2023-10-20 06:29:26 ET
Summary
- Genus is a rare global leader from the UK, responsible for 15% of pigs and 9% of cattle bred globally.
- Its expanding royalty model, growing capacity, and scientific focus are positives.
- Many headwinds livestock agriculture faces are tailwinds for Genus, but this needs to be counterbalanced with long-term secular concerns.
- Though not cheap relative to the FTSE at 26x vs. 13x NTM P/E; and there are concerns over shareholder alignment.
- We reason investors should take a closer look.
1. Introducing demographic growth and implications on food
[People] also demand the same resources. … they all need food and they all need shelter. And desire doesn't stop at subsistence - people will demand ever more as globalization continues. Now that millions of Chinese peasants can finally enjoy a secure supply of basic calories, they want more of them to come from pork instead of just grain.
Thiel and Masters (2014) ' Zero to One '.
By 2040, the global population is forecast to reach a staggering 9.2 billion people . While discussions surrounding the impact of this growth on the economy, environment, and health are commonplace, one crucial aspect often overlooked is how we will feed this expanding population. Neglecting this question is regrettable because it disregards nuanced and constructive conversations to be had and, perhaps, opportunities for investors. Currently, the world supplies 2,947 kilocalories per capita - likely much of which is unequally dispersed and wasted. This figure is correlates closest with per capita income (Figure 1). Hence, regardless of population growth, food consumption is set to increase .
Producing food for human consumption falls largely on agricultural and aquacultural systems. These systems are under increasing pressure to meet the growing demand for food. For instance, production of rice, the world's most popular carbohydrate, is expected to rise by 30% by 2050 [Economist paywall]. However, these demands must be met while simultaneously addressing the need for more efficient resource utilization, driven by economic, environmental, and societal challenges.
These challenges are pronounced in livestock agriculture because protein is a resource-intensive macronutrient and, hence, tied closely to rising global wealth. Consumption of animal-based foods is set to continue to rise globally, as scalable plant-based alternatives remain elusive . This dynamic creates a unique set of pressures on the industry, as public calls for change driven by ethical and environmental considerations often conflict with the pursuit of economic maximization and better lifestyles.
Cost is the biggest factor affecting our ability to scale alternative proteins and the rate at which we can do so. To lower costs, the efficiency of sourcing, processing and production will need to improve, which will require major investments across the value chain.
Tony Blair Institute (2021). ' The Protein Problem : How Scaling Alternative Proteins Can Help People and Planet'.
In recent years, formalization of genetic selection methods grounded in science has markedly enhanced feed conversion - a crucial KPI for farmers. For example, the feed conversion ratio ("FCR") for broiler chickens has gone from over 2.8x to under 1.7x (~40% more efficient), which is credited to breeding. We explore this by delving into Genus plc ( GENSF , GENSY ), a pure-play leader in pig and cow breeding.
2. Introducing Genus plc
Briefly, Genus provides breeding stock to farmers in porcine (pigs) and bovine (cows) industries. Its annual revenue is ~593M USD; operating margins of 8.3%; ~3,500 employees; and a ~1,500M GBP (~1,900M USD) market capitalization.
business Unit | Sales (percentage of total) ((USD)) |
Pigs (under PIC brand) | 306.6M (51.7%) |
Cows (under ABS brand) | 272M (45.8%) |
Other services | 14.8M (2.5%) |
2.1 History
…wool conglomerates; privatization; and mad cow disease.
Genus' history is both compelling and dense; featuring 19th century wool conglomerates; privatization; and mad cow disease.
In the 19th century, Australian tycoon Frederick Dalgety's namesake holding company dominated the global wool trade, where wool was exported from Australia to Britain for textile production. As synthetic textiles like polyester crippled wool prices in the second half of the 20th century, it exited wool and expanded into:
- Consumer Packaged Goods : including 'Pot Noodle' and 'Homepride', now part of Unilever ( UL ) and Premier Foods (PFODF), respectively.
- Livestock Genetics : including the Pig Improvement Company ("PIC"), a porcine breeder.
- Ingredients : including bakeries, human ingredients, and pet food (notably 'Winalot'), now parts of Associated British Foods (ASBFY); Kerry Group (KRYAY); and Nestlé (NSRGY), respectively.
Dalgety began the 1990s as a FTSE100 constituent with sales of 8.3B USD (13.1B USD, inflation adjusted ), however over the decade its business was spectacularly undone. Dalgety was found at the centre of a severe Bovine Spongiform Encephalopathy ("BSE") outbreak - better known as Mad Cow Disease. Briefly, BSE is a degenerative neurological disorder in cattle that can be transmitted to humans and causes a fatal condition called variant Creutzfeldt-Jakob disease ("vCJD"). From 1994 to 1996 , 178 people contracted and later died from it, along with over four million cattle. Exports and consumption of UK beef was consequently crippled - well into the 2000s. Notoriety and investigations discovered the inclusion of the use of animal-based feed additives in agricultural food ingredients as its cause, prompting the UK government to ban its practice and use. As a principal provider, reputational damage, mismanagement, and litigation led Dalgety being effectively dissolved in 1997. Its assets were sold to bidders including those mentioned previously.
Around the same time, the UK government was coming to the end of ' Privatization ': a period where public sector assets were transferred into private sector assets - spearheaded controversially by Margaret Thatcher. It included large organisations like British Petroleum ("BP") (BP) and small organisations like the Milk Marketing Board ("MMB"). A dairy breeder, it was privatized in 1994.
Genus began emerging in its current form following the acquisitions of the American Breeders Service ("ABS") in 1999 and the last remnant of Dalgety, PIC, in 2005. It's a dramatic history and indicative of its ownership today.
2.2 Business Model
Genus sells semen, embryos, and mature animals into the porcine (pig) and bovine (beef and dairy) industries. Operationally, semen and embryos are extracted and (cold storage) delivered using primarily in-vitro fertilization ("IVF") methods. Mature animals are reared by Genus as well as 3rd parties and delivered to farmers. Approximately 73% of sales are recognized upfront (immediately or accruals); 25% are recognized through a royalty model and the remaining 2% are recognized as services.
A royalty model is intriguing - unusual within agriculture. Customers meet 'performance objectives', which act as hurdles triggering royalty sales to Genus, including '% successful births', 'average dead weight', and '% mortality'. Pig farms have been quickest to adopt a royalty model, a consequence of more industrialized processes ; greater adoption of advanced genetics; and shorter lifecycles (pig slaughter age is ~6 months).
In livestock breeding, scale is a meaningful value proposition (for customers) and competitive advantage (for Genus). Traditional genetic selection breeding methods involve farmers comparing pedigree records. This is subjective and takes time; limited by the available gene pool. Genus' is larger than any farm, with ~280M GBP and ~110M GBP worth of pigs and cattle, respectively, on their balance sheet. Genus analyses traits of this large genetic pool, from which it can better select superior genetics. Genus' data advantage enables it to accelerate the rate of genomic progress. Recent strategies around improving genetic efficiency include 'Porcine Reproductive and Respiratory Syndrome virus' (PRRSv) resistant pigs , a disease which can cost farms hundreds of thousands USD per year . Adaptation to real-world conditions, like disease and climate, are capturing greater attention as evidence suggests productivity gains from weight, fertility, or milk production are slowing down (sidenote: read this illuminating article exploring this within poultry titled ' How Chickens Became Like Apple and Android Phones '). Genus' strategy to scale is further reflected in expanding global operations (Figure 2), improving delivery to farms which further scales Genus' genetic advantage.
Breeding is an asset-heavy industry, holding (literally) live, dynamic inventory. Genus seeks to minimise this by contracting 3rd parties for rearing, referred to as 'Multipliers'. It works by Genus selling livestock (e.g. piglets) to Multipliers to rear, before Genus buys the animals back to then sell to farmers for a premium. Occasionally, end customers are also Multiplier farms. This process is convoluted; reducing inventory and retaining Genus' control of customer relationships but opening other risks like market dynamics (buying from Multiplier is done at market price) and potential blowback from animal abuse.
It has been indicated that the livestock industry is becoming more consolidated and technified. We see this trend extending the moat of large breeders like Genus (porcine, bovine); Cobb (poultry), owned by Tyson Foods (TSN); and Mowi (fish) (MHGVY). However, livestock markets develop at different speeds (Figure 4). For example, beef is less industrialised, dulling ABS' value proposition. Beef farms range from 10,000 -head ranches in the Australian Bush to 100 -head in the Scottish Highlands. Moreover, beef consumption is contracting is many markets - we aren't blind to potential structural challenges. Dairy is a bright spot within ABS. Genus' sexed semen products can bias the ratio of female: male calves birthed. This eradicates a huge problem for the industry: where young male calves are slaughtered. It has quickly become an industry norm: in the UK, ~77% of all dairy semen is now sexed , from ~16% in 2016. Similar trends are observed in North America, albeit with a lag ( ~35% in Canada ). Direct pressure from buyers like Arla in Europe and Danone (DANOY) in North America, via pressure from consumers, is driving this trend. Further consolidating bovine breeding will take time.
2.3 Strategy
Genus articulates its strategy for growth clearly:
- " Deliver a differentiated proprietary genetic offering ": i.e. enhancing genetics of its livestock.
- " Focus on progressive protein producers globally ": i.e. increasing its ability to supply customers globally.
- " Share in the value delivered ": i.e. growing profitably and enhancing profitability.
Within breeding, customer relationships tend to be sticky (no pun intended) where farmers are unlikely to switch provider provided a clear return on investment is being achieved.
…many of our competitors are regional single-species cooperatives.
Genus has few technified competitors. In porcine, its nearest competitor is Topigs Norsvin . In bovine, there are even fewer technified competitors, where Genus competes against dairy breeding cooperatives as well as traditional breeding practices augmented by genetics testing, offered by the likes of Zoetis (ZTS) and Neogen (NEOG). Not bad. Given the competitive landscape, Genus' focus on genetic improvement and Research and Development ("R&D") is curious. This pipeline is delivered by deploying modern gene-editing techniques like CRISPR - used in the development of PRRSV-resistant pigs . R&D accounts for 13% of its headcount and, financially, utilizes 12.3% of revenue (67.1M GBP).
This is significant when compared against close peers like Zoetis (6.7%), albeit a different market. Without evaluation, one may conclude this is a positive or a negative. A positive, in that Genus is investing significant amounts in the nascent stages of an expanding industry, or a negative, where said industry is highly capital intensive and therefore yields unattractive returns. Is the scientific approach taken ill-suited to a sector with such weak economics?
As a cost, R&D appears well managed: consistently ~12% of sales; ~33% of gross profit; and growing alongside gross profit (89.7% 10-year correlation). As an investment, R&D is difficult to quantitatively evaluate. PRRSV-resistant pigs, and its commercial success, will be the best qualitative barometer.
Product characteristics necessitates breeders' proximity to farmers. Live animals should not be transported long distances; embryos require cold storage during transportation; and laws prohibit cross-border animal trade.
Increasing Genus' ability to supply customers with genetics and livestock is financially represented on the cash flow statement as capital expenditures and acquisitions. This, including R&D, is Genus' other growth vector. When Genus acquires a local breeder, they typically inherit tangible assets like facilities and intangible assets like proximity to farms. Genus usually then expands facilities in anticipation of higher future demand. Figure 2 shows select markets of focus, like Canada, China, and Brazil. Its ability to manage sellable inventory (livestock animals), as it expands is consistent - a positive (Figure 9).
2.4 Financials
Many of Genus' financial characteristics have been alluded to:
- Steady, durable growth…
- …where unit economics are closely tied to its cyclical end-market(s)…
- …yielding limited profitability and returns…
- …which Genus tightly navigates.
Figure 11 shows Genus' sales have consistently (R 2 of 96.7%) compounded annually over a 3-year (6.7%), 5-year (5.3%), and 10-year period (5.7%). Though unspectacular, Genus' growth must be lauded for its steadiness. Sales growth targets are not given by management (EPS, cash flow, and strategic objectives dominate management incentive plans), however we see ~6.0% as achievable of the next 3-5 years. Divisionally, we suspect growth in PIC will outpace ABS, but innovations discussed in ABS Dairy (a subdivision of ABS) should enable it to keep pace.
Genus' unit economics (money made on animals or genus sold) are closely tied to farmers' economic fortunes, in terms of volumes and pricing. As Genus' cannot change this, we view it as the main detractor of its business model - though the royalty revenue may soften this. For example, COVID-19 lockdowns in China in 2021-2022 severely impacted PIC volumes, where sales fell -48% YoY, contributing to the Asia region declining -34%. Further, during FY22 weaker farm profitability in Europe (caused by rising input costs) led to revenue declining -6% despite volumes increasing 7%. This herein lies the challenge with serving the cyclical agriculture sector.
Moreover, because it serves commoditized markets (e.g. pork, beef, and dairy) - despite its products being positively differentiable - profitability is low, with adjusted operating margins and net margins of ~10% and ~7%, respectively. Its capital intensity means returns are consequently not special either: with a ~7% Return on Capital and Return on Equity.
Despite this, Genus' financial astuteness is clear (often complimented by analysts) with strict targets of cash conversion (~90%) and a well-maintained balance sheet. Currently, with a market capitalization of ~1,500 GBP, Genus has cash of 38.8M GBP and debt (short-term) of 189.2M GBP (7.1M GBP). This equates to a net debt / EBITDA ratio of 2.0x - where their target upper threshold is 2.0x. Indebtedness has marginally increased over time (Figure 14).
2.5 People
Genus employs ~3,500 people, including ~400 PhDs mostly located within the R&D division.
Assessing the quality of its management team and board members, as well as their alignment with shareholders, there is nothing striking - which is good and bad. Stephen Wilson announced his retirement as CEO in February 2023, being replaced by Jorgen Kokke in July 2023. An outsider from Ingredion ( INGR ), a food ingredients business, his skills in sales and international markets (particularly north America) are highlighted . His location in Chicago and not the UK further highlights potential focus on sales as opposed to science, where the region contributes 40.1%. Other key people are scientific with animal science backgrounds, except for Alison Henriksen ((CFO)). They are Bill Christianson (head of PIC), Jerry Thompson (head of ABS Beef), Nate Zwald (head of ABS Dairy), and Elena Rice (head of R&D). Some have been at Genus their whole career, however persons like the CFO and head of R&D are relatively new. Similarly, most of the board has been present since 2017.
Concerningly, none of these figures are meaningful insiders. This might be due to the company's history as a government entity; however the executive compensation structure poorly incentivizes shareholder value generation (Figure 9) - in our opinion. First, the Performance Share Plan ((PSP)) and Annual Bonus are the two incentive-based compensation methods however, their base salary and benefits is higher. The PSP is linked to 3-year EPS growth (reasonable) and has an annual potential of 1.1M and 0.5M GBP for the CEO and CFO respectively. We see the ratio of base salary to PSP still as suboptimal. Second, we are not big fans of the factors influencing annual bonus and their respective weightings, which are as Adj. EBIT (50%), Cash generation (15%), and Strategic measures (35%). A split of measuring Cash Generation (e.g. FCF), Capital Allocation (e.g. ROIC) and Strategy (e.g. FCR improvement) would be preferable metrics, in our view. This is a detractor as potential shareholders. We believe shareholders should flag this as a concern or ask for clarity. Third, considering again insider ownership, it is disappointing to us that management does not allocate a greater proportion of their personal wealth to Genus.
Investor Name | Position | Value of Shares Held ((MM)) | % Of Shares Outstanding Held | # Shares Held |
Wilson (Stephen) | Former CEO | $2.3 -2.44% | 0.13% | 86,902 |
Thompson (Jerry) | Head of ABS Beef | $1.3 -2.44% | 0.07% | 48,420 |
Hartley (Dan) | Board member | $1.1 -2.44% | 0.07% | 43,274 |
Zwald (Nate) | Head of ABS Dairy | $0.7 -2.44% | 0.04% | 26,198 |
Rosata (Angelle) | Head of HR | $0.5 -2.44% | 0.03% | 17,938 |
Ferguson (Iain George Thomas) | Chairman | $0.3 -16.21% | 0.02% | 10,000 |
Henriksen (Alison) | CFO | $0.1 -16.21% | 0.01% | 5,375 |
Culbertson (Matt) | Head of PIC | $0.1 -2.44% | 0.01% | 4,204 |
Knox (Lesley M. S.) | Board member | $0.1 -9.84% | 0.00% | 2,000 |
Source: TIKR and Genus investor relations.
Meaningful investors are indicated below. Baillie Gifford is the largest single shareholder group: a large Scottish growth investor. It is held in their UK equity funds as a top-10 position . To us, the most interesting shareholders are Devon Equity Management and Bronte Capital Management, both of whom have publicly written ( here and here , respectively) regarding their investment thesis - similar to what we have written.
Investor Name | Value of Shares Held ((MM)) | % Of Shares Outstanding Held | # Shares Held | Change in # of Shares Held | This Holding as % of Firm's Portfolio |
Baillie Gifford & Co. | $153.6 -10.07% | 8.83% | 5,830,181 | -85,451 | 0.08% |
Wellington Management Company, LLP | $91.8 -4.27% | 5.28% | 3,485,992 | 237,010 | 0.02% |
Devon Equity Management Ltd. | $70.4 -10.07% | 4.05% | 2,674,080 | - | 6.40% |
The National Farmers Union Mutual Insurance Society Limited | $28.5 -4.27% | 1.64% | 1,081,055 | 14,770 | 0.66% |
Bronte Capital Management Pty Ltd. | $16.2 -4.27% | 0.93% | 613,877 | -24,624 | 1.53% |
Lord, Abbett & Co. LLC | $2.8 1.27% | 0.16% | 105,003 | 26,570 | 0.01% |
AJ&RG Barber Ltd | $0.4 1.27% | 0.02% | 15,030 | - | 5.96% |
Source: TIKR and Genus investor relations.
2.6 Valuation
One of the biggest risks to Genus, from a shareholder's perspective, is its valuation which, depending on the metric, remains bizarrely high or is starting to become palatable.
Given its growth characteristics of durable mid-to-high single digit revenue growth and (albeit erratic) low double digit EPS growth, a P/E of 15x-25x would be reasonable. Genus trades at LTM P/E of 44.2x; LTM EV/EBIT of 27.1x; NTM P/E of 25.9x; and NTM EV/EBIT of 19.0x. Its trailing valuation has become normal over the past 3-4 years. On a company level (ignoring overall market risk appetite), its scarcity premium, as a rare listed agricultural technology and genetics play may explain this. Similarly, its normalizing growth (evident in Figure 11) may explain its valuation collapse. Management has indicated it expects approval for its PRRSV-resistant pigs in North America and Latin America in mid-2024, where increases in earnings and decreases in R&D expense lends to a continuation of rational valuations.
3. Closing remarks
Who benefits from this business' success and who is it being optimized for?
It's a question we like to ask. Ideally, it is the shareholder as investors. Having actively followed Genus for almost 1 year, our overarching view is that Genus is a quality business not tilted enough in shareholders' favour. Contentions would include an explicit strategic desire to grow profitably. Support would include a disappointing management compensation scheme that does not greatly align management with shareholders; use of adjusted metrics; and an overall low level of insider ownership. It is unfortunate because we have a lot of confidence in the business. Genus differentiates itself by providing meaningful ROI to its customers in a non-technified industry as its competitive advantages only widen. Confidence in its durability encourages us to build a small toehold position as we seek better alignment.
Written by M.
For further details see:
Genus: Playing Demographic Growth At The Breeding Edge