EBITDA margin

From our financial analysis we have revealed cost of materials as the most significant expense item affecting MHG’s EBITDA margin. Consequently this is where our main focus will be. Other items with less volatility and smaller relative size will be forecasted mainly with basis in historical data. When analysing historical data our main focus will be costs relative to quantity produced. This is to avoid the volatile salmon price to bias our reasoning.

The salmon farming industry has been characterized by large productivity improvements over the past decades. The strategic analysis revealed that these productivity gains have now to a large degree stagnated. We believe that increased regulations as seen in correspondence with new “green”

85 licenses will have the potential of increasing costs. Cost of materials has traditionally been 50 to 65 per cent the size of revenues. The cost per kilo harvested has had a marginally decreasing trend for the past years.

From our analysis we know that feed accounts for approximately 50 per cent of the total costs within fish farming. Feed suppliers operate on cost plus contracts, transferring the price risk entirely up to the salmon farmers. We have found a significant demand pressure on essential commodities used in fish feed, with significant price growth. As a result of this suppliers have been experimenting with various inputs in the feed. There is however strong indications that commodities like fishmeal and fish oil will be very difficult to fully replace. From this we interpret that MHG will mainly be affected by commodity prices on fishmeal and fish oil while other input factors are more available for replacement and variation.

Figure 6.10: Predictions fishmeal and fish oil (2013=100)

Source: Own construction, OECD FAO (2013)

These most vital input factors are expected to remain at a high historical price level. Based on this we choose 2013 levels as the basis for forecasting the cost of material. Although FAO expects a small short-term decrease the long-term prices are predicted to slightly increase. We believe that a long-term stabilization is realistic due to high short-term price growth. Further we expected slow production growth within salmon farming and moderate economic growth worldwide.

As emphasized in the strategic analysis the global weather phenomenon El Niño have the potential of affecting prices on marine raw material in the short term. Due to limited historical data of commodity prices and large uncertainty regarding the strength of the expected phenomenon, an accurate forecast is challenging. Regardless we choose to adjust the expected feed costs up by 1 NOK/kg in the years 2015 to 2016.

MHG’s plans for internal feed production have the potential to improve the cost efficiency of the company. The exposure to changes in raw material prices is however not expected to change. MHG

90 100 110 2012 2014 2016 2018 2020 2022 Fish meal Fish oil

86 explains their strategy of integrating their value chain further by maintaining control over the quality of their product. Cost efficiency is not mentioned as a particular target (MHG 2013: 12). The largest fish feed producers have reached an EBITDA-margin in the range 6 to 9 per cent over the past three years. Due to inexperience in feed production we do not expect any cost reduction in the short term. Over time we believe it is natural with a moderate reduction in feed costs. This can interpret as the return on investments in the feed production. We forecast this to materialize during the mid-term period.

MHG achieved improved (lower) feed conversion ratios in 2013 due to lower produced volumes (Annual report 2013: 4). When we forecast increased utilization of capacity we need to account for higher feed conversion ratios and thereby higher feed costs. This will thereby result in higher costs per kilo. It is natural that the company will seek to reduce the time of their production cycle when prices in the markets are high. We have forecasted relatively high improvements in utilization for 2013. As a result of the increased production cycle we forecast an isolated effect of this by additional 0,5 NOK/kg in cost of materials.

Disease outbreaks and escapes will also impact the cost of goods sold. 2013 is described as a challenging year with regards to escapes due to extreme weather conditions. Sea lice has also been a problem for the harvested fish, but direct costs related to this is stable from 2012 (Annual report 2013: 46). We believe that these incidents will be recurring and is an expected part of operating within the business.

Items related to freight and other purchases under other operating costs have been relatively stable over the period. We have not information indicating that these items will change in the foreseen future. However, the planned stock listing on NYSE has caused some increase in the item the last year. Based on this we choose a slightly lower level than 2013 in our forecast.

Salaries and other personnel costs increased the last financial year partly due to bonuses and partly due to general pay rise (Annual report 2013: 28). We do not believe a high level of bonuses will continue so we choose to forecast a somewhat lower level than for the last financia l year.

Income from associated companies is a relatively small item that is difficult to forecast. Based on our expectations of continuing good times in the industry we choose a moderately higher level than the historical for our forecast.

87 In the medium term we have attempted to account for general inflation by an upward adjustment of the most significant items.

Table 6.13: Forecasted EBITDA

Source: Own construction Long-term growth

In our long-term forecast we assume that the company have reached a steady, mid-cycle, state. Consequently our NOPAT, invested capital and FCFF grow at the same rate. Invested capital items will thereby be fixed at a constant percentage of revenues. As a result of our conservative views on the growth potential in the industry, we have chosen a moderate long-term growth rate of 2,5 per cent. The growth rate corresponds to the long-term inflation target in Norway (Norges Bank 2001), but is moderately higher than the target for the euro area (European Central Bank n.d.).

We are fully aware that there will be up and downturns in the perpetuity period. This is inevitable with regards to weather conditions and biological risk. The timing of these cycles are however such uncertain in timing that we believe it is worthless trying to forecast the explicitly. The perpetuity forecasts can therefore be interpreted as an average, or trend line, throughout these cycles.