Profiting from soaring commodity prices

Surging commodity prices have driven yet another profit upgrade for Hargreaves Services (HSP:560p), a diversified industrial services group and brownfield land developer. In fact, this is the sixth time in the past 12 months that analysts have been forced to upgrade their earnings estimates.

That’s because German metals trading subsidiary, HRMS, is a key supplier of specialist raw materials to European customers in the steel, smelting, ferroalloy, limestone, and ceramic industries. In the six months to 30 November 2021, HRMS delivered a £9.3mn net profit on 80 per cent higher volumes of 750,000 tonnes. The strong momentum has continued into 2022, so much so that the board expect an even better second half outcome.

The spike in zinc and pig iron prices is especially good news for Hargreaves as it owns a 94.9 per cent stake in DK Recycling, a German company that produces 285,000 tonnes of high-quality pig iron by recycling waste material from the steel industry. Moreover, the operational changes implemented (cost reduction and improving procurement processes) mean that DK’s profits are likely to be 30 per cent higher than previous market expectations even if current levels of commodity prices are not sustained.

Analysts at house broker Singer Capital Markets have taken note, upgrading their 2022, 2023 and 2024 earnings per share (EPS) estimates to 71.5p (from 55.5p), 67.2p (from 49.2p) and 63.2p (from 54.3p), respectively. On this basis, the shares trade on a forward price/earnings (PE) ratio of 8 and offer a 3.6 per cent dividend yield.

Hargreaves' share price has risen 171 per cent since I initiated coverage, at 206p (Alpha Report: ‘A high yielder offering significant hidden value’, 19 March 2020), and the board has paid out 23.8p a share of dividends, too. The shares are now within pennies of my 575p target price (‘Priced for a highly profitable outcome, 8 February 2022), but I now feel that the strength of the operational performance is such that fair value is closer to 650p, or 1.3 times spot book value estimates. Buy.

Wynnstay harvesting profitable growth

• Fertiliser operations experiencing one-off gains from exceptional trading environment
• Poultry and point-of-lay pullets acquisition
• Analysts upgrade 2022 and 2023 pre-tax profit estimates by 3 and 7 per cent, respectively

Specialist agricultural products supplier Wynnstay (WYN:610p) was already a beneficiary of higher commodity prices before the conflict in Ukraine made markets even tighter. However, Russia’s invasion of that country has sent a raft of commodity prices surging.

For instance, Wynnstay’s fertiliser operations are experiencing “one-off gains from the exceptional trading environment.” That’s because Russia controls most of the key ingredients (nitrogen, potash and phosphate) used in the manufacture of fertiliser. In Europe, nitrogen production uses natural gas, which means surging gas prices are accentuating costs to produce fertiliser. This has implications for crop prices as fertiliser can make up more than a third of the input cost for crops such as corn in the UK. Although 85 per cent of our wheat is produced domestically, ultimately prices reflect what’s happening on global markets. That’s relevant because Russia and Ukraine account for 30 per cent of the world’s traded wheat.

Note:

Simon recommended tendering 30 per cent of holdings in Vietnam Holdings at US$4.4528 (322.3p) a share, and tendering 3.9 per cent in the excess application ('Exploiting a tender offer', 4 August 2021), with a view to buying back the tendered shares at the lower market price (284p offer price on 13 and 14 September 2021) when the cash distribution was made during the week of 13 September 2021. Total return reflects these transactions which have reduced the entry point to 188.3p a share.

Source: London Stock Exchange

The uncertain geopolitical situation is boosting farmgate prices, too. This offers reassurance to farmers taking advantage of elevated prices as it mitigates higher input cost inflation (energy, fertiliser and fuel), albeit in some cases high prices are likely to curtail demand. It’s a favourable backdrop for Wynnstay.

The group has also just completed the complementary poultry and point-of-lay pullets acquisition of Hampshire-based Humphrey Feed & Pullets, a business that has 200 customers and produced 109,430 tonnes of poultry feed from its Wiltshire manufacturing facility. The plan is to spend £13mn over the next three years redeveloping and modernising the plant to lift capacity to 185,000 tonnes. The £11.5mn total consideration equates to 10 times operating profit and is being funded from a £12.5mn bank facility.

Reflecting the acquisition, house broker Shore Capital upgraded 2022 and 2023 adjusted pre-tax profit estimates to £11mn (3 per cent upgrade) and £11.9m (7 per cent), respectively. On this basis, the shares trade on 13 times next year’s earnings and offer a 2.8 per cent dividend yield.

The holding has produced a 45 per cent total return since I included the shares in my 2021 Bargain Shares Portfolio and I maintain my 685p target. Buy.

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