Carr’s Group — Recovery in both divisions confirmed

As flagged at the AGM and the interims, UK farming sentiment remains positive, helping to drive a 8.7% increase in feed volumes, a 7.8% rise in machinery sales, an 8.9% uplift in feed block volumes and a 4.4% like-for-like sales growth in the country stores. The acquisition of Pearson Farm Supplies in October 2017 helped to drive a total increase in country store sales of 12.1%, as well as contributing to the higher feed volumes. While fuel volumes benefited from the late spring, this was in part offset by lower on-farm demand during the dry summer resulting in a 4.6% y-o-y improvement in volumes. As noted at the AGM, US feed block volumes continued to recover as cattle prices for producers improved. In addition, a drive to improve sales during the summer from the sale of products such as those designed to reduce hornfly larvae infestation in cattle was successful. Management reported a 17.7% y-o-y increase in volumes sold in North America. The German joint venture noted a 12.4% rise in feed block volumes resulting from the favourable environment for dairy producers in the region. Divisional revenues increased by 13.8% y-o-y, and EBITA by 16.9% in FY18.

Looking forward, management expects sentiment in the UK Agriculture sector and demand for feed blocks in the US and Germany to remain positive. The favourable trend in the US will be augmented by the availability of low-moisture feed blocks from the new plant in Tennessee which gives access to new geographic markets. This was commissioned in January 2018, which is towards the end of the season of high demand, so the full impact will be felt in FY19. The new plant opens up the market in the eastern states of the US. Feed block sales in New Zealand should benefit from the formation of a direct sales operation in the region which has already secured supply agreements with several domestic agricultural merchants, rather than relying on a distribution partner as previously. Plans to develop the South American market are proceeding as per management’s timeline. The group started to supply product to distributors during FY18 and made its first commercial sales in the region, albeit at low levels. Trials at research institutes in Brazil continue to make good progress. Since it is not reasonable to expect a repeat of the drought experienced this summer in the UK and unusually high demand for feed because of the lack of forage, we model a small y-o-y drop in total JV profits during FY19.

Divisional performance will also benefit from the acquisition of Animax in September 2018 for a total cash consideration of up to £8.5m. The transaction broadens the group’s existing range of animal health products and supplements, enabling farmers to administer trace elements via boluses rather than licks. Together with sister company Clinimax, a manufacturer of patented specialist disinfectant products for the medical industry, Animax generated £0.6m EBITDA for the year ended November 2017. Management expects that the transaction will be earnings enhancing in FY19.

Work continued throughout FY18 on the significant fabrication contract that was delayed until almost the end of FY17. The precision engineering business is benefiting from a recovery and stabilisation of the oil price, which happily coincides with a strengthened management team, resulting in more effective business development and improved operating efficiencies. The UK manufacturing business’ performance was consequently significantly ahead of the prior year. The remote handling businesses performed well as it too worked through a strong order book, completing the substantial orders from China that were won last year. The integration of NuVision, acquired in August 2017, is progressing well. NuVision generated £5.7m sales during FY18 (£0.2m in FY17), worked with the UK manufacturing business on the major contract referred to above, was instrumental in helping Wälischmiller secure several contracts in the US and won two significant Mechanical Stress Improvement Process (MSIP) contracts. Divisional revenues increased by 43.6% y-o-y, while EBITA increased sixfold.

The strength of the divisional order book, which is based on long-term contracts from the nuclear industry, indicates that these favourable trends are set to continue during FY19. The extension of the German premises, which is now complete, provides additional capacity. Management remains confident of securing further sales of Wälischmiller equipment through NuVision’s sales channels.

Group FY18 revenues rose by 16.5% year-on-year to £403,2m, reflecting a recovery in the US feed block and UK manufacturing businesses, a continuation of positive sentiment in the UK agriculture sector and strong order books for the remote handling businesses. This was ahead of our £377.4m estimates, reflecting commodity price inflation and a stronger than expected recovery in demand for US feed blocks. Adjusted pre-exceptional PBT grew by 48.8% to £17.7m, also ahead of our estimate (£16.6m), because of the stronger than expected performance in Agriculture, especially in the US. Outperformance here is also attributable to higher than expected share-based payment charges (£1.1m actual vs £0.5m estimate), as this is stripped out as part of our adjustments. The dividend was raised by 0.5p to 4.5p/share, ahead of our 4.3p/share estimate.

Net debt rose by £1.2m during FY18 to £15.4m at end August 2018. This is primarily attributable to a £4.7m increase in working capital requirements; £4.5m capex, half of which was for the Wälischmiller expansion; £4.2m payable for acquisitions including the initial consideration for Pearson Farm supplies and the deferred consideration for Staber; and £3.8m in dividend payments to shareholders. The increase in working capital is due to 1) commodity price inflation; and 2) the decision to build up stock levels of certain third-party products ahead of price increases. The retirement benefit surplus increased from £5.2m at end FY17 to £10.1m at end FY18. The group no longer makes deficit reduction contributions since the pension scheme was fully funded at the last full actuarial valuation.

We have revised our estimates to reflect:

These changes are summarised in Exhibit 2. We also present FY21 estimates for the first time.

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. Following the small upwards revision to our estimates, this gives a fair value of 182p/share (previously 178p/share).

In Exhibit 4 we compare Carr’s EV/EBITDA and P/E multiples for the years ended August 2019 and August 2020 with calendarised multiples for listed peers in the agricultural sector. At the current share price (156p), on our estimates Carr’s is trading below its peers with regards to all mean EV/EBITDA (10.5x vs 8.3x) and P/E (10.2x vs 13.2x) multiples for the year ending August 2019. The discount to the average peer multiples should close as feed block demand continues to recover in the US and there is further confirmation of sustained recovery in the Engineering division. At the indicative value of 182p/share derived from our DCF calculation, Carr’s implied EV/EBITDA multiple for the year ending August 2019 is slightly below the peer group average (7.6x vs 8.3x), as is the P/E multiple (11.9x vs 13.2x).