Ag Growth International Cleared For Takeoff

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About: AG Growth International Inc. (AGGZF), Includes: AGCO, BRK.B, VICUF
by: Chris Damas

AGI is a premier grain handling business based in Winnipeg, Manitoba. It has the largest share of portable grain handling equipment in the United States.

AGI agreed to buy Westeel, the largest provider of grain storage bins in Canada, for $221.5 million.

The deal was financed with a $90 million subscription receipt and convertible debenture deal which closed December 1. Until just recently, most analysts covering the stock were restricted on it.

Six analysts have come out with EPS targets implying 22% growth in 2015 and 15% in 2016. Target Prices are in the $53.50-$65 CAD range versus the $52.01 close.

I think AGI/Westeel will be competitive with leaders GSI and Brock and will gain a higher P/E multiple, leading to my 12 month price target of $72.20.

(Editors' Note: Ag Growth International trades on the Toronto Stock Exchange under the ticker symbol AFN.TO, with ~$CAD 1.8M average daily volume).

Ag Growth International (OTCPK:AGGZF) is a Canadian agricultural equipment company I have followed for several years. I have noted their slow but steady growth since the company, founded in 1996, went public in 2004. The company makes a variety of crop handling and conditioning equipment, including conveyor belts, aerators and storage bins, selling largely to the US and Canadian farmer and grain and food processor, but increasingly offshore.

(Slides from corporate presentation (PDF))

AGI was a contrarian stock buyback in the middle of 2012, when drought decimated the major US field crops and corn prices reached $8/bushel but the crop size shrank to 10.75 billion bushels. The company generally does less well when crops are damaged and small, even though prices are higher, because it is volume that causes farmers to order more equipment to handle it. The equipment is also worn out more quickly from a big crop, especially corn, which is an abrasive seed. AGI's stock dropped below $30 CAD in 2012. But AGI has risen steadily over the ensuing two and a half years to a high of $55.30 CAD reached just last Friday. The best, however, is still in the future for AGI, as it announced a transformative acquisition on November 11, with a proposed deal to buy Westeel, the grain storage arm of British Columbia based construction materials company Vicwest, Inc. (OTC:VICUF).

Two large US competitors include Grain Storage Inc. owned by AGCO (NYSE:AGCO) and Brock Grain Systems owned by CTB, Inc., a subsidiary of Berkshire Hathaway (NYSE:BRK.B). These two companies have all three product lines meaning in grain storage, grain handling as well as animal feed handling systems (protein). They dominate the US grain storage and handling business. Up to now, Ag Growth only supplied the equipment on the bins (elevators, conveyor belts, etc.) but never owned a big piece of the bin business itself.

The prospect of combining the forces of AGI and Westeel mean greater market share in Canada and the US as well as a competitive threat in the international markets. I would expect GSI and Brock will mount a competitive response to a stronger and larger Canadian competitor that also benefits from a 15% discounted dollar for much of its costs. However, it should be noted steel, a big part of the bin cost, is priced in USD and is a natural hedge to AGI's and Westeel's revenues.

Those big pointed gray or metallic colored steel bins you see by the road when driving around farm country are generally made by Westeel in Canada, with an estimated 60% market share, far greater than GSI or Brock. Westeel has been expanding abroad as has Ag Growth. Combined, the entity can combine its offices and field efforts (AGI operates out of Finland to service the East European markets) and will have to be able to provide a total grain handling solution on a world-wide basis.

AGI, begun in 1996, has made over a dozen acquisitions in various lines of business complementary to the grain handling business, particularly portable farm equipment in the five digit price range. The company specializes in the small portable grain augers and conveyor belts that go on those bins. They figure they have 47% of the US market with competitors being smaller private companies such as Hutchison Mayrath, Harvest International and Farm King, a unit of Buhler. As AGI CFO Steve Sommerfeld put it to me "the bin is the razor, our auger is the blade that needs to be replaced regularly." During wet harvest conditions, the augers wear out more quickly, and the farmer will have to replace the auger rather than sacrifice precious harvest time.

North American farmers are in a bind because the 2013 row crops were large in size and now they have even larger 2014 crops to store alongside them (you can't store one over the other due to moisture and mold effects). The farmers are also facing a wet and delayed harvest. The wet conditions burn out the augers that AGI sells and also increases the demand for aerators and grain dryers, which AGI also sells.

In 2013, AGI earned $22.6 million or $1.80 per share ($1.75 diluted) on $357 million CAD in revenues. Cash flow was $72.6 million or $5.63 per share, comfortably covering the $2.40 dividend. which is partially funded by a DRIP program. Unlike many energy companies, AGI has only minimal maintenance capital expenditures required to sustain the business. CAPEX, which included REM, a grain vacuum company, totaled $14.3 million in 2013.

AGI has grown organically and also by acquisition with over sixteen made since forming in 1996. Here is a slide showing all the acquisitions by AGI over the past 18 years. The grain handling and related businesses are fragmented and AGI has capitalized on this, with the Westeel acquisition being the latest. Westeel is 110 years old and a well-known and trusted brand, so intangible value in obtaining this gem, rumored to be a likely and wanted acquisition for years, should add value to AGI down the road.

AGI did 53% of its 2013 sales in the USA, 21% in Canada, and 26% offshore. The company sells in Europe, the RUK (Russia, Ukraine and Kazakhstan), South America, the Asia Pacific and the Middle East and Africa. The Ukraine business was the most important emerging markets business for the company but obviously the troubles in that country have made for concern. I discussed the RUK business with the CFO of AGI and feel the prospects for this business are not material to the stock price. Current accounts receivable outstanding from the Ukraine are 90% insured by Export Development Canada which facilitates export sales for Canadian companies.

The big demand driver for grain storage, conditioning and handling equipment is volume more than crop price. Therefore, the large US corn crop in 2013 (13.9 billion bushels) and 2014 (14.4 billion estimated) plus bottlenecks in getting crops to market by rail or barge, are driving farmers need and desire to store corn on their farms. In addition, grain and oilseed processors require larger scale commercial equipment to process the crops quickly and efficiently.

AGI and Vicwest agreed to transfer Westeel to AGI upon approval by the Competition Bureau of Canada and a positive vote by Vicwest shareholders, for $210 million plus $12.5 million in working capital adjustments. Closing is expected no later than April 30, 2015.

The deal was financed by AGI doing a bought deal of $45 million in subscription rights ($51.75 million with the 15% greenshoe) and $45 million in 5.25% five year convertible debentures. The remaining $130.5 million will be financed with the company credit facility and pro forma post approval total debt will be about $300 million including the two convertible debenture issues which would then be outstanding. With the greenshoe exercised, the 14.1 million shares will equate to a $733 million market cap and an enterprise value for AGI that now exceeds $1 billion in size, quite an achievement given the grassroots the company came from 18 years ago. Ag Growth founder Rob Stenson, deceased four years ago, would be proud of what his team has accomplished (so far).

My target price for AGI was $50 before this deal was announced. I have calculated immediate upside of $8.58 per share that would be created by the Westeel transaction based on its pro forma 2014 adjusted EBITDA of $20 million financed with $11 million of interest and distribution payments for an incremental EBITDA of $9 million, pre the initial estimated synergy savings of $5 million guided by the company. There will be more cost and marketing synergies as the two companies learn to operate together and market together.

With the 11 times multiple on the company preceding the deal, the increment would be $121 million in value on 14.1 million pro forma shares outstanding or $8.58 per share. Added to the $46 the shares were trading at pre the November 11 announcement, and my valuation is already up to $54.58. Six of ten Canadian brokerage analysts that cover Ag Growth have weighed in on the stock with new targets for EPS and the stock. These analysts were previously conflicted on the stock given their firms participated on the financing and they were therefore restricted until December 1 the closing date for the subscription receipts. Now the reports have been released (the lead banker TD Securities and Cannacord Genuity have yet to come out with their own estimates) and the target prices range from $53.50 to $60 with one as high as $65.

AGI has earned $2.32 EPS ($2.51 adjusted EPS) on $317.4 million in the first nine months of 2014 and according to S&P Capital IQ the consensus is 45 cents for Q4 for a total of $2.96 adjusted FY14.

The average 2015 EPS estimate from the six analysts is $3.61 and four have estimates for 2016 averaging $4.14 per share.

At today's closing price of $52.01, the stock is trading below the analyst range and at 14.4 times their 2015 average estimated EPS. Adding $20 million EBITDA to AGI's $79.2 million TTM EBITDA gets us to about $100 million. With an EV of $1.033 billion, the EV/EBITDA multiple is 10.33. However, synergies of $5 million would add to that and I expect sales growth to accelerate as AGI management use the Westeel platform to gain more larger turn-key commercial and industrial size storage and handling projects.

Given the growth rate in EPS implied by the analyst targets of 22% in 2015 and 15% in 2016, I believe a multiple of 20 is warranted on 2015 EPS average estimate, for a 12 month target price of $72.20 per share. Neither AGCO nor Berkshire are obviously good pure comparables in the crop handling space and a survey of international players shows few have the breadth of product line AGI has.

The stock pays a 20 cent per month dividend and therefore yields 4.6% at the $52.01 price. Given CFPS should reach $4.62-4.96 per share next year according to these analysts, I believe the payout should increase from the 50% implied by the current $2.40 dividend rate. With no dividend increase, the implied total return at today's $52 CAD price equates to an attractive 43.5%.

The subscription receipts, issued at $46.55 CAD, are trading under the symbol AFN.R, and closed at $50.92, a $1.09 CAD discount to the stock, because these receipts will not receive the 20 cent dividend until the deal is closed (estimated no later than April 30) and the receipts would be then converted to stock.

I believe the very recent and consistently positive analyst buy recommendations on AGI will push the stock higher once energy commodity markets stabilize. Lower energy and diesel fuel prices actually help farmers to buy ag equipment and I note corn for December 2014 delivery has rallied to the $4.30/bushel range.

One trading risk should be noted on AGI: The stock trades only on the TSX and is illiquid with a wide (25-50 cent) spread so one needs to place limit orders only and if you are buying, a weak day such as yesterday is best to get filled.

Disclosure: The author is long AGGZF. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This information was sent to subscribers of The BCMI Report previously.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.