Motley fool AGT produces and exports pulses, staple foods, and food ingredients worldwide.
Why Buy:
- It owns and operates a global logistics network for pulse shipments that is virtually irreplicable.
- Growing demand for pulses from the developing and developed world supports the network.
- Significant inside ownership aligns interests of management and shareholders.
Relative to a lot of companies that are worth less than $1 billion, AGT Food and Ingredients (TSX:AGT) does a lot. To tie its business into one sentence, we could say that the company is among the world’s largest value-added producers and splitters of pulse crops and an international producer, processor, and exporter of staple food products to over 120 countries.
Now, there’s a lot behind that sentence. Let’s start with what exactly is meant by a pulse crop. (For those of you that live in the Prairies, or have an agricultural background, feel free to skip ahead, as this may be rudimentary.)
Pulse crops include peas, beans, lentils, and chickpeas, all of which produce edible seeds called pulses. Pulses represent a major source of protein and fibre and underlie a market valued at more than US$100 billion annually at the retail level. While much of the demand stems from the developing world, where pulses are relied on to meet growing energy and protein requirements, the developed world is beginning to catch on to the nutritional benefits as well.
AGT’s legacy business, which continues to be the company’s backbone, is to source these products from an origination network that spans the globe and includes thousands of local growers—many that are located in the Canadian Prairies—and move this product through to its supplier and customer network. Value-added processing and packaging occurs in between at one of the company’s 47 owned facilities which are located in Canada, the U.S., Turkey, Australia, China, and South Africa. It’s a truly global operation, which brings about a collection of benefits to be discussed below.
This global network accounts for the company’s Pulse and Grain Processing division and contributed about 58% of 2016 revenues. Clearly, it’s important and is likely to always serve as the company’s foundation. However, there are two other divisions within AGT that are being built on this foundation, and these, in our opinion, are where the real potential in this company reside.
You see, processing pulses is a very high fixed-cost business, and on a standalone basis, it isn’t overly profitable. The spread between what you pay the farmer and what you receive from your end customer is rather slim, as illustrated by a net margin of 5.2% from this division in 2016.
In recent years, AGT has made several moves to address this issue:
- The company has added a Bulk Hauling and Distribution division to leverage its logistics networks with products not sourced by AGT. This division was bolstered in 2015 by the acquisition of two rail lines, Last Mountain Railway and Big Sky Rail, creating one of the largest Class 3 railways in Canada that includes about 650 km of track in Saskatchewan. The idea is that these gathering assets will ramp up utilization across AGT’s entire system.
- AGT has added a Food Ingredients and Packaged Food division. Anchored by its Minot Facility in North Dakota, AGT has rapidly grown into the business of utilizing its raw products and transforming them into proteins, flours, fibres, and starches to be used in human food, pet food, and aquaculture. From one operating production line when the plant was completed in June 2013, the fourth production line at this facility will begin operating in the coming months.
Unique Assets: An Investor’s Best Friend
From its farming relationships to an ability to move product from the Canadian west around the world, and now to a more processed offering, this collection is nothing if it’s not unique. In an industry that’s mainly filled with small regional players that offer a limited number of products in few geographies, AGT stands out.
Where these small players run into issues is that the supply and demand variables that swirl around these various pulse crops are incredibly unpredictable. On one side of the equation, you have things like weather and disease to consider as well as crop size in other parts of the world. On the other, while demand is increasing across the globe, it’s critical that a company has as many channels as possible through which to deliver its product or risk being stuck with it. That AGT can source product just as easily from Canada or Australia, for instance, and deliver to 120 countries from either is a true competitive advantage.
That it’s tacked on assets to better leverage this global reach through bulk handling and distribution and increased margins through food ingredients adds to its uniqueness.
Opportunity Is Knocking, Finally
You can see from the chart above that AGT’s stock has had a rather tough go of late. Mentioned above was the fact that in the short term, variables that surround AGT are highly unpredictable, yet have a constant impact on the company. For that matter, the same can be said for every other agricultural entity that I can think of. It’s simply the nature of the beast. Longer term, however, these variables tend to even out, and the bottom line is, we humans have to eat.
For whatever reason, the market tends not to focus on this “us having to eat” dynamic and isfocused on the collection of unpredictable variables. These variables have been the root cause of a couple “weak” quarters for AGT. When I say that, I mean “weak” in the eyes of the sell-side analysts that try to corner this company by predicting quarterly earnings that simply aren’t predictable. Why on earth anyone thinks they can forecast what pulse imports into India are going to be, for instance, in any given window of time is entirely beyond my comprehension.
However, the winds of short-termism are working to our advantage. This is a company I’ve been eyeing since the inception of Stock Advisor Canada (and have owned personally for longer than that).
Stepping above the quarterly noise that will inevitably impact the Pulse and Grain Processing division, there is great potential in the assets that have been tacked on in recent years. And these assets have been all but ignored at current levels, in our opinion.
The railroads mentioned were just added in 2015, and the integration of this gathering system in Saskatchewan is still getting its legs underneath it. As the integration progresses, and this division really begins loading more product through AGT’s channels, the operating leverage could be significant. After all, logic indicates it costs roughly the same to run one tonne of material through the system as it does one million tonnes. Higher utilization should improve margins across the company.
Adding to this is the Food Ingredient division, which sports higher margins than the rest of the business on its own. With a fourth production line ramping up, demand for the Minot Facility’s output has been insatiable from the get-go. While there’s more room to go on that front, it’s reasonable to believe the company is considering other facilities like this elsewhere across its footprint. As this division carries more weight across the entire company, it too should add to overall margins.
Juggling the mix through all of this is the company’s founder and CEO, Murad Al-Katib. Al-Katib is not that old and seemingly has plenty of gas in the tank to continue to oversee the company’s evolution. And we love that he’s the largest shareholder with a 16% stake in AGT.
Potential Risks
As mentioned, I’ve followed this company for a number of years, and while it faces a bevy of transient risks (weather, crop size, crop prices, currency, and even political events that impact trade) on an almost daily basis, the thing that really knocked the stuffing out of it several years back was when global credit markets seized up. Credit greases the wheels of global trade, and when it’s not available, moving goods around the world becomes incredibly difficult. The problem with this is that a seize on this front is entirely unforeseeable and therefore virtually impossible to quantify. Credit does not often freeze, but it’s a variable that should be kept front and centre with AGT.
Taking a Stab at Valuation
To be clear, because numbers can move around so much in the short term, AGT is a slippery one to value—more so than most.
That said, here’s where we wash out. The potential for margin expansion thanks to the various initiatives within the company was mentioned. This, Fools, is where the home run potential in AGT lies. When you’re dealing with a company that has annual revenues in excess of $2 billion, yet a market capitalization that’s now less than $600 million, a couple hundred basis points in margin improvement can be rather significant.
Just to provide some indication, expected revenues in 2018 are about $2.4 billion. Net income margin in 2016 was 1.1%. As a stretch, let’s assume that gets to 2% by 2018. Based on current shares outstanding, this equates to $1.98 in earnings per share. Over the past five years, AGT has traded at a trailing earnings multiple in the mid-30s. Heck, forget mid-30s. Apply a multiple anywhere north of 20 to that potential earnings figure, and you’re looking at a pretty decent return in just a few years. And as the network continues to grow and revenue climbs, it should coincide with a very nice trajectory for the stock.
Foolish Bottom Line
The only other example of a unique logistical network like this in the Canadian market that comes to mind are the two railroads—CN and CP. Given AGT’s collection of assets, and its orientation to something that every human needs—food—this is a company that, in my opinion, you can sit on for the next decade with the potential to be absolutely shocked by the return it may generate, if it even exists in 10 years. It would not surprise in the least if a bigger food-oriented concern (along the lines of Glencore AG or even Cargill) were to write a cheque and tuck this unique collection under its wing at some point.
Regardless of the outcome, this is a company that warrants confidence, even though the market currently has none. It’s a small cap to be sure, and one that has the potential for volatility, but we foresee a bountiful harvest ahead for any allocation made at current levels.
Disclosure: Iain Butler owns shares of AGT Food and Ingredients. David Gardner owns shares of CN Rail. The Motley Fool owns shares in CN Rail.