A 'Large Smolt' Bakkafrost Is Transformative But Not Great Value

Bakkafrost reported a quarter impacted by a 15% YoY decline in salmon prices due to improved biological conditions, though volumes remained strong. Investments in larger smolt, particularly in Scotland, are progressing well and showing early signs of margin improvement, with average smolt size up 40% in Scotland for Q1. While the Scottish overhaul is expected to significantly improve earnings in the coming years, the current valuation, with a run-rate adjusted FCFY in the 6% area, doesn't present a particularly strong value case relative to established peers, especially considering potential price risks.

Analysis

P/F Bakkafrost's recent quarterly performance reflects a challenging salmon market, primarily characterized by a significant 15% year-over-year decline in salmon prices due to improved biological conditions and increased supply from Norway. Despite this price pressure, Bakkafrost's volumes remained robust, and the company is making substantial progress with its strategic investments in large smolt production, particularly in Scotland. These investments are already yielding tangible results, such as a 40% increase in average smolt size in Scotland during Q1, contributing to early signs of margin improvement and operational efficiencies, although these gains (less than 10% of Q1 operational EBIT) were insufficient to fully offset the impact of lower salmon prices. The comprehensive overhaul of the Scottish operations, including the Applecross facility slated for completion by the end of 2025, is anticipated to markedly improve earnings in the coming years, potentially adding a 15%+ EBIT boost over peers not undertaking similar investments. However, the fishmeal, fish oil, and fish feed segment experienced volume reductions as the company increased inventory. From a valuation perspective, Bakkafrost's run-rate adjusted Free Cash Flow Yield (FCFY) stands at approximately 6%, and its EV/EBITDA multiple is around 5.5x on a two-year forward basis (incorporating expected improvements), aligning it with peers like Leroy Seafood. While the transformative Scottish investments could lead to an 8-10% FCFY post-investment cycle at 2024 average prices, the current valuation does not present a compelling case relative to established regional farmers, especially considering the persistent risk of salmon price volatility.

Key Decisions for Investors

• Investors should closely monitor the execution and impact of Bakkafrost's large smolt strategy, particularly the progress of the Applecross facility in Scotland, as these are critical catalysts for future margin expansion and operational outperformance.
• Carefully assess the balance between the long-term earnings potential driven by the Scottish operational overhaul and the current valuation, which offers limited immediate upside compared to peers, especially factoring in ongoing salmon price uncertainties.
• Maintain a cautious stance regarding salmon price volatility, as further declines could offset the financial benefits derived from operational improvements and delay the realization of the company's projected 8-10% post-investment FCFY.