Allied Farmers (NZSE:ALF): ROCE Decline Masks Turnaround Opportunity - Buy the Dip Now?

Allied Farmers (NZSE:ALF), a New Zealand-based agricultural services conglomerate, faces scrutiny over its declining return on capital employed (ROCE), which has dropped from 15% to 11% over the past two years. While this metric suggests suboptimal capital reinvestment, the company’s improved balance sheet, strategic asset redeployment, and bullish technical signals paint a compelling contrarian picture. For risk-tolerant investors, this could mark a high-risk, high-reward entry point to capitalize on turnaround catalysts.

ROCE Decline: A Symptom or a Catalyst?

The ROCE decline—now at 11%—reflects challenges in aligning capital allocation with profitability. The company’s capital expenditures (CapEx) have been negative in recent quarters due to asset sales, such as the Frankton saleyards (sold for NZ$4.2 million in FY2024). While these transactions freed up capital for redeployment, the lag in translating these moves into earnings growth has dragged down ROCE.

However, this decline isn’t uniform across business segments. NZ Rural Land Management (NZRLM), which manages the NZ Rural Land Company (NZL), has seen earnings surge due to a 25% equity stake sale in its land portfolio to Australian firm Roc Partners. This partnership injected capital into high-yield forestry and horticultural assets, boosting recurring management fees and performance-based income. The ROCE drop, therefore, may be temporary as these investments mature.

Capital Allocation: Shifting Gears for Growth

Allied Farmers’ strategy hinges on asset recycling—selling non-core assets at above-book value and reinvesting proceeds into sectors with higher returns. For instance, the Frankton sale and NZL’s expansion into horticulture (now 17,457 hectares) exemplify this pivot. While sales growth in core livestock services has stalled due to market volatility, the company’s focus on tax-efficient capital deployment is critical.

The firm holds NZ$178.1 million in deferred tax assets, which can offset future profits, effectively lowering the cost of growth initiatives. This is underpinned by constitutional reforms in July 2024 to preserve shareholder continuity—a move that safeguards these tax benefits.

Balance Sheet Strength: A Solid Foundation

Despite the ROCE headwinds, Allied Farmers’ debt-to-equity (D/E) ratio of 0.5 outperforms the industry average of 0.6, signaling financial resilience. The company’s liquidity is further bolstered by:
- Negative CapEx (NZ$-10.61M in 6M Dec 2024), driven by asset sales.
- Net profit growth of 56% in FY2024, excluding one-off gains.

Technicals Signal a Turnaround

Technically, Allied Farmers’ stock has been consolidating, with a rising volume trend and a recent upgrade to “Hold/Accumulate” by brokers. Key signals include:
- Breakout potential: The stock is approaching resistance at NZ$1.80 (a 2023 high), with a bullish MACD crossover.
- Relative Strength Index (RSI): At 55, it suggests neither overbought nor oversold, indicating a neutral-to-bullish bias.

Why Buy Now?

• Valuation Discount: Trading at 12x trailing P/E, ALF is undervalued relative to its 5-year average of 18x.
• Catalysts Ahead:
• Horticulture/forestry harvests from NZL’s expanded portfolio (2,703 hectares added in FY2024).
• Rebounding livestock prices (sheep and cattle), which underpin NZFL’s revenue.
• Tax-loss utilization: Earnings could surge once reinvestments start generating taxable income.

Risks to Consider

• ROCE rebound uncertainty: If capital redeployment fails to boost earnings, the stock could stagnate.
• Market volatility: Agricultural commodity prices and weather risks could impact sales.
• Execution risk: The Frankton sale and NZL partnerships require flawless execution to deliver returns.

Final Call: High-Reward, High-Risk Opportunity

Allied Farmers presents a compelling contrarian play for investors willing to bet on turnaround catalysts. The ROCE decline is a near-term headwind, but the company’s asset-light strategy, balance sheet strength, and improving technicals suggest a potential 30-40% upside over 12-18 months.

Action:
- Entry Point: Buy on dips below NZ$1.40 with a stop loss at NZ$1.25.
- Target: NZ$1.80 (resistance) and NZ$2.20 (2022 peak).
- Hold for: 12-18 months to capture turnaround benefits.

The time to act is now—before the market catches up to Allied Farmers’ strategic pivot.