Recently the management team of Ag Growth International Inc. (TSE:AFN) visited Toronto to meet with institutional investors. We summarize the key discussion points. Westeel acquisition integration is progressing well. Company remains confident that it will realize its forecasted $5 million of near-term EBITDA synergies (roughly split 50/50 between revenue and cost synergies).
In June 2015, rainfall in W. Canada was lower than average, which is inclined to shrink crop yields. Given crop volume is a key driver of company’s portable farm equipment sales; this will potentially negatively influence company in second half and first half of 2016. StatPub currently estimates average crop yields to decrease 10% lower than normal. In 2015, company is benefiting from new projects in Ukraine and LatAm, and a poorer CAD. In Brazil, it expects to book moderate sales in 2015, with more meaningful volumes in 2016. In estimate revisions, we reduced our 2015 and 2016 EBITDA estimates largely to indicate lower anticipated sales in Western Canada.
Westeel integration is progressing well. Ag Growth has been busy with the integration of Westeel since the acquisition closed in late May 2015. Senior management of Ag Growth remains very confident that they will realize the forecasted $5 million of EBITDA synergies in the near-term (first full calendar year of owning Westeel), although they will be more weighted towards 2016 given the timing of the deal close. Ag Growth provided investors with a detailed breakdown of its estimate synergies. Senior management estimates that synergies will be split approximately 50-50 between revenue and costs.
Company plans to assign dollar amounts to the synergy categories at a later date, along with an forecast for longer-term synergies. Growing smoothwall bin market share is a key priority. Ag Growth estimates that approximately 40% of Westeel’s sales are generated from products that will be new to its catalogue. Included in this are smoothwall bins, which are mainly used to store seed and fertilizer. Ag Growth perspectives its expansion in smoothwall bins as strategic given it will expand its ability to sell to seed and fertilizer targeted customers. Westeel’s share of the Western Canadian smoothwall bin market (annual sales of roughly $100 million) is currently estimated at 20% and Ag Growth aims to grow this by raising an existing facility to expand its production capacity. We expect this plant upgrade is inclined to commence in 2015 (we have estimate capital spend of $3 million) so the firm can grow the business in 2016.
In June 2015, rainfall in various areas in Western Canada fell lower than average, which is inclined to have a negative influence on average crop yields. While rainfall in the next few weeks could result in some yield recovery, it is not presently estimate. Given that crop volume is a key driver of portable farm equipment sales; this will potentially have a negative influence on Ag Growth’s portable grain handling, aeration, and storage equipment sales in Canada in second half and first quarter of 2016. StatPub is presently estimating average crop yields in Western Canada to decrease 10% lower than normal. We note that the influence of a drought in Western Canada would have less financial influence on Ag Growth compared with the U.S. given over two-thirds of its high-margin portable farm equipment is sold into the U.S.
While some crop regions have received too much rainfall in current weeks, the crop situation in the U.S. by and large looks generally favourable. The USDA currently estimates that 69% of the corn crop and 63% of the soybean crop is in good-to-excellent condition. The large U.S. grain handler, ADM, is presently guiding to average crop yields. This should be positive for Ag Growth’s portable equipment sales in the U.S. in 2015/2016.
Commercial equipment sales guidance is yet robust. In contrast to portable farm equipment sales, the key drivers for commercial equipment sales are not crop production volumes or harvest conditions in a given season. Instead, the level of investment by commercial grain handlers and grain processors will fluctuate derived from regional storage practices and infrastructure gaps, as well as macroeconomic conditions. In 2015, Ag Growth’s U.S. commercial equipment backlog remains strong as a result of the infrastructure gap exposed by the large harvests in 2013 and 2014, but is lower than record 2014 levels given a return to more normalized seasonal buying. Ag Growth revealed that its orders picked up in second quarter of 2015, which suggests a solid second half of 2015.
In 2015, company’s leverage will temporarily increase ahead of its focused 2.0 times-2.5 times range following the acquisition of Westeel. Ag Growth intends on paying down its debt over the next year to bring it back down to its desired level. At the end of 2016, we forecast that the net debt-to-EBITDA ratio will fall to 2.5 times from our forecast of 3.4 times at the end of 2015. The boost in leverage is short-term and the company remains fully motivated to reiterate its annual dividend of $2.40 per share (current yield of 5.2%).
We revised our earnings estimates mainly to indicate poorer expected sales in Western Canada in late 2015 and early 2016 as a result of recent drought conditions. We also moderated our revenue estimates for Westeel to indicate management’s comments that 2014 was an “exceptional” year for the business given record backlogs following the record harvest in 2013. In 2015, we estimate trade revenue to boost 28% from 2014, led by the acquisition of Westeel (closed on May 20, 2015), good impetus in international sales, and the boost in the U.S. dollar relative to the Canadian dollar. We anticipate this to be moderately offset by lower equipment sales in Western Canada (we estimate a 12% fall. In 2016, we estimate trade revenue to grow by 22%, led by a full year of Westeel contribution (including the anticipated realization of revenue synergies) and continued growth in international markets.
We reduced our 12 months target price to $56.00 per share. We updated our 12 months target price to $56.00 per share from $60.00 per share mainly to indicate a lower revenue estimate for Western Canada. This was moderately negated by a lower FTM net debt forecast (to indicate Ag Growth’s belief to use its rest $16 million of tax shelters through mid-2016). Our one-year target price persists to be derived from applying a 9.0 times multiple to our FTM EBITDA estimate (one-year forward) less our average FTM net debt forecast.
We reiterate our “Sector Outperform” rating – perspective the shares as oversold. We advise Ag Growth to investors given its market leading position in small-scale farm equipment, strong management team (execution, focus on shareholder returns, successful acquisition track record), good future earnings growth possible (we estimate EBITDA to grow 14% in 2015 and 26% in 2016) and free cash flow generation (we forecast 10%-11% in a normalized year), and an striking dividend yield of 5.2% (we perspective this as sustainable). We anticipate the balance sheet to remain healthy following the transaction and forecast net debt-to-EBITDA of 2.5 times at the end of 2016. The implied return to our 12 months target price is an attractive 26%, which is one of the highest in our coverage universe.