Bakkafrost: Taxes All Around

Bakkafrost (OTCPK:BKFKF) investors still have some taxes to worry about, despite being in a different jurisdiction from Norway where ground rent taxes have been implemented on salmon farmers with a big effect on stock prices. Revenue taxes are no joke, and they can go quite high. This quarter saw pressure due to volume and pricing hits in their core Faroe operations, with the Scottish operation, as well as excesses from the fishmeal and fish oil business unable to offset.

Q2 Breakdown

The first thing to mention is that common sources for salmon prices tend to quote them in NOK, since Norway is the key producer of salmon in Europe. The NOK has declined a lot, so in NOK terms salmon prices have actually gone up, but in DKK terms, which is the currency that Bakkafrost reports in, saw salmon prices broadly decline.

In particular, there were serious declines in both volumes and prices for the core Faroe salmon business. This business is core because it is the main value chain for Bakkafrost, that comprises both the fishmeal and oil business as an input in the vertically integrated chain, as well as the value-added product segment at the end.

Volumes and prices are down. For VAP, the operations EBIT improved. This is because these prices tend to lag the market. While VAP is still unprofitable, profitability improved since previously contracted prices are better than the current prices, but this is coming down steadily into the next quarters as salmon prices have continued to make declines in DKK terms.

The fishmeal and oil segment saw improvement due to the fact that unexpectedly high sourcing from their North Atlantic fisheries meant excesses could be sold off at good prices. A unit that is normally utilised internally was able to sell off excesses to produce better than expected results here.

The other offset has been from the Scottish salmon farming business, which was able to contract higher prices and achieve higher volumes, opposite to the Faroe value chain. The Scottish business unfortunately is smaller than Faroe value chain, so the positive results in operating EBIT together with the fishmeal and oil business were not enough to offset the price and volume-driven declines from Faroe.

Bottom Line

Prices are still under pressure in salmon, and economic conditions don't help. VAP is lagging down and will contribute even more poorly in price together with the Faroe business. On the plus side, global salmon supply isn't growing quickly, and Bakkafrost is prepped for a better H2 than H1 in terms of volumes.

The issue though is that despite dodging the Norwegian ground rent taxes, Faroe also jumped aboard and instituted its own taxes. The system is a revenue tax that depends on broad Faroe farming margins. The impacts are large, and actually go further than a previously proposed system, with the current one having a sliding scale based on industry profitability that determines the revenue tax. While we don't have the respective indices handy, Bakkafrost believes that a 20% tax rate, which is the maximum possible, may be where tax rates end up after all. An average rate of 10% is what we expect given the past iteration of the tax plan.

Some elements that were really nasty in the Norwegian plan effectively made it into this system, specifically the use of broad indices rather than the company's specifically contracted performance. This is also not great because it seems to incentivise shorter term selling contracts, since it's better to not sacrifice margin for security when you will still be taxed for having that margin.

With the hits to income imminent as the tax regime comes into force on Faroese salmon producers, current EV/EBITDAs at around 10x just don't look terribly appealing. We pass on Bakkafrost with these recent developments of regulatory heavy-handedness.

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