Bakkafrost — One Terribly Expensive Stock That You Should Under No Circumstances Buy (BAKKA:OSE)

The latest Islero report is about Bakkafrost, a danish salmon farming company. Rating: Underperform

One Terribly Expensive Stock That You Should Under No Circumstances Buy

Shares of Danish company P/F Bakkafrost (BAKKA.OSE) have been on a tear this past year, rising 75% [RS1] in 12 months. Bakkafrost, however, is not some red-hot tech stock, nor the inventor of the latest biotech wonder-drug.

Bakkafrost is a fisherman. Admittedly, it’s a quality fisherman — a “leading producer of top quality Atlantic salmon from the Faroe Islands,” according to its description on oslobors.no[RS2] . But it’s still just a fisherman. And there’s no way that an individual investor should be buying shares of this company, at these prices.

And now I’ll tell you why.

In defense of Bakkafrost
The preceding few words probably sounded a bit harsh, so allow me to salve the wound just a bit. In many ways, Bakkafrost is a fine company. As it self-lauds on its website, Bakkafrost produces “a wide range of healthy and nutritious salmon products … [of] consistent high quality [and is] committed to maintaining the highest standards in relation to fish welfare, sustainability and sound stewardship of the environment.” These are of course all admirable qualities in a company.

Bakkafrost is also not half bad as a business. Last year [RS3] , Bakkafrost grew its revenues a respectable 6.2% to NOK 3.63 billion and expanded its operating profit margin by 400 basis points (to 35%). In so doing, profits leaped right out of the water, landing at NOK 1.03 billion — a 25% year over year improvement. Share dilution was essentially nonexistent, with the result being that earnings per share likewise grew 25% to NOK 21.24.

Analysts who follow the company expect to see strong performance going forward, albeit not quite as strong performance as Bakkafrost shareholders enjoyed in 2015. Over the next five years, analysts estimate that Bakkafrost’s earnings will grow approximately 16% annually.

Bakkafrost’s debt load is moderate at just over NOK 570 million, and even that modest amount is offset by the NOK 130 million cash Bakkafrost has in the bank.

And now for the bad news 
For a stock that currently costs less than 15 times trailing earnings, and promises to pay shareholders a tidy 3.3% dividend yield, that all sounds pretty good. But here’s where the story turns.

While earnings at Bakkafrost grew nicely in 2015, cash from operations tumbled 12% last year, falling to NOK 977 million (a number that you’ll note is already far below Bakkafrost’s claimed profit for the period). At the same time, capital spending by the company nearly tripled year over year, to an astounding NOK 773 million, slashing cash on hand by nearly 75%.Granted, 2015 was something of an outlier year for Bakkafrost, with capital spending more than twice as high as in any other period for the past five years. But even so, there wasn’t a single year in the preceding five in which Bakkafrost generated positive free cash flow equal to or greater than its reported net income. (The company came closest in 2014, when the difference between reported income and actual cash profits was de minimus — but even then, the free cash flow number was the smaller one).

Valuation 
As profitable as Bakkafrost looks on the surface, if you peer down into the hold, you’ll find there’s a lot less cash profit than you’d expect to be the case.

At the company’s current level of cash production, the stock is selling for a market capitalization about 76 times trailing free cash flow. Even taking a more generous approach, and valuing the stock on its average annual free cash flow over the past five years, I get a price-to-free cash flow ratio of nearly 32. And that’s way too much to pay for a company growing its profits at 16%.

So long story short? I can’t say why it is, precisely, that Bakkafrost’s stock has done so very well over the past year. All I can say — but I say this with a high degree of confidence — is that moving forward from today’s high prices, it’s not going to do anywhere near this well in the months and years ahead.

by Richard Smith

Disclaimer: Richard Smith does not own shares of, nor is he short, any company named above. He has no present intention to take a position, either long or short, in any company named above within the next five days. Neither does he have any present financial relationship with any company named above.

[RS1]http://www.oslobors.no/ob_eng/markedsaktivitet/#/details/BAKKA.OSE/overview
[RS2]http://www.oslobors.no/ob_eng/markedsaktivitet/#/details/BAKKA.OSE/overview
[RS3]http://www.bakkafrost.com/media/1435/q4-2015-condenced-interim-consolidated-accounts.pdf

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