Bega Cheese (ASX: BGA) is up 3.7% today on the back of a result that was in line with previous expectations. The company previously downgraded their EBITDA guidance of $123-130m. EBITDA stands for earnings before interest, tax, depreciation and amortisation and the measure is often used by institutional investors alongside other metrics to value businesses. The company had changed their EBITDA guidance to be in a narrow range of $113-117m, blaming new initiatives aimed at increasing market share. The business today achieved EBITDA of $115.4m, right in the middle of their range. They increased market share from 8.1% to 12.4%, despite a downturn due to drought and farmers exiting the industry.

The company trades on 15.4 times forward earnings and rallied on the back of what would otherwise seem fairly standard results. This is common amongst companies that have recently downgraded; investors will sometimes reward companies that meet estimates just out of relief that there is no further downgrade. Companies with agricultural exposure who miss estimates are however vulnerable to significant multiple contraction, one of the downsides of investing in the sector. Costa Group is the most famous announcement this year, with a 40% selloff on the back of disappointing results and an investor conference call that several shareholders believe reflected poorly on management. In the case of Bega Cheese, investors are particularly worried about margin compression, given management cited increased competitive pressure in the update.

Margins are a key measure of earnings quality, which is highly valued by investors. Shareholders would typically pay a higher PE multiple for a business with higher margins, all other things being equal. Mutually destructive competition can make it much harder to make a profit in an industry, potentially leading to further downgrades as competitors try to undercut each other and gain margin share. The fact that Bega Cheese had cited margin compression in its market update before the result concerned investors enough to overlook very attractive revenue and market share growth, with today’s rally only partially reversing the selloff.

 

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August 28, 2019