Ag Growth International Inc T.AFN

Complete Scotia Upgrade Report/Analysis

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Agriculture

Ag Growth International Inc.

• AFN-T: C$35.72
• Target: C$45.00
  Old: C$39.00
• Rating: Sector Outperform
  Old: Sector Perform

Time to Harvest; Upgrading to SO

OUR TAKE: Positive. The setup for AFN may be as good has it has been for a while. The shares trade at the lowest EV/NTM EBITDA multiple in more than a decade. Strong growth prospects and moderating steel prices (~30% of COGS in 2020) should boost profits and cash flows into 2022. We think its leverage has peaked. And its margins are likely to improve from its 3Q21 low-point. Further, with one of the bin projects remediated, we see little incremental risk of negative surprises and believe AFN will look to fully resolve the issue in 2022. The wind-down of the bin incident and wind-up of profits should enhance FCF (~15% yield) and ROIC, accelerating the prospects for delevering and, therefore, aiding the shares to re-rate higher.

We are raising our target and upgrading the shares of AFN to Sector Outperform.

KEY POINTS

Time to decompress. AFN shares lagged those of other ag equipment companies in 2021. Today, at 7.5x EV/EBITDA on our 2022E, AFN shares are trading at their lowest level in over a decade. Last year, higher steel inputs, a cash drag from WC, and the bin incident collectively weighed on margins, cash flows, and its trading multiple. As these headwinds reverse (or are resolved), we expect profits, cash flows, and its multiple to expand. Our valuation multiple of 8.5x on our 2023E is below AFN’s historical average of 9.0x and our 2023E is conservatively below consensus – despite that, our target implies significant upside.

Profit growth set to accelerate. Through 2021, AFN’s backlog expanded in size (+100% y/y as at 3Q21) and duration, providing enhanced visibility into accelerating profit growth into 1H22. While we expect backlog and sales growth to moderate through 2H22, we expect margins to improve as the company recaptures its price/cost spread on steel, supply chain bottlenecks ease, and as profits grow in Brazil, India, and the U.S. Longer-term, management is targeting EBITDA margin expansion of >200bp (on the 2021 base). We expect margins to begin to improve toward the historical range in 2H22 (and beyond).

FCF inflection, a major catalyst. In the last several years, AGI made significant investments to expand its footprint, but the associated profit growth lagged (due to politics, weather, COVID-19, etc.) compressing its return metrics. We now think its FCF (and ROIC) is poised to ramp. We think higher steel prices and cash payments for the bin remediation only deferred the FCF inflection into 2022/23. Excluding the remaining remediation payments, we forecast FCF of ~$100 million in each of 2022E and 2023E (>$5/share), which translates to a 15% FCF yield. A combination of expanding EBITDA and FCF should accelerate the deleveraging process, reducing net debt to EBITDA to 4.4x by the end of 2022 (from 5.3x in 3Q21).

• Quarterly Financials
• Yearly Financials

Historical price multiple calculations use FYE prices. All values in C$ unless otherwise indicated.
Source: FactSet; company reports; Scotiabank GBM estimates.

Note: The payout ratio is calculated based on dividend as a percentage of FFOPS.

Qtly Adj EBITDA (M)	Q1	Q2	Q3	Q4	Year	EV/Adj. EBITDA
2020A	$26	$44	$52	$28	$149	9.0x
2021E	$39A	$46A	$46A	$41	$173	8.5x
2022E	$44	$55	$57	$41	$198	7.7x
2023E	$47	$54	$60	$48	$209	6.9x

AFN shares underperformed relative to peers in 2021. Higher steel inputs weighed on margins and cash generation. Also, the bin incident diverted cash and investor sentiment. With sales growth expected to accelerate as steel prices retreat, margin expansion and cash flow conversion prospects look good. AFN shares are trading at their lowest multiple in more than a decade – and the prospects for debt repayment and a normalization of the trading multiple underscore significant upside potential in the shares (see Exhibit 1).

• While business fundamentals have strengthened since September 2020, the bin incident has led to successive negative surprises: AGI increased its estimated remediation costs twice and, incrementally, two companies (Fibreco and AGT) filed legal claims for a total of $180 million. At this stage, based on the completed remediation at the Fraser Grain Terminal project, our learnings, and our conversations with management, we are confident that the amount provisioned captures a large extent of the liability.

 

Exhibit 1 - Trading at Lowest Level in More Than a Decade

Source: Company reports; FactSet; Scotiabank GBM estimates.

Exhibit 2 - FCF Inflection Expected in Near Term

We forecast $40 million in provisions paid in 2022.

Source: Company reports; Scotiabank GBM estimates.

Underlying fundamentals remain robust. As at 3Q21, AGI’s backlog stood nearly 100% higher than last year. While the company does not disclose the dollar amount of its backlog, its increase and extended duration should provide added visibility into strong earnings growth in the 1H22. As at 3Q21, AGI’s Farm backlog increased 200% versus the prior year as dealer inventories remain low due to a strong crop yield in the U.S. and Brazil. The combination of a strong backdrop and market share gains should continue to power sales in Farm into 2022 and beyond. According to the USDA, net farm income is forecast to decrease by $5.4 billion (4.5%) in 2022 relative to 2021 but still to come in above the historical average – and higher yet if crop prices continue to strengthen. We expect Canada Farm to be somewhat softer given drought conditions in the Prairies in 2021. AGI’s Commercial backlog increased 80% versus last year. We are particularly bullish on the near-term and long-term growth prospects in Brazil and India. In terms of downside risks, we highlight that the company’s sales to Russia/Ukraine market represents between 2% and 3% of its consolidated sales.

 

Accelerating profit growth momentum. AGI’s 2021 EBITDA guidance is for >$170 million, reflecting growth of >14 %. The growth was achieved despite the company incurring consulting charges ($5 million), losses in Farm Mobile ($5 million), margin compression from higher steel prices (we estimate $5 million), and a stronger Canadian dollar (~$10 million). The easing, non-recurrence, or reversal of these headwinds combined with the contributions from Eastern Fabricators underscores the potential for EBITDA to exceed our and consensus expectations (see Exhibit 3). AGI is targeting EBITDA margin improvement of 100bp to 200bp over the next several years as cost inflation subsides and as its newer businesses mature (i.e. Brazil, India, Global Industries, etc.). EBITDA margins averaged 16.7% between 2015 and 2017; we expect margins return towards those levels over the next several years (see Exhibit 4).

 

Exhibit 3 - More than Enough Drivers to Meet 2022E Consensus

Source: Company reports; FactSet; Scotiabank GBM estimates.

Exhibit 4 - Margins to Improve from Low Point

Source: Company reports; Scotiabank GBM estimates.

FCF and ROIC inflection…around the corner. In the last several years, AGI has made significant investments to expand its geographic and product footprint. Since 2016, AGI’s invested capital increased approximately $500 million, primarily reflecting its expansion in Brazil, India, and the U.S. The associated profit growth lagged – in part due to changing crop/trading flows (i.e., in 2019), poor weather conditions (in 2019), COVID-19 (in 2020), and higher steel prices (in 2021). However, at this point, we believe its Brazil expansion, Global Industries, Miltec (India), and Technology appear to be at an inflection point and expect higher profits and enhanced working capital efficiencies to drive strong incremental ROIC through 2023 (see Exhibits 5 and 6).

• We forecast FCF, before provisions paid, of approximately $100 million in 2022 and 2023, which translates into a FCF yield of ~15% (see Exhibit 2). We expect the company to repay approximately $40 million in provisions related to the bin incident in 2022 (as well as any potential settlement).
• As at 3Q21, the company had net debt of approximately $840 million. We expect leverage to decline from 5.3x in 3Q21 to 4.4x at the end of 2022 (see Exhibit 8).

 

Exhibit 5 - ROIC Set to Rise...

Source: Company reports; Scotiabank GBM estimates.

Exhibit 6 - ...as Profits Ramp from Recent Investments

Source: Company reports; Scotiabank GBM estimates.

Exhibit 7 - Cash Conversion Improving...

Source: Company reports; Scotiabank GBM estimates.

Exhibit 8 - ...Helping Delever Balance Sheet

Source: Company reports; Scotiabank GBM estimates.

Exhibit 9 - Financial Forecasts (in C$ millions, unless noted otherwise)

Source: Company reports; Scotiabank GBM estimates.

Exhibit 10 - Public Comparables

Source: Company reports; FactSet; Scotiabank GBM estimates for Ag Growth International Inc. For companies with FYE other than Dec. 31, we have included their results in the nearest calendar year.

Scenario Analysis

Agriculture

Ag Growth International Inc. (AFN-T; C$45.00; SO)

1-Year Target/Bull Case/Bear Case Scenarios

Source: FactSet; Scotiabank GBM estimates.

Bull Case (C$53.00)

2022/2023 EBITDA exceeds consensus driven by incremental EBITDA from total reversal of 2021 headwinds and better-than-expected organic growth.

9.0x EV/EBITDA on our 2023E.

Base Case/Target (C$45.00)

Reversal of majority of 2021 headwinds, moderate to strong organic growth.

8.5x EV/EBITDA on our 2023E.

Bear Case (C$30.00)

Headwinds linger, organic growth is moderate.

7.0x EV/EBITDA on our 2023E.

Investment Thesis

The setup for AFN may be as good has it has been for a while. The shares trade at the lowest EV/EBITDA multiple in more than a decade. Strong growth prospects and moderating steel prices (~30% of COGS in 2020) should boost profits and cash flows into 2022. We think its leverage has peaked. And its margins are likely to improve from its 3Q21 low-point. Further, with one of the bin projects remediated, we see little incremental risk of negative surprises and believe AFN will look to fully resolve the issue in 2022. The wind down of the bin incident and wind up of profits should enhance FCF (~15% yield) and ROIC, accelerating the prospects for delevering and, therefore, aiding the shares to re-rate higher.

Risks

Financial leverage (and covenants).

Commodity price risk.

Crop conditions and seasonality Industry and economic cyclicality.

Customer credit risk.

FX risk.

Key Drivers

Favourable macro set-up.

Receding cost inflation.

Margin normalization and acceleration.

FCF generation.

Company Description

Ag Growth International Inc. (Ag Growth) is a leading shortline agricultural equipment manufacturer. The company is headquartered in Winnipeg, Manitoba (employs over 3,800 people), and has 34 production facilities based in Western Canada, the United States, and, more recently, in Italy, Brazil, France, and India. Ag Growth specializes in the production of portable grain handling, stationary grain handling, and storage and condition equipment, which serve individual farms, corporate farms, and commercial (grain handling and processors) customers. Its agricultural equipment is used broadly across the supply chain, including in/for on-farm production usage, transportation infrastructure, and agricultural processing facilities. In 2018, 41% of sales were based in the United States, 35% in Canada, and 24% in the rest of the world.

Stock Catalysts and Timing

Further clarity or resolution of grain bin incident.

Deleveraging.

Re-rate in line with historicals.

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