In eighth grade, I had a teacher who used to assert her power with the over-enforcement of rules. Her behavior was bully-like. By the middle of the year, I had enough with her haughty antics.
It was Friday-pajama-day and everybody was in a great Friday-pajama-day mood. However, this teacher yelled at a group of girls for wearing nighttime slippers, which was against the dress code. One girl seemed like she was on the verge of tears. Nobody deserves to cry on Friday-pajama-day!
I went against my rule-following nature, walked across the room, and called the teacher out. I said something to the tune of: “They are wearing slippers because it’s Friday-pajama-day, give them a break. There’s no reason to be a jerk.” The teacher was shocked. I turned around and walked back to my seat.
Afterwards, I figured it’s okay to break the rules if you have conviction in doing what’s right.
From an investment perspective, good investors follow their philosophies, but great investors know when to break their own rules.
Ag Growth International is a Warrior Stock with some qualities I am apt to fade in the current macroeconomic climate.
Ag Growth International (AFN)
Key Financials in USD (as of 7/20/2022)
- Market Cap: $466.1 mm
- Enterprise Value: $2,435.9 mm
- EV/NTM EBITDA: 7.26x
- Forward P/E: 10.44x
- Current Stock Price: $24.69
Overview
Founded in 1996, Ag Growth International (the “Company” or “AGI”) is a Canadian based leading supplier of products that surround grain, fertilizer, feed, seed, and food processing. In addition, AGI provides technology solutions for farmers, grain buyers, and agricultural retailers. Some of AGI’s products include on-farm storage bins, aeration structures, and farming software.
The Company is building around a 5-6-7 strategy: five platforms (grain, fertilizer, feed, seed, and food processing) in six continents (North America, South America, Europe, Africa, Asia, and Australia) through seven product components (storage, structures, processing, handling, technology, engineering, and project management). Grain is AGI’s core platform, and the majority of the Company’s sales come from the United States and Canada with opportunities for growth domestically and abroad.
The Company’s additional platforms, global presence, and ecosystem of goods and services developed through product, company, and facility acquisitions. Between 2016-2020, the Company deployed $240 mm in capital expenditures and $400 mm in M&A.
AGI’s acquisition growth based strategy falls in line with the CEO’s background. Tim Close, AGI’s CEO since 2016, has a Chartered Financial Analyst Certification (CFA) and background in ag-business, capital raising, and M&A.
Competition
The agriculture machinery industry is highly competitive and there are companies that are larger than Ag Growth like the Agricultural Machinery Company (AGCO). Unlike AGI, AGCO is not as focused on the grain storage business; it only represents 10% of its sales.
Brock is an On-Farm Grain Storage company that is a subsidiary of CTB Inc., which is owned by Berkshire Hathaway (BRK.A). Warren Buffet acquired CTB Inc. in 2002. Brock and AGI sell similar products such as grain storage systems, handling equipment, and feed bins.
There are other smaller non-public companies like Sioux Steel and GSI. In addition, there are companies around the world that compete with AGI for market share in their respective markets.
Broken Rules
Like I said earlier, there are times when you can break the rules, but you also need conviction.
High Leverage
In the current economic climate, higher interest rates mean debt is going to cost more. If a company has lots of debt, then it will take a larger-than-projected hit on its net income. This environment can make risky assets like small cap stocks with high leverage riskier.
To fund AGI’s expansion, the company increased its long term debt over the past five years and possesses a Net Debt/EBITDA ratio of 7.7x, which is high.
P/E Alarm Bell
As a value oriented investor, AGI’s LTM P/E of 54x has my internal intercom system blaring: “This stock is overvalued!” But again, we need to take a step back, look at the whole picture, and ask why.
Ag Growth’s expansion has been largely driven by inorganic methods instead of pure bottom line growth, and the stock is priced like a growth stock on a P/E basis. Based on comments by management, FY22 EBITDA is expected to be at least $200 mm driven by a strong backlog and favorable margins, which would be a ~70% year-over-year improvement. The increase should be reflected in significant EPS growth and P/E multiple compression. FY21 diluted EPS was $0.50, which leads to the immense LTM P/E. If FY22 diluted EPS ends up conservatively at $2.50, then LTM P/E will drop to around 10x (based on a share price of $24.69).
From an LTM EV/EBITDA perspective, the Company is trading at 12x, which is more favorable from a value investor perspective compared to a 54x LTM P/E.
Catalysts
Ag Growth International’s next phase will be to switch roles from buyer to grower. The War in Ukraine showed the world that we need to improve our global food infrastructure. Through acquisitions, the Company placed itself in the best position possible to benefit from a global need for better food security.
AGI planted all the seeds and now it is time to reap the harvest: free cash flow (FCF). According to Scotia Bank, the top priority by the end of 2022 of the management team is to reach a Net Debt/EBITDA ratio of 4.0x by paying down debt with FCF. Ag Growth’s strong backlog and projected EBITDA makes this goal feasible. This would decrease the Company’s interest expense and buoy net income.
At the end of Q1, the Company made a significant increase in steel inventory to ensure fulfillment of backlogged orders. Margins in the second half of 2022 should improve from decreased lead times on steel prices and eased supply chains.
Market share wise, Ag Growth seeks to improve its United States presence through its expanded sales team and dealer network. In addition, the Company should benefit from expansion in Brazil, India, and Southeast Asia.
In a time of rising interest rates, it can be risky to make a bet on a deleveraging story. However, debt repayment, accelerated FCF growth, and a forward EV/EBITDA (7x) breeds an environment for earnings surprises from better-than-expected demand, which could be beneficial to shareholders. If Ag Growth International can wrangle in its debt and grow organically over the next few years, it could become a very strong, durable, and important company for the future.
Continue the Research
Although this company is not easily tradable since it is a small cap Canadian stock, it does not mean that you should stop the research. Earnings come out 8/10/2022, which will give us an opportunity to have a better picture of Ag Growth’s health. We want to see if the Company has or will generate accelerated FCF, pay down debt, and grow organically.
Moreover, looking at Ag Growth International could lead you to other interesting companies in Ag or a completely different industry.
I stumbled into AGI because I was looking at a tire company that makes customizable wheels and tires for agriculture and off-road vehicles.
You never know where your research will take you.
If you have more questions or want to talk all things AFN, do not hesitate to reach out on twitter, instagram, or shoot me a text.
Employ your curiosity.
-Maximus Beach
Learn more about Maximus Beach’s background here.
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