Carr’s Group — Demand and balance sheet resilience

Divisional revenues declined by 5% year-on-year to £175.0m, reflecting lower volumes of feed, fuel and feed blocks. Divisional EBIT (adjusted for amortisation of acquired intangible assets and non-recurring items but not share-based payments) fell by 16% to £9.0m.

As noted in January, compared to financial H119, demand for animal feed in the UK during H120 was depressed by the unseasonably mild weather that resulted in plentiful supplies of forage. Moreover, H119 followed a prolonged period of drought, so while farmers typically started H119 with very low stores of forage, levels were more normal at the start of H120. Total compound feed volumes declined by 10% year-on-year during H120, in line with the market. The mild weather also resulted in a 6% reduction in volumes of fuel sold. However, an improvement in UK farmer confidence generally compared with the corresponding period a year previously when farmers were very concerned about an impending no-deal Brexit at the end of March 2019, resulted in a 2% like-for-like rise in sales in the retail business and a 20% jump in machinery revenues. In addition, the combination of unseasonal weather and lower cattle and lamb prices resulted in lower sales in the UK of both feed blocks and Animax supplements because farmers were not pushing to maximise outputs.

Volumes of feed blocks were slightly down overall in the US, with growth in the eastern and south-eastern states following the commissioning of the low moisture feed block in Tennessee towards the end of H119, which has enabled the group to extend its geographic footprint across the region. Demand for feed block volumes in the US was lower than management originally expected because of a delayed start to winter feeding. Feed block sales were slightly down in Germany because of the mild winter there.

Considering H220 and the impact of the COVID-19 pandemic, all of the division’s UK and overseas manufacturing facilities remain operational, as does the network of UK retail outlets which provide a critical role in the UK’s food supply chain. As the second half is typically weaker because of greater availability of forage, we do not expect the division to make up the lost volumes from the first half and continue to model a 22% reduction in divisional EBIT to £11.4m for FY20 as a whole. Longer term, we see potential for divisional growth from sales of feed blocks from the South Dakota plant into the Canadian beef market, as Carr’s has completed a two-year process to gain approval for the product in the country. Noting continued uncertainty in the UK agriculture sector relating to Brexit, especially for sheep farmers, and the potential for input prices to rise if this year’s harvest is poor we model a recovery in profits during FY21 and FY22, but not to the level reached in FY19. Given the significant uncertainty in agricultural markets, management has begun to implement longer-term cost reduction measures to better position the division beyond the current financial year. This programme refines management’s strategy of growing the division by focusing on added-value activities such as the manufacture of feed blocks and supplements and by making bolt-on acquisitions. It is possible that the COVID-19 pandemic may encourage the UK government to support its farmers in the interest of ensuring shortening food supply chains and improving food security. This would be of benefit to the division.

Divisional revenues increased by £3.9m year-on-year to £24.9m. The UK Service and Manufacturing business performed well with NW Total, which was acquired in June 2019, contributing an estimated £6m in sales and the manufacturing businesses benefitting from strong order books. As flagged earlier, the Global Robotics business experienced delays to contract awards, primarily on a major order from Japan for remote handling equipment. As anticipated because of the long timescales of projects, the Global Technical Services business experienced lower levels of activity because of contract phasing on key mechanical stress improvement process (MSIP) projects. Divisional EBIT fell from £2.0m to £1.2m.

Considering the impact of the COVID-19 pandemic, all of the division’s facilities in the UK remain operational, except for one relatively small business. While the two US sites are closed, this is not having a significant impact because the key MSIP projects being worked on are currently at the design phase so engineers are able to continue their work from home. The main UK manufacturing sites are currently operational, so we expect profitability to improve substantially during the second half as the UK Service and Manufacturing business moves from the design to the manufacturing stage on some key projects, though this could change if the lockdown intensifies. We do not expect a significant improvement in Global Robotics performance during H220 since the major Japanese order related to the Fukushima clean-up activity is not expected to come in until Q121. While the Global Technical Services order book includes two significant MSIP contracts won during FY19, these will primarily benefit FY21, which is when the manufacturing phase will take place. Similarly, the recent $6.2m MSIP contract for a customer in Switzerland will primarily benefit FY21 and FY22. We currently expect the contribution from NW Total to compensate for the year-on-year dip in both the Global Robotics and Global Technical Services, resulting in divisional EBIT for FY20 as a whole year being the same as FY19 (£5.9m).

We expect the MSIP contracts and delayed order from Japan to deliver profit growth in FY21. As much of the division’s work related to long-term contracts from the nuclear industry, we do not expect the COVID-19 pandemic to have a lasting impact on the division.

P&L

Group H120 revenues declined by 3% year-on-year to £200.0m, primarily reflecting lower volumes of feed blocks, animal health supplements, feed and fuel associated with the unusually mild winter. Pre-exceptional PBT (excluding amortisation of acquired intangibles and non-recurring items) decreased by 16% to £9.6m because as well as the negative impact of lower volumes in the Agriculture division, the phasing of long-term contracts in the Engineering division meant that divisional profit is expected to be skewed towards the second half. The most significant non-recurring item was a £2.1m credit related to a net decrease in fair value of deferred consideration payable. While NW Total has outperformed post-acquisition, Animax’s performance was lower than expected in H120 because of reduced demand for animal health supplements. Management has decided to defer payment of an interim dividend until the full effects of the COVID-19 pandemic are clearer and will review the position at the time of the scheduled trading update in July. We have not changed our FY20 dividend estimate at this point and will revisit it in July.

Balance sheet gives resilience

Net debt (excluding £15.2m leases and £15.9m right-of-use assets) rose by £4.5m during the period to £25.4m, which is 1.2 times adjusted EBITDA. The movement is primarily attributable to a £2.5m increase in working capital requirements, which is lower than the usual first half movement because of lower agricultural sales, £2.6m capex, £1.6m deferred consideration and £3.3m dividend payments. The retirement benefit surplus reduced from £7.8m at end FY19 to £6.6m at end H120. The group no longer makes deficit reduction contributions because the pension scheme was fully funded at the last full actuarial valuation. At the end of H120 the group also had undrawn facilities of £22.4m. Management notes that it has modelled scenarios including the temporary closure of several businesses and the impact of delays in collecting debts from farming customers. Its assessment is that it has sufficient funding in place within these existing facilities in each of these scenarios.

Estimates

We currently leave our estimates unchanged from revision following the trading update in March when we cut our FY20 and FY21 EPS estimates by 26% and 10%, respectively. We are not currently modelling any exceptional items in FY20, though note the £2.1m credit relating to a change in the fair value of deferred consideration and £0.5m restructuring costs recognised in H120 and an estimated £0.5m of further restructuring costs in H220. We present a table reconciling Edison’s adjusted PBT and EPS estimates, which are calculated before deducting share-based payments and amortisation of acquired intangibles, with management’s preferred calculation of PBT and EPS which strips out amortisation of acquired intangibles but not share-based payments.

DCF methodology

Our valuation methodology is based on a DCF analysis, supplemented with a comparison of peer group multiples. We continue to use a conservative 10.0% WACC and a 1.0% terminal growth rate for our DCF calculation. This gives a fair value of 172p/share (unchanged). We prefer this metric because it looks beyond the share price volatility related to the uncertainty caused by the COVID-19 pandemic as well as the short-term issues of unseasonal weather and order delays that are specific to the group. The valuation gap should begin to close as investors see signs of a recovery in the Agricultural division which will depend on clarity on the impact of COVID-19, trading arrangements post-Brexit and data on the cost-reduction programme, as well as positive news regarding contracts to replenish the order book for the German robotics business.

Peer-based multiples

In Exhibit 4 we compare Carr’s EV/EBITDA and P/E multiples for the years ended August 2020 and August 2021 with calendarised multiples for listed peers in the agricultural sector. In common with these peers, Carr’s share price fell substantially as markets realised that COVID-19 was a global phenomenon and has since started to recover as investors have recognised that agricultural supply companies should be relatively resilient to the impact of the outbreak. At the current share price (104.25p), Carr’s is trading below its peers on all metrics. In our opinion this is undeserved. Firstly, Carr’s derives around one-third of its profits from engineering related activities. While divisional performance this year has been affected by contract delays, it is likely to recover next year, regardless of what happens in the UK agricultural sector. Secondly, Carr’s feed block activity in North America, mainland Europe and New Zealand reduces the exposure of its agricultural businesses to challenges caused by the UK climate and government policy. This sets Carr’s apart from both NWF and Wynnstay, whose agricultural activities are confined to the UK.

At the indicative value of 172p/share derived from our DCF calculation, Carr’s is trading at a substantial premium to its peers on all metrics. This is not surprising given that a DCF valuation looks at the long-term cash-generation profile rather than short-term profits and is not affected by the general slump in share prices caused by the COVID-19 pandemic.