Carr’s Group — Local, international and sustainable

Carr’s Group serves two diverse sectors: agriculture and engineering. The Agriculture division is increasingly focused on proprietary, high-margin products such as feed blocks or Animax’s patented system of delivering mineral supplements via boluses. These supplements improve livestock performance and thus farmers’ profitability and are sold in the US, mainland Europe and New Zealand as well as the UK. The supplements raise divisional and group margins, give scope for developing overseas markets, and support long-term relationships with customers by providing a complete nutritional package for livestock based on advice from animal nutritionists. The Engineering division designs, manufactures and services bespoke equipment supporting markets in the global nuclear energy, nuclear defence and oil and gas industries. These capabilities are complemented by a portfolio of remote-handling manipulators and robotics.

Group FY20 revenues declined by 2% year-on-year during FY20 to £395.6m, primarily reflecting lower volumes of animal health supplements and feed associated with the unusually mild UK winter. Pre-exceptional PBT (excluding amortisation of acquired intangibles and non-recurring items) decreased by 17% to £14.9m because of the negative effect of lower volumes in the Agriculture division and delays to contracts in the Engineering division. Management maintained the full-year dividend at FY19 levels of 4.75p/share. At group level, trading for the first 19 weeks of FY21 was in line with management’s expectations, with outperformance from the Agriculture division and underperformance in Engineering. We model a £0.7m increase in group underlying EBITA to £16.9m during FY21, driven primarily by growth in sales of feed blocks in North America and the Republic of Ireland. Conversely, the £1.0m rise in underlying group EBITA to £17.9m during FY22 is primarily attributable to the Engineering division and assumes that the delayed Japanese order will be received during FY21 and that global oil prices will recover by the end of FY21.

Our DCF analysis gives an indicative value of 170p/share (unchanged). Confirmation that outperformance in the Agriculture division can compensate for the reduced Engineering revenues associated with the low oil price should, in our view, support the share price and help move it back towards our indicative valuation. So too should news of the delayed engineering order from Japan.

Weather: the performance of Carr’s agricultural division is significantly affected by the weather. This is mitigated by having agricultural activities both inside and outside the UK and involvement in the global engineering sector. Commodity prices: the cost of raw materials for compound feeds and feed blocks is determined by global commodity prices. Demand for products that improve dairy cow yields is adversely affected by weak global farmgate milk prices. Brexit: the changeover from the EU system of subsidies to the UK Environmental Land Management system will leave farmers with a shortfall by 2024. The last-minute deal with the EU, while avoiding a no-deal that would have been ruinous for sheep farmers, will add additional paperwork costs and potentially expose farmers to competition from cheap imports. Diversification, as discussed above, reduces the potential effect of these changes. Investment in the oil and gas industry: the Engineering division’s performance is affected by investment in the global oil and gas industry, which is linked to the global oil price.

Carr’s Group’s headquarters are in Carlisle, UK. It employs over 1,100 people. Its two divisions, Agriculture and Engineering, are growing through a strategy that combines innovation, investment and internationalisation. The Agriculture division manufactures and sells high-margin feed supplements to farmers in North America, New Zealand, mainland Europe and the UK. This international activity complements its UK agricultural activity, which is effectively a one-stop shop for farmers in Northern England, the Welsh Borders, South Wales and Scotland. The group’s UK Agriculture business manufactures and distributes animal feed, operates a network of over 40 retail outlets dedicated to the needs of farmers and other rural dwellers and distributes fuel in northern England and South-West Scotland.

The Engineering division designs, manufactures and services bespoke equipment supporting markets in the global nuclear energy, nuclear defence and oil and gas industries. These manufacturing and service capabilities are complemented by a portfolio of remote handling manipulators and robotics. The division has manufacturing operations in the UK, Germany and the US. The company’s diversification both within and outside the UK agricultural market reduces the group’s exposure to the vagaries of the British climate, farming policy, Brexit and volatile commodity prices.

Unlike smaller competitors, Carr’s has the balance sheet strength to invest in innovative, high-margin agricultural products, to expand internationally and to act as a consolidator in both the agricultural supply and engineering sectors. Importantly, over half of the group’s profit is derived from international activities in both the agricultural and engineering divisions. This sets Carr’s apart from its UK-listed peers in the agricultural supply segment, NWF Group and Wynnstay, whose activities are confined to the UK.

Carr’s UK agricultural activities encompass a broad range of services for farmers and other rural dwellers. This is complemented by an international business manufacturing and selling high added-value feed blocks in the US, UK, mainland Europe and New Zealand. Carr’s range of agricultural activities provides a level of protection against negative influences affecting one part of the agricultural sector. Within the Agriculture division, Carr’s frequently opts to form JVs (see Exhibit 3) with established industry partners in regions outside the UK as this gives an accelerated market entry and reduces the risk of entering new territories.

Traditional agricultural supply merchants rely on selling high volumes of relatively low-value feed, fertiliser and other agricultural inputs. The cost of transporting these significant distances tends to limit geographic expansion. For Carr’s, the ability to offer high-margin feed blocks, boluses and other animal health products raises margins overall, provides the potential to develop overseas markets and sustains long-term relationships with farmers by providing a complete nutritional package for livestock based on advice from animal nutritionists.

Carr’s molasses-based branded feed blocks are made in the UK, Germany and North America and sold throughout the UK, Europe, North America and New Zealand. It sells around 140–150 thousand tonnes of feed blocks worldwide each year. The feed blocks are manufactured according to a patented process. The feed block formulation is adjusted for different animal species and specific life-stages such as pre-calving, post-calving or finishing lambs. The acquisition of Animax in September 2018 broadened the group’s existing range of animal health products and supplements, enabling farmers to administer trace elements via boluses rather than licks.

Consumption is linked to the adoption of more sophisticated farming practices where the calorific, protein, mineral and vitamin content of forage and feed are precisely controlled to maximise the return on investment. Its flagship Crystalyx feed blocks are formulated to promote increased utilisation of forage, thus maximising the economic performance of an animal and in the process reducing the volume of methane emissions per kg of liveweight gain by almost 20%. The ability to quantify the economic benefit for farmers by providing results from locally based trials helps overcome any innate conservatism and supports a high margin. During FY20 there were 24 research trials underway across the UK, Europe, North America and New Zealand.

During FY20, the US supplements business launched FesCool following research trials undertaken with Kansas State University. This supplement enhances the performance of cattle grazing on tall fescue by combatting constriction of blood vessels, which can result in the cattle overheating. The German JV launched its PICKBLOCK range following the commissioning of a dedicated production line for the blocks. PICKBLOCKs improve poultry welfare and performance by giving birds something destructible and ingestible to peck at, reducing feather pecking and cannibalism, which is more prevalent following the prohibition of debeaking. As planned at the time of the acquisition, management has made significant investment in automation of bolus manufacture at Animax, driving future efficiencies and ensuring consistent product quality. During FY20, the group invested £2.1m in the US to improve production efficiency at two of the feed block manufacturing sites and establish a new research facility.

The feed blocks are suitable for those regions where cattle are reared on forage-based systems. Carr’s has started to ship feed blocks from the South Dakota factory into Canada. It continues to ship feed blocks to New Zealand where feed block sales grew by 40% during FY20 and intends to construct a production facility in the country once volumes are sufficiently high. During FY20 the German JV experienced increased exports across Europe including into Russia, Spain, Italy and Turkey. Management is keen to push sales of Animax products through the group’s existing international sales channels.

Demand for feed blocks in the US is primarily driven by beef cattle farmers and is linked to weather conditions, consumer demand for quality beef and cattle prices. A significant proportion of demand for feed blocks in the UK and Ireland is from sheep farmers and is linked to weather conditions at lambing time. The business is reducing volume seasonality by promoting products for use by beef and dairy farmers. Demand for feed blocks in continental Europe and New Zealand is primarily from dairy farmers and linked to the adoption of more sophisticated feeding regimens that deliver increased output from the same number of animals.

Demand for supplements providing trace elements is likely to increase if there is a ban on routinely feeding animals antibiotics, as farmers will potentially turn to nutritional supplements to boost the resilience of their livestock to infection. Demand for supplements is also likely to increase if farmers are required to reduce carbon dioxide emissions because supplements such as Crystalyx enable animals to digest forage more efficiently, leading to a proven reduction in methane output per kilogram of liveweight gain of almost 20% (see our AgTech report for details).

There is limited competition for low-moisture feed blocks in the UK and New Zealand. Carr’s estimates it has over 80% share of the UK market. New Zealand is a relatively new market where farmers are beginning to adopt the more sophisticated feed regimes common in the US. Ridley, which was acquired by animal nutrition and health specialist Alltech in 2015, is the North American market leader, with an estimated 40% share, compared with Carr’s 26%. In the US, Carr’s competes through branding with its ‘Feed in a Drum’ and SmartLic supplements.

Through its associate company Carr’s Billington Agriculture (Operations), Carr’s Group manufactures around 500,000 tonnes of compound and blended feeds each year. These are sold to sheep, dairy and beef cattle farmers in the North of England, Scotland, Wales and the Midlands. The feed is manufactured at compound feed mills in Staffordshire, Lancashire and Cumbria, and at blending plants in Cumbria, Lancaster and Staffordshire. Management remains intent on expanding the group’s sales reach into areas of the UK with high concentrations of livestock farmers, although during FY20 the emphasis was more on realising cost efficiencies through improved processes and more centralised purchasing rather than acquiring new retail outlets.

Carr’s is the third-largest manufacturer in the UK behind ForFarmers and NWF Group. There are numerous small feed suppliers in the area, also served by Carr’s. Underlying demand for dairy feed in the UK is linked to the volume of milk produced, which the Agriculture and Horticulture Development Board predicts will increase by 0.2% year-on-year during the 2020/21 season because of strong year-on-year growth in yields and an increase in autumn calving. The trend to larger herds and more intensive rearing regimens favours a more technical approach to feeding cattle, which benefits larger operations such as Carr’s, which can offer nutritional advice and specialised feed blocks as well as feed. This technical approach is important whether farmgate milk prices are high or low, as farmers are keen to investigate changes to feed regimens that can help improve either yield or profitability, depending on the economic environment. Demand for ruminant feed varies from year to year depending on weather conditions. Because Carr’s also sells substantial volumes of sheep and beef cattle feed, it is less exposed to changes in demand for dairy feed than NWF Group.

Carr’s operates a chain of over 40 retail outlets in Scotland, the North of England, Staffordshire, Derbyshire and the Welsh borders. This includes seven machinery branches, making Carr’s one of the largest Massey Ferguson distributors in the UK. The retail outlets specialise in products for farmers and the broader rural community including animal health products, agricultural sundries such as fencing and farm consumables, pet and equine products and rural clothing. The products offered vary between stores to reflect the type of farming locally.

A high proportion of sales at Carr’s Country Stores relates to non-discretionary farming expenditure, so underlying demand, especially for farm machinery, is linked to farm incomes. Carr’s has been able to grow sales independently of this by broadening the product offer to include higher-margin animal healthcare products. The retail outlets are typically situated at places convenient for farmers, such as livestock auction markets rather than on conventional retail parks. The stores initially responded to the coronavirus pandemic by introducing a click-and-collect service but have remained open in subsequent lockdowns.

Carr’s operates eight fuel distribution depots that collectively service rural premises in Dumfries & Galloway, Cumbria, Lancashire and Northumberland. At around 120m litres per year, the operation is significantly smaller than that of NWF Group (665m litres in FY20), which is the third-largest oil distributor in the UK. However, unlike NWF, Carr’s is not intending to become a national player in the sector, but views this as a service within its agricultural supply offer. The operation is highly complementary to the feed and machinery sales operations, providing significant opportunities for cross-selling. Demand for heating oil is dependent on weather conditions. This dependence is reduced by selling tractor fuel as well. Demand for tractor fuel is typically higher over the summer when demand for heating fuel is weaker.

The Engineering division designs, manufactures and services bespoke equipment supporting markets in the global nuclear commercial, nuclear defence and oil and gas industries. These capabilities are complemented by a portfolio of remote handling manipulators and robotics. 49% of divisional FY20 revenues were attributable to the global commercial nuclear industry, 21% to oil and gas and 18% to defence. The division serves customers in Europe, Russia, the Far East, Australia, South Africa, the US and Latin America. Since it has been built up through a sequence of acquisitions between 1996 and 2019, management is working on driving the synergies between the division’s different businesses by organising them into three segments to foster cross-selling and joint work on projects. The three segments are UK service and manufacturing, Global Robotics and Global Technical Services.

UK service and manufacturing (£29.4m revenue FY20)

This part of the division primarily designs and manufactures bespoke steel fabrications, such as bespoke pressure vessels up to 5.0m in diameter and special purpose fabrications up to 50m long. These are typically sold to customers in the nuclear, oil and gas, petrochemical and process industries. Safety is critical in these sectors, so full material traceability along with radiographic weld testing, hydraulic testing and documentation packages are offered as standard. During FY20 the group invested £1.3m in state-of-the-art large scale machining capability at its Carlisle site, bringing capability in-house.

The offer for the nuclear industry was enhanced through the acquisition of NW Total in June 2019. NW Total designs and manufactures bespoke process equipment packages and provides onsite technical support, installation and condition monitoring services to the nuclear defence, nuclear power generation and decommissioning markets. The deal extended the customer base in the UK and provides opportunities for cross-selling, with NW Total designing complex fabrications such as pressure vessels and heat exchangers and the other UK businesses manufacturing them.

This segment designs and manufactures remote handling equipment such as robotic arms and master-slave manipulator units. These devices are widely used in the nuclear industry in post-irradiation examination laboratories and fuel element reprocessing cells. The robotic arms incorporate specialist gearing systems that permit the very precise control of movement required for remote handling applications and are unusual in that they have no external cabling or hydraulic systems so there is no restriction on rotational movement. The robotic arms are typically customised for deployment in specific applications. A single robotic arm sale may be around €1m. The division is one of the largest providers of highly specialist remote handling equipment for the nuclear industry globally and has the broadest product range.

Before the acquisition of US-based NuVision in 2017, customers for these products were primarily engaged in the nuclear industry in France, Germany, the Far East and the UK, where the main customer is Sellafield. In calendar year 2012, the UK robotics business was awarded a ‘life of plant’ contract with Sellafield, under which it supplies master-slave manipulator parts for the major operating plants at Sellafield. This contract is being extended and generates revenues of over £2m each year. The acquisition of NuVision, which has offered its own robotic arms for over 20 years, created a route to market that overcomes the resistance in the US to purchasing from overseas suppliers that the segment had previously experienced, helping the German robotic business win a US$8.5m contract in the US.

Global Technical Services (£8.8m revenue FY20)

Carr’s has been engaged in this activity since the acquisition of NuVision. The segment is engaged in the design and implementation of technically advanced engineering solutions that help extend the life and safe operation of power plants and enable the movement and management of radioactive waste. For example, its patented Mechanical Stress Improvement Process (MSIP) technology is a patented, permanent solution that has been accepted by the United States Nuclear Regulatory Commission as a technique for mitigating stress corrosion cracking in both boiling water reactor and pressurised water reactor plants. If not addressed, stress corrosion cracking can compromise nuclear plant safety and availability. The segment is also involved in the validation of new plant designs and analysis of existing systems to predict and proactively manage potential problems, in which capacity it has conducted more than 100 large-scale demonstration test programmes for the US Department of Energy (DOE) and UK customers. Its customers include the US and other governments, utilities, nuclear plant designers and OEMs. It has assisted with the clean-up of legacy waste in North America and the UK for more than 30 years, having developed, designed, built, tested and implemented waste management systems at key sites such as Oak Ridge, Los Alamos, Sellafield and Dounreay.

In 2018 the segment was awarded US$3m funding from the US DOE to develop a small-scale working prototype of its passive cooling technology. This provides an engineered solution to mitigate the effects of loss of power to light water-based nuclear reactors (as happened in Fukushima) and to remove decay heat from the reactor core, mitigating losses due to random equipment failures and severe accidents. This potentially opens a new product area longer term.

Around 80% of the Engineering division’s contracts are related to the global nuclear energy industry, primarily supporting existing plants and decommissioning activities. Decommissioning activity on its own provides a good base level of activity for the group. Western Europe has 150 plants to decommission by 2030 (Global Data, Washington Post). Considering the UK alone, the cost of decommissioning 17 sites across the UK, some dating back to the 1940s, is estimated by the National Audit Office to exceed £70bn, with the work extending over several decades. For its financial year 2021/2022, the Nuclear Decommissioning Authority intends to spend £3.5bn. In September 2020 McKinsey noted that Japan was decommissioning 26 of its 62 nuclear reactors. The World Nuclear Association estimates that decommissioning the Tokai-1 reactor alone will total $1.04bn. The division is well placed to benefit from decommissioning in Japan because of its long-term relationship with Mitsui Engineering and Shipbuilding.

The UK manufacturing businesses are also involved in the global oil and gas industry. The offshore oil and gas industry suffered from a lack of investment caused by low oil prices during FY15 and FY16 and again in 2020 and into 2021. In contrast, a recovery in oil prices meant activity levels were strong during both FY18 and FY19.

There are fewer than six competitors worldwide for the Global Robotics segment and none have as broad a product range. The UK service and manufacturing segment is in a good position in the UK nuclear market when contracts are awarded because it can offer the full traceability required and has good relationships with Sellafield. The oil and gas sector is more competitive. The primary competitors for large fabrications are based in South Korea, hence the lower margins attributable to contracts for this sector.

In line with the succession plan announced in August 2020, Hugh Pelham was appointed as CEO on 24 September 2020 and took up his role when the previous CEO, Tim Davies, stood down at the group's AGM on 12 January 2021. Hugh brings over 30 years' experience in leading growing businesses across various sectors. Before joining Carr’s Group, he was global president at Minova, part of ASX-listed Orica, which is a manufacturer and supplier of chemical and mechanical earth control products, adhesives and support equipment. Minova has revenues of A$600m (£336m), generated from 40 countries globally. Before that, Hugh spent four years as managing director of Wood Group Industrial Services, a provider of specialist coatings, access and fabric maintenance services to the oil and gas, marine and rail industries. He also served as president (EMEA) of Wood Group Industrial Services, being responsible for international growth and leading a team of over 2,000 people.

We believe the key sensitivities are:

Weather: in common with all other companies involved in the sector, the performance of the agricultural division is significantly affected by the weather. The division’s presence in agricultural markets in the US, mainland Europe and New Zealand makes it less dependent on weather conditions in the UK, as do its engineering activities.

Commodity prices: the cost of raw materials for compound feeds and feed blocks is determined by global commodity prices. Derivatives are used where possible to hedge exposure to movements in future prices of commodities, although most of the futures risk is borne by suppliers. Within the agricultural sector there is typically a delay in passing on full price increases to feed customers. Demand for products that improve dairy cow yields are adversely affected by weak global farmgate milk prices.

UK Government farming policy: under the EU system, which ended in December 2020, the amount of subsidy a farmer received was based on the amount of land they farmed. These area-based subsidies will be halved by 2024 and abolished by 2028, with subsidies being distributed instead through the Environmental Land Management system, some details of which were announced at the end of November 2020. Under this new scheme, which will not be fully rolled out until late 2024, farmers will receive grants for protecting 'heritage' farm buildings and stone walls, expanding hedges, capturing carbon in soils and cutting pesticides, implementing natural flood management programmes such as restoring river bends and landscape recovery programmes, such as restoring peatland and planting new woods, reducing antibiotics and improving animal health and welfare. Because the changeover will mean upheaval for farmers, some of whom will find it difficult to adjust, the government is making lump sums available for those who decide they want to retire at this point. This is likely to result in consolidation of farms and wider adoption of more sophisticated farming methodologies, resulting in higher levels of productivity. There are concerns that the EU scheme is being phased out without a complete replacement programme for three years, resulting in a shortfall in farm incomes. While the government’s policy document ‘Farming is Changing’ states its commitment to maintaining the current annual budget, this is only for every year of the current Parliament. The National Farmers Union states that for livestock farmers, the changes could represent a 60% to 80% shortfall in farm business income by 2024.

Brexit: although the lastminute deal agreed with the EU means there will not be any tariffs imposed on UK produce exported to the EU, the agricultural industry will still have to bear increased costs now the transition period has ended. The Agriculture and Horticulture Development Board estimates that border checks could add 3–8% to the cost of goods and the prospect of delays at ports may reduce the trade of highly perishable produce. While the government’s points-based immigration system is likely to make it difficult for farmers to secure migrant labour from 2021 onwards, we expect this will have most impact on fruit and vegetable picking and thus have minimal effect on the group’s customers. However, if the government is successful in concluding trade deals with countries with lower costs of production, UK farmers will be increasingly exposed to competition from cheap food imports. Diversification, as discussed above, reduces the potential impact of changes.

Investment in the oil and gas industry: the Engineering division’s performance is affected by investment in the global oil and gas industry, which is linked to the global oil price.

Divisional revenues declined by 4% year-on-year to £342.6m, reflecting lower volumes of feed and feed blocks during the first half. Divisional EBIT (adjusted for amortisation of acquired intangible assets and non-recurring items but not share-based payments) fell by 9% to £13.4m.

Global feed block sales volumes were up 1.2% year-on-year. 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 during the first half because farmers were not pushing to maximise outputs. This reversed in the second half as livestock prices improved, resulting in 5% volume growth for the year as a whole. Similarly, feed block volumes in the US were depressed in H120 because of a delayed start to winter feeding, then improved in the second half as livestock prices recovered towards the year end, resulting in a 0.5% increase in volumes for the year as a whole in the region. Feed block sales were slightly down in Germany during the first half because of the mild winter there and finished with a 4% volume decline for the year as a whole. The sales team were not able to fully recover increased raw material costs, primarily of molasses, in the UK because of increased competition.

Compared with H119, demand for animal feed in the UK during H120 was depressed by the unseasonably mild weather, which 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 substantially above normal at the start of H120. A significant pick-up in demand for meat and dairy products during H220 led to a recovery in feed demand, resulting in total compound feed volumes declining by 7% year-on-year for FY20 as a whole, in line with the market. The mild weather in H120 resulted in a reduction in volumes of fuel sold. However, this was more than offset during H220 by customers stocking up on heating oil when commodity prices were low at the start of the coronavirus pandemic, and a busy spring period on farms once the excessively wet winter was over and it was possible to work the land again. Fuel volumes rose by 3% for the year as a whole. Machinery revenues jumped by 19% against a significant market decline. Like-for-like sales in the retail business rose by 2%. The group’s network of UK retail outlets, which provide a critical role in the UK’s food supply chain, remained operational throughout the pandemic, as did all of the division’s UK and overseas manufacturing facilities.

Cattle prices in the US began to rise towards the end of FY20, boosting demand for feed blocks in the region. At the AGM in January management noted that cattle prices in the US have remained robust since the FY20 year-end, supporting demand for feed blocks. Exports of both feed blocks and Animax supplements to the Republic of Ireland have increased following deployment of additional sales personnel there. Both these positive trends are likely to continue because US cattle prices are not significantly above the 10-year average, so there is no sign of a spike and the Brexit deal ensures there are no tariffs on exports to Ireland. We also see potential for divisional growth from sales of feed blocks from the South Dakota plant into the Canadian beef market now that Carr’s has completed a two-year process to gain approval for the product in the country. Trading in the UK Agriculture business has been in line with management expectations for FY21 so far and may potentially benefit from continued farmer confidence now the worry of a no-deal Brexit, which would have been ruinous for sheep farmers, has gone. We model a £0.5m increase in divisional EBITA during FY21 to (including JVs and associate) £13.9m.

Divisional revenues increased by £6.5m year-on-year to £53.0m. NW Total, which was acquired in June 2019, generated revenues of £11.7m compared with £1.9m in FY19. Divisional adjusted EBIT fell from £5.9m to £3.8m, reflecting delays in receiving and executing contracts.

The UK Service and Manufacturing business performed well during the first half. However, the second half was adversely affected by significantly reduced investment by the oil and gas sector caused by the low oil price, which resulted in delays in executing a major project. The Global Robotics business experienced delays to contract awards, primarily on a major order from Japan for remote handling equipment related to the Fukushima clean-up activity and restrictions on exports to China. The situation was made worse during the second half by travel restrictions related to the coronavirus pandemic, which made it difficult to progress potential sales or install equipment on customer sites. As anticipated, because of the long timescales of projects, the Global Technical Services business experienced lower levels of activity during the first half because of contract phasing on key MSIP projects. This was followed by a pick-up in activity in the second half.

We model only a modest £0.2m increase in divisional EBITA during FY21 to £4.0m. The Global Technical Services order book is strong. It includes two significant MSIP contracts won during FY19 that will primarily benefit FY21 when the manufacturing phase will take place and a $6.2m MSIP contract received in FY20 from a customer in Switzerland, which will primarily benefit FY21 and FY22. NW Total’s order book also remains very strong and the Global Robotics order book was significantly stronger at the end of FY20 than at the beginning. Moreover, management stated at the AGM in January that work on these contracts is progressing well, without some of the delays that have marred performance in previous years. However, global oil prices remain relatively low as the pandemic drags on, reducing investment by the oil and gas industry. This is having a negative effect on some of the UK manufacturing activity, which, because of the long-term nature of the division’s contracts in the nuclear and defence industry, cannot be compensated for by swiftly securing additional business elsewhere in the division. While the division has also remained fully operational through the recent lockdowns, we note a risk that some FY21 revenue may slip into FY22 if prolonged lockdowns delay the completion of installations on customer sites.

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 effect on the division. Management expects the delayed Japanese order to be signed in H221, thus contributing to FY22 numbers. Assuming a recovery in investment from the oil and gas industry in FY22, we model a £0.9m jump in divisional EBITA during FY22 to £4.9m.

FY20 profits hit by mild UK weather and contract delays

Group FY20 revenues declined by 2% year-on-year to £395.6m, primarily reflecting lower volumes of animal health supplements and feed associated with the unusually mild winter. Pre-exceptional PBT (excluding amortisation of acquired intangibles and non-recurring items) decreased by 17% to £14.9m because of the negative effect of lower volumes in the Agriculture division and delays to contracts in the Engineering division. Management maintained the full year dividend at FY19 levels of 4.75p/share.

Balance sheet gives resilience

Net debt (excluding £13.9m finance leases) reduced by £2.0m during the period to £18.9m, which was 0.8x adjusted EBITDA. The movement was primarily attributable to a £5.2m decrease in working capital requirements related to lower commodity prices and a deliberate reduction in inventory levels. The retirement benefit surplus increased from £7.8m at end FY19 to £8.0m at end FY20. The group no longer makes deficit reduction contributions because the pension scheme was fully funded at the last full actuarial valuation. We note that net debt (excluding leases) was 24% lower year-on-year at the end of November 2020 (£20.4m), reflecting close inventory control and lower commodity prices.

We model a £0.7m increase in group underlying EBITA to £16.9m during FY21. This is driven primarily by growth in sales of feed blocks in North America and the Republic of Ireland. We expect growth in the Engineering division to be only modest in FY21 because of the lack of investment in the oil and gas industry caused by continued low oil prices. Conversely, the £1.0m rise in underlying group EBITA to £17.9m during FY22 is primarily attributable to the Engineering division and assumes the delayed Japanese order will be received during FY21 and that oil prices will recover.

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 170p/share (unchanged). We prefer a DCF analysis to a peer-based multiples approach because it looks beyond short-term issues such as unseasonal weather, which can cause substantial underperformance or outperformance. Confirmation that continued growth in feed block sales in international markets can compensate for the reduced Engineering revenues associated with the low oil price should, in our view, support the share price and help move it back towards our indicative valuation. So too should news of the delayed engineering order from Japan.

Peer-based multiples: Justifying a premium to mean

In Exhibit 9 we compare Carr’s prospective EV/EBITDA and P/E multiples with those of its listed peers in the agricultural supply sector. At the current share price (132.25p), Carr’s is trading in line with its more traditional agricultural supply peers on most metrics. However, in our opinion a premium to the mean is justified. Firstly 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. Secondly, Carr’s derives a substantial proportion of its Agriculture profits from supplements which are high-margin added-value activities. Its two peers in this segment are trading on higher multiples that the more traditional agricultural supply peers. Thirdly, Carr’s derives around one-quarter of its profits from engineering-related activities based in mainland Europe, the UK and the US, further reducing the group’s exposure to any potential short-term set-backs for UK farming.

At the indicative value of 170p/share derived from our DCF calculation, Carr’s is trading at a substantial premium to its agricultural supply 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 one-off contract delays or unseasonal weather. At the 170p level, the multiples are at a discount to those peers focused on added-value activities.