Carr’s Group — Update 14 November 2016

Agriculture (£284.8m revenues, £12.4m operating profit)

The Agriculture division’s revenues declined by 4% year-on-year, reflecting lower commodity prices. The variance compared with our £291.7m divisional estimate is not significant given the volatility of commodity prices. Divisional operating profit (including share of post-tax profit of associate and joint ventures) rose by 5%. It is not possible to make a direct comparison with our estimates because divisional results now include costs that were previously designated as central costs. However, we note that our estimates assumed a £0.2m increase in divisional profit, so to have an actual year-on-year improvement of £0.7m is encouraging. Sales of feed blocks in the US continued to rise, supported by continued recovery in the beef industry following a period of protracted drought and market share gains. Demand for feed blocks in the UK, which is primarily from beef and sheep farmers rather than dairy farmers, picked up in the second half to give a very modest year-on-year volume improvement. Demand in mainland Europe, which is primarily from dairy farmers, was lower year-on-year, reflecting challenges caused by low farmgate milk prices. Volumes of compound feed sold increased by 2% as Carr’s took share in a market that declined by 4% nationally, but margins were under pressure because of the dip in farmgate milk prices. Low milk prices meant that dairy farmers in the UK were less incentivised to boost milking cows’ productivity, so there was a reduction in demand for high-margin AminoMax by-pass proteins in the UK during Q1. Although demand picked up in H2, sales were constrained by the loss of two months’ output following the floods in Cumbria. In contrast, demand for AminoMax from dairy farmers in the US increased. Machinery sales were adversely affected by pressure on farm incomes resulting from low milk, meat and grain prices.

Retail sales rose by 16% (5% like-for-like). This growth was supported by the acquisition of Morpeth based Green (Agriculture) Co, in September 2015, as well as investment in the Country Store portfolio with redevelopment of the facilities in Ayr, Balloch and Oban.

In the longer term, we expect the division to benefit from the adoption of more sophisticated feed regimens for dairy and beef cattle across the developed world. In the nearer term, management expects the low-moisture block line in Nevada, which produced its first product in January 2016, to help boost feed block sales. This facility gives access to the significant Californian dairy market. FY18 is expected to benefit from the construction of a low moisture feed block plant alongside the existing high moisture facility in Tennessee, which is scheduled for completion during FY17. This plant will supply the eastern states of the US, which cannot be accessed from the existing operations. The first shipment of feed blocks was sent to Brazil during FY16 to support trials that will demonstrate the benefits of the supplements to farmers in the region. Management continues to consider locating a feed block production facility in New Zealand. The acquisition of Lancashire-based Phoenix Feeds in June 2016 is expected to benefit UK feed sales. We expect further retail sales growth related to the new store in Wigton, Cumbria, which opened during FY16, and the new store in Penicuik, Midlothian, which is scheduled to open in December 2016. Like the other Country Stores, the products stocked in this store will be tailored to the local community. In this case the outlet will focus on the local equine market as well as supplying the normal range of products and services.

We note that the division is less dependent on demand for dairy feed than NWF Group because it also sells substantial volumes of sheep and beef cattle feed. Given the location of the rural areas Carr’s serves in the UK, the division has little exposure to the arable sector so it has not been affected significantly by a reduction in demand for arable inputs such as fertiliser, pesticides or seeds caused by low wheat prices.

We maintain our divisional FY17 revenue estimate at £294.7m, giving a 3% divisional revenue increase year-on-year. We continue to model a £0.6m year-on-year reduction in divisional profits as although it is possible to pass through commodity price increases when selling feed blocks, this is not the case for feeds, where margins remain under pressure.

The Engineering division’s revenues reduced by 10% year-on-year in contrast to our estimates, which looked for a 9% increase to £36.5m. The remote handling business performed in line with management expectations, completing two major contracts for Sellafield, the Demo 2000 Telbot project for Statoil and a contract worth c £1.8m with Cavendish Nuclear for the supply of master-slave manipulators into Sellafield. However, the UK manufacturing businesses experienced low utilisation levels at the start of the year while waiting for significant nuclear projects to commence, while demand from the oil and gas industry remained subdued because of the lack of capital investment by customers in the oil exploration sector. Divisional EBIT reduced very slightly (£0.1m) year-on-year. This is close to our estimates, which expected PBT to be the same as the previous year.

The order book relating to nuclear related projects is strong. The remote handling business is working on follow-on orders to develop a lightweight version of the Demo 200 Telbot for use on offshore platforms, to supply a second Telbot (dubbed Sally) to assist in the removal of high-level toxicity waste at Sellafield and to supply a self-propelled vehicle mounted Telbot (dubbed Robbie) for use at the vitrification plant in Karlsruhe. The STABER acquisition will be instrumental in fulfilling these significant orders. The UK manufacturing business is working on a contract to design and manufacture Sellafield’s highest complexity vehicles for the next 10 years. This was worth £48m at the time of the tender and underpins the division’s growth in the medium term.

We maintain our FY17 divisional revenue estimate (which had been adjusted to reflect the STABER acquisition) at £37.5m, giving a 25% rise in divisional revenues year-on-year. We continue to look for a £0.4m (16%) increase in divisional EBIT.

Food division (£71.4m revenues, £3.5m PBT)

Prior to the disposal of the division at the end of August 2016, Carr’s Food division had three mills located in Cumbria, Kirkcaldy and Maldon, Essex. The division was operating in a difficult market environment. The UK flour market continued to suffer from overcapacity, despite the closure of three Premier Food mills. Demand for flour was static and bread manufacturers were under constant pressure from supermarkets to reduce prices. Revenues dropped by £8.8m (11%) and divisional profit dropped by £0.3m (8%) during FY16. Under current market conditions, it would have been difficult to increase divisional profits significantly. Moreover, the division was reliant on a relatively small number of customers at some locations, making it vulnerable to them changing supplier. The disposal, which was initiated by Whitworths, frees management to concentrate on the two divisions capable of delivering strong growth.

Group revenues (continuing businesses) reduced by 5% year-on-year to £314.9m, slightly below our £328.2m estimate. The drop simply reflects lower commodity prices and the variance of actuals compared with estimates highlights the volatility in commodity prices. Reported profit before tax from continuing businesses grew by 3% to £14.1m. If the reported profit before tax from the Food division is included, total reported profit before tax totalled £17.6m, in line with our £17.5m estimate and very slightly ahead of the record £17.5m achieved in FY15. Adjusted profit before tax for continuing businesses (adjusted for amortisation, share-based payments and exceptionals) reduced by 1% year-on-year, reflecting a switch from £0.5m share-based payment cost to a £0.1m share-based payment credit. DPS was raised from 3.7p to 3.8p, excluding an additional special dividend payment of 17.54p/share (see below) related to the disposal of the Food division.

We leave our estimates unchanged except for adjusting the divisional profits so that the segmental split is presented at operating profit level instead of reported profit before tax level and so that central costs, including supplementary contributions to the pension scheme to address a previous deficit, are split between the two divisions rather than being shown separately. Our estimates do not model any supplementary contributions to the pension scheme, which shows a modest surplus (see below), going forward. We introduce FY19 estimates for the first time.

The group moved from a net debt position to a net cash position because of the proceeds from the disposal of the Food division. Net capital expenditure was higher at £5.4m (FY15: £4.2m) because some of the costs of completing the Nevada Springs facility were deferred until FY16. The retirement benefit surplus reduced from £1.8m at end FY15 to £0.3m end FY16.

Looking forward, we expect FY17 capex to be a relatively high £7.8m in order to cover development of the Country Store site at Morpeth, a new showroom at the German engineering facility and new equipment for the UK manufacturing businesses to support some of the new projects, which require the ability to machine very large components. During FY17 £16.0m of the £24.9m paid by Whitworths for the Food division will be returned to shareholders via a special dividend of 17.54p/share. (This has been paid out.) We expect this payout, together with the £4.2m initial consideration payable for the STABER acquisition, to return the group to a net debt position at the end of FY17. Putting this in context, we estimate that gearing at the end of FY17 will be only 8%, while debt/EBITDA will only be 0.5x. This gives the group sufficient headroom to make further small acquisitions and to invest in additional feed block capacity, potentially funding any larger acquisitions through equity.

We have not changed our estimates or valuation of 161p/share. Our valuation is derived using a sum-of-the-parts methodology based on peer group multiples as presented in our September update note. We will review this in our forthcoming Outlook note.