks to earnings in 2023 and beyond.
The proposal is still in the public consultation process until January 4, 2023, but most analysts believe it will go ahead as planned.
In the end
Despite the positive long-term outlook, Mowi ASA could still be adversely affected by the newly proposed “resource rent tax”, which could potentially cut revenues by a third. Plans to invest in new production capacity are also on hold, presenting significant downside risks to earnings growth in 2023 and beyond.
We open our coverage on Mowi with a “Hold” rating for the time being, with the intention of upgrading once further clarity on future earnings becomes available.