[Please note that all currency references are to Canadian dollar except if indicated otherwise.]
AG Growth International Inc. (oronto symbol AFN; AGGZF:US; Fishing and Farming; Shares outstanding: 18.64 million; Market cap: $804 million; www. aggrowth.com) is a manufacturer of equipment used in the handling, storage, and processing of seed, fertilizer, and grain. The company was founded in 1996 by three entrepreneurs; one is still a director and shareholder of the company. AG Growth started trading on the Toronto stock exchange in May 2004.
The company is well-established in the Western Canadian and U.S. agricultural equipment markets. However, in the past, the business was often plagued by the cyclicality of the agricultural commodity markets. Under the new CEO it is aiming to expand its product range and increase its geographical reach, mainly through acquisitions, in order to bring more stability to its revenue and profits. Apart from boosting the revenue and gross profits of the business, this has also increased the debt load considerably. We prefer to wait until there are clear signs that the strategy of the CEO is working.
AG Growth (“AGI”) was founded in 1996 by Rob Stenson, Art Stenson, and Gary Anderson. Mr. Anderson was the CEO between 2010-15 and is still a director of the company.
The current CEO is Tim Close, who joined the company in 2012 as Vice-President, Strategic Development. He became President in March 2015 and CEO in 2016. The chair of the board is Bill Lambert, an independent director and former partner of Birch Hill Equity, a private equity firm.
Mr. Anderson holds 0.4% of the company’s shares while Mr. Close holds about 0.9%. Altogether, the top executives, as well as the non-executive board members, hold less 3% of the shares. Major shareholders are institutional investors such as Fiera Capital, 1832 Asset Management and Mackenzie Financial Corporation.
A revised business strategy
With a new CEO normally comes a revised business strategy, and the appointment of Tim Close in 2016 was no exception. The new strategy essentially aims to broaden the product range from grain handling to equipment that supports the world’s food infrastructure. The movement, handling, and processing of fertilizer, seed, chemical, grains, is now the focus of the company. In the process he hopes to reduce the cyclicality and regional seasonality of the business.
The target market for the company is enormous—more than 7 billion people, 25 billion animals for protein production and 500 million pets need food every day. Massive volumes of food and feedstock are constantly required—this demands a robust global infrastructure.
The company employs 2,780 workers at production and distribution facilities. Production facilities are located in Canada, the U.S., Italy, Brazil, and the United Kingdom while distribution takes place across six continents and in 100 countries. Production costs consist mainly of steel purchases (30% of production costs), major components (32%) and labor (23%).
In 2018, the company generated sales of $932 million. The U.S. was the largest market representing 41% of the sales, followed by Canada (35% of sales) and other markets, including Brazil with 24%. Sales to farmers, including grain storage and portable handling equipment made up 48% of sales while sales to commercial enterprises such as large-scale grain handlers or fertilizer distributors made up the balance.
The company reports its results in Canadian dollars but conducts its sales and has input costs in various currencies. Management indicates that, on balance, EBITDA decreases when the Canadian dollar strengthens relative to the U.S. dollar.
Sales in 2018 were 24% higher than in 2017 and 263% higher than 5 years ago. The gain reflects the numerous acquisitions that the company has made over the past few years. Excluding only the major acquisitions, we estimate that the organic growth of the business was less than 10% per year. EBITDA has risen from $60 million in 2013 to $136 million in 2018 while the earnings per share has grown by 5% per year on average.
The large number of regular acquisitions tends to mask the volatility in the revenues and profits of the overall business. However, other measures such as profit margins and return on capital fluctuate considerably from year to year as the fortunes of the food-producing industry vary. As an example, over the past ten years, EBITDA margins reached a high of 25% in 2009, a low of 10.5% in 2015, and considerable variation in between. The volatile share price with a beta of 1.55, also reflects the volatility of the company’s earnings.
A comparison of the profitability of AGI with other companies involved in the manufacturing and distribution of agricultural infrastructure equipment, indicates that the company lags somewhat behind the major players such as Deere (see table).
The current CEO has been in place since 2016 and there is hope that his strategy will eventually lift the profitability of the company and the reduce the volatility of the revenues and profits. However, we are not seeing evidence of that happening as yet, with the EBITDA margin almost unchanged over the past 3 years and still below levels achieved in 2013-14 (see graph).
The competitive advantages of the company are limited, in our view. First, it has chosen to operate its product offerings under a range of brand names. This does not support brand recognition—Deere, a global farm equipment manufacturer, markets its extensive product range under one brand. Second, it has numerous regional and multi-national competitors that operate in all of its chosen areas of operation. Lastly, the company does not have the scale to be the lowest-cost producer.
Growth through acquisitions
The company regularly acquires complementary business to grow its footprint into different regions or to add complementary products. Over the past 4 years, we count about 20 separate acquisitions; while most of those purchases are relatively small, the company has made three larger acquisitions since 2015.
The largest acquisition made to date by the company was the 2015 purchase of the Canadian based, Westeel, a manufacturer of grain bins, fuel, and water tanks. The purchase price was $222 million, which implied an EV/EBITDA ratio of 12 times. Unfortunately for AGI, sales and profits dropped sharply in the period after the acquisition was finalized; this was ascribed to poor growing conditions in Western Canada. AGI extracted synergies of about $5 million in the 6 months after the acquisition was concluded.
In April 2017, the company paid $100 million for Global Industries, a U.S. based manufacturer of grain storage bins, grain handling equipment, and grain drying equipment. The EV/EBITDA ratio on the purchase price was about 9 times. In March 2019, the company paid $110 million for India based Milltech Machinery, a manufacturer of rice milling and processing equipment.
Recent acquisitions under the new CEO include a range of companies focused on automation and technology solutions for the food production supply chain. The acquisitions include IntelliFarms, a provider of hardware and software solutions for grain growers and processors, CMC Industrial Electronics, a supplier of hazard monitoring systems and sensors used in agricultural material handling and Farmobile, a provider of hardware and software for the collection and analysis of farm data.
Most of the acquisitions are financed with a combination of internal cash resources, revolving credit facilities, or the issue of debt instruments or equities.
The acquisitions have helped the company to diversify its business into complementary product lines and different geographies. It also helped to grow the top line of the company. We estimate that acquisitions added annually around 15% to the sales of the company over the past 4 years.
Considerable debt and poor cash flow
The company had shareholders equity of $414 million by the end of June 2019, and net debt of $741 million. Total debt ballooned from $158 million at the end of 2014 to the current level as the company used debt instruments to partly finance its numerous acquisitions. The share count also jumped by 41% over the same time as equity finance was used as another tool to finance the acquisitions.
Debt now represents 65% of the total capital while the interest expense is covered 3.9 times by the EBITDA. We would consider this leverage as high for a company exposed to cyclical commodity forces.
Cash flow from operations (including working capital changes) amounted to $41.2 million in 2018 while maintenance capital expenditure was $11.3 million, leaving a free cash flow balance of $29.9 million. This was less than the $39.3 million in dividend payout to shareholders. That implies the company had to finance part of the dividend. Other capital expenditures including acquisitions amounted to $89 million for the year.
We note that operating cash flow in 2018 was negatively affected by a large investment in working capital resulting in the lowest level of operating cash flow since 2014. The company ascribed the additional working capital requirements to a decision to secure additional steel supplies in the face of rising prices as well as the growth in the international business, which resulted in slower debtor payments.
Risks on the horizon
Despite its recent attempts to reduce its reliance on the farming industry, the company remains exposed to the cyclicality and challenges faced by the agricultural industry. Combined with relatively high levels of debt, this has the potential to substantially depress company profits and cash flows during times when agricultural commodity prices decline.
AGI is a highly acquisitive company and has made 3 major acquisitions over the past 4 years; it would also seem that the pace is picking up under the new CEO. It is unclear how successful these acquisitions have been, but apart from increasing debt, major acquisitions divert management’s attention from the current business.
Recent results below par
For the first 6 months of 2019, AGI has increased its sales revenues by 6.8%; excluding acquisitions, the increase was 0.2%. Canada fared relatively well while U.S. sales was up slightly, and international sales declined. Gross margins were unchanged at 28.9% while EBITDA margins declined slightly compared to the first 6 months of 2018. We also note that cash flow from operations was a negative $23 million compared to a positive $17 million in the first half of 2018. A high cash drag caused by higher accounts receivable was the main culprit.
Earnings per diluted share for the first six months amounted to $1.37, a 29% increase on the first 6 months of 2018. The dividend was unchanged at $1.20 per share.
Earlier this year, the company stated that it expected strong sales and EBITDA growth for 2019; however, the performance would be weighted towards the second half. The latest guidance from management is that the second half would be softer than previously indicated. Poor planting conditions in the U.S. have reduced the acres planted and lowered yield expectations, which tempered farmers’ spending. In Canada, crop conditions are mixed as the impact of a very dry spring was only partially alleviated by rains early in the third quarter. Management also commented in August that uncertainty related to trade tensions was complicating customer decision making, resulting in delays before investment decisions are finalized; this is especially relevant on the commercial side.
Consensus forecasts indicate revenue growth of around 8% and 12% for 2019 and 2020 with EBITDA profits growing by a slightly higher rate.
Attractive but uncertain dividend
The company pays a regular monthly dividend, which amounted to $40.7 million in 2018 (or $2.40 per share); this was partly financed by shares issued in lieu of dividends (DRIP) program.
The company’s intention is to finance the dividend out of cash flow from operations; we note that when operating cash flow is adjusted for working capital and maintenance capital expenses, the cash portion of the dividend exceeded the free cash flow in 2018 and 2014, which implies that the company had to raise additional capital to finance the dividend in both these years. The company estimates its dividend payout as a portion of funds from operations at 42% in 2018; this method does not adjust for the investment in working capital and is less conservative, in our opinion.
The company converted from an “income trust” to a company in 2009 and continued paying its regular dividend although there has been no growth in the dividend since November 2010.
Given the stock’s current price and consensus estimates for the next 12 months, the company is valued on a price-to-earnings ratio of 13.8 times, and an EV/EBITDA ratio 9.0 times. The 5.6% dividend yield is attractive, although we have some concerns (see above) that the current dividend’s sustainability.
The valuation is below the industry leader (Deere), which we believe is appropriate given the smaller size of the company and the lower levels of profitability.
Bottom line … it is 'show-me' time
The current CEO has completed 3 years at the helm and is in the process of implementing his strategy to broaden the product and geographical scope of the business. He needs favourable conditions in the agricultural industry to carry the business through the transition; we suggest that investors wait for evidence that his strategy is succeeding in lowering the cyclicality of the business and improving margins and profitability.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. Business relationship disclosure: By Deon Vernooy, CFA, for TSI Network