Carr’s Group — Profits dip as expected with FY18 recovery underway

The trends observed during H117 continued during the second half. The recovery in UK farmer confidence relating to better commodity prices, particularly farm gate milk prices, offset weak demand for feed blocks in the US caused by a surplus of beef cattle following a period of restocking and resultant collapse in deadweight cattle prices in late FY16/early FY17. In the UK, Carr’s took share in the compound feed and blend market, increasing volumes by 10.9% against a market that rose by 6.6%. UK feed block sales were 2.1% down year-on-year because of the mild spring. Sales in the Country Stores network rose by 2.2% (like-for-like 0.8%), reflecting a new Country Store opening in Penicuik, Midlothian in December 2016 and the acquisition of Horse and Pet Warehouse in Ayr in March 2017, as well as investment in new stores, site refurbishments and bolt-on acquisitions made in prior years. Sales volumes of feed blocks in the US were down 4.1% year-on-year, but began to pick up in the second half, finishing slightly ahead of management expectations. Divisional revenues increased by 10.9% year-on-year, EBITA dropped by 8.4% to £11.4m, both ahead of our estimates.

Looking forward, management expects the UK Agriculture sector to remain positive, with farm incomes continuing to improve in FY18. Management expect the gradual recovery in feed-block demand in the US to continue as well, supported by improving deadweight prices. We expect FY18 divisional performance to benefit from feed block sales to the new markets that become accessible when the low-moisture plant in Tennessee becomes fully operational in December. We also expect some uplift from the acquisition of Cheshire-based Mortimer Feeds in June 2017 and of Pearson Farm Supplies last month. Pearson has retail locations across Yorkshire, Lancashire and North West Wales, raising the number of retail locations to 43. Longer-term, we expect divisional revenue to benefit from the formation of a direct sales operation for feed blocks in New Zealand, rather than relying on a distribution partner, and potential feed-block sales in South America, where trials are going well.

Divisional full-year performance also followed the pattern presented at the interims. The remote handling businesses (Wälischmiller and MSM), which are both focused on the nuclear industry, continued to deliver ahead of management expectations, as they worked on some large orders for the supply of power manipulators into China. The first stage of the STABER acquisition, which was announced in October 2016 and augments Wälischmiller’s design capability, was completed successfully. However the UK Manufacturing business was affected by delays in commencing a major nuclear contract expected to utilise a significant proportion of FY17 production capacity. Management filled capacity with short-term work for other sectors, but these jobs were on relatively low margins. Divisional revenues were maintained at FY16 levels, which was below our £37.5m estimate, but EBITA was only a quarter of that of the prior year.

Looking forward to FY18, the delayed nuclear contract was finally signed in July and will benefit FY18 performance. Work on the Sellafield Vessels and Tanks Category Management Framework is scheduled to start in FY18. This contract, which is worth up to £48m over 10 years, underpins the growth and development of the UK Manufacturing activity for the medium and long term. The Chinese Remote Handling contracts extend into FY18 and Statoil continues to fund development of a lightweight Telbot inspection arm for use on oil and gas platforms. The strength of the order book gives confidence in a divisional recovery. In addition, FY18 performance will benefit from the acquisition of US-based NuVision in August. For the year ended March 2017, NuVision generated $8.8m revenues and $1.1m profit before tax (adjusted for non-recurring items and amortisation of intangibles).

Group revenues rose by 9.9% year-on-year to £346.2m, boosted by higher commodity prices and higher volumes in the UK Agricultural businesses. The reported number is ahead of our £332.2m estimate, reflecting the difficulty in predicting soft commodity price movements. Pre-exceptional PBT, adjusted for share-based payments and exceptional items, declined by 16.2% to £11.9m, in line with our estimates. Growth in the UK Agriculture and Remote Handling activities was offset by weak demand for feed blocks in the US and a significant contract delay in the UK Manufacturing part of the Engineering division. The full-year dividend of 4.0p/share, which showed a rise from 3.8p/share in FY16 (excluding the special dividend of 17.54p/share), was higher than our estimate of 3.9p/share.

The group moved from a net cash position of £8.1m at the end of FY16 to a net debt position of £14.1m. This is primarily attributable to the payout of a £16.0m special dividend (at 17.54p/share), the acquisition of STABER for an initial consideration of €5.9m and the $11.5m initial consideration payable for NuVision. The retirement benefit surplus increased from £0.3m at end FY16 to £5.2m at end FY17. The group no longer makes deficit reduction contributions since the pension scheme was fully funded at the last full actuarial valuation.

We adjusted our estimates in August following the NuVision acquisition. We make further revisions, (see Exhibit 2) raising Agricultural revenues in the light of higher soft commodity prices, and raising contribution from the agricultural associates and JVs to reflect the continuation of a positive environment in UK farming, supported by favourable farm gate prices for milk and livestock. This translates into a 33.8% year-on-year rise in group PBT (adjusted for share-based payments and amortisation of intangibles) to £15.9m in FY18.

Our valuation methodology is based on a DCF analysis, supplemented with a comparison of peer multiples. We continue to use a conservative 10.0% WACC and a 1.0% terminal growth rate for our DCF calculation, which gives a fair value of 167p/share (previously 163/share).

A comparison of Carr’s EV/EBITDA and P/E multiples for the years ended August 2018 and August 2019 with calendarised multiples for listed peers in the agricultural sector is shown in Exhibit 4. At the current share price (143.5p), Carr’s is trading below its peers with regards to mean EV/EBITDA (7.8x vs 10.8x) and mean P/E (11.5x vs 16.5x) for the year ending August 2018. The discount to the average peer multiples should close as feed-block demand continues to recover in the US. There is already sufficient visibility of the 2018 Engineering order book, which is based on long-term contracts in the nuclear industry, to give confidence in a recovery in this division. At the indicative value of 167p/share derived from our DCF calculation, Carr’s implied EV/EBITDA multiple for the year ending August 2018 is still lower than the peer average (8.9x vs 10.8x), as is the P/E multiple (13.3x vs 16.5x).