Ag Growth International Inc T.AFN.DB.J

Scotia ups to 88 from 83

[SunsetGrill]

• AFN-T: C$57.76
• Target: C$88.00
  Old: C$83.00
• Rating: Sector Outperform

Gears in Motion

OUR TAKE: Positive. First and foremost, AFN is a story of enhanced execution. Previously a loose combination of acquired businesses, in the last couple of years, management has integrated functions, improved manufacturing efficiencies, and coordinated an organic push across its geographies. The outcome of this heavy lift has been much higher profitability. There is still more to do — and more to gain, in our view.

In 2023, EBITDA margins stepped up sizably and, in our view, will stabilize (or build higher) as revenue growth re-accelerates. The bulk of the re-acceleration is being driven by (i) company-specific initiatives and (ii) secular dynamics in International. To us, the 2024 EBITDA guide should clear the deck in terms of investor concerns that profits may moderate in 2024 as the ag cycle softens. Instead, we believe investors should view AFN has having reached a tipping point, where margin improvement, higher FCF, and lower leverage free up capital to pursue market-beating growth — such that AFN can become a double-digit organic compounder. Contrasting that view with its discounted trading multiple (~6.5x EV/EBITDA on our 2024E; 30% discount to historicals) highlights the upside opportunity in the shares.

KEY POINTS

AFN is guiding for 2024 EBITDA of >$310 million (i.e. >5%). Management provided additional details: expectations are that (i) 2H EBITDA growth will be more pronounced (growth still expected in 1H24), (ii) EBITDA margins will be sustained near 19% as continued operational improvements are offset by unfavourable mix, and (iii) farm/commercial mix change more so in the 2H24 as commercial sales ramp. The company’s expectations that margins will remain flattish in 2024 feels somewhat conservative to us — that being said, we believe the potential upside to the 2024 guidance is skewed more heavily to revenue growth. AFN has three growth initiatives that should boost sales: (i) product transfers, (ii) geographic expansion, and (iii) growth platforms. In February, it disclosed that its product transfers (alone) were expected to contribute >3.5% to organic growth. We believe geographic expansion and growth platforms can each contribute a similar amount in 2024, such that we believe growth can exceed double-digits in 2024. As a note, management’s initial guidance tends to lean conservative; in 2023, AFN guided for 2023 EBITDA growth of >13% and instead it grew 25%.

Net debt leverage was 2.8x as at the end of 2023 (from 5.0x in 2021). As leverage approaches its target of 2.5x, AFN plans to ramp up its capex to pursue high-return growth investments. Capex is expected to ramp progressively through 2024 and into 2025 as AFN deploys capital to debottleneck manufacturing capacity in certain facilities and also expand its India footprint to sustain growth momentum in the region. Management reiterated its $2 billion revenue target to be achieved in the next two to three years (implying a revenue CAGR of >9%).

• 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
2022A	$41	$66	$76	$51	$235	7.4x
2023A	$48	$88	$85	$73	$294	6.2x
2024E	$54	$91	$91	$78	$313	5.8x
2025E	$59	$95	$98	$86	$337	5.1x

4Q23 sales/EBITDA came in at $379.3 million/$73.1 million, compared with consensus of $413.4 million/$72.5 million. On a consolidated basis, sales grew 1% (assuming constant steel prices, sales would have increased ~5%). EBITDA increased 43% as margins expanded 570bp. Management attributes the higher margin performance to the “new era of performance and profitability”. Management noted that operational excellence initiatives delivered ahead of expectations in 2023 as revenue management, enhanced product quality, and improved supply chain management resulted in >200bp of structural margin expansion in 2023.

• Farm sales/EBITDA increased 4%/44%. The increase in sales was driven by strong demand in the U.S. Farm EBITDA margins of 24.7% increased 680bp driven primarily by favourable mix, manufacturing efficiency initiatives, and digital reorganization completed throughout 2023.
• Commercial sales decreased 1% while EBITDA increased 17%. Sales were negatively impacted by tough comps in Canada. Sales in India were particularly strong. EBITDA margins of 18.8% expanded 295bp due to operational excellence initiatives implemented.
• By region, sales increased 10% and 2% in the U.S. and International, offset by 13% lower sales in Canada.

Exhibit 1 - Softer Sales More than Offset by Higher Margins

Source: Company reports; FactSet; Scotiabank GBM estimates.

4Q23 adj. EBITDA of $73 million included $11 million of “Transaction, Transitional, and Other” costs and $14 million of “ERP transformation” costs. On the former, the costs include the final digital restructuring costs and the legal costs to defend its patents; costs should subside into 2024 and will be limited to legal costs and smaller restructuring costs. In terms of the ERP, as noted at its investor day, the company is implementing a single ERP solution across its platform. Traditionally such costs would have been capitalized (but cannot be due to accounting considerations). Total ERP costs are expected to be between $45 million and $55 million over the next three to four years and are expected to deliver significant benefits.

The company’s order book increased 25% to $747.3 million and provides five to seven months of visibility (from the more normal four to six months). Due to the project-based nature of what is booked in backlog, the majority of the backlog reflects Commercial orders.

Net debt to EBITDA declined to 2.8x as at the end of 4Q (vs. 3.2x as at 3Q23). The company expects to reduce net debt leverage to ~2.5x or below in 2024. Management noted that it is exploring options to expand capacity in India, North America, and Brazil. The company recently acquired land for future expansion in India, and it is currently in the planning phase with final approvals expected in 2024 to support groundbreaking in 2025. M&A is expected to gather pace towards the end of 2024, and in 2025.

 

For 2024, management guided to adj. EBITDA of “at least $310 million”. Given its strengthening Commercial order book and the expected timing of such orders, the company expects a gradual ramp-up in EBITDA through 2024. For the year, EBITDA margins are expected to be in the 19% range, with benefits of the operational excellence initiatives offset by unfavourable mix toward Commercial (i.e., Farm has higher margins). Management also provided the following disclosures:

• Management is planning spend of $70 million to $90 million on capex and ERP in 2024. As ERP costs (~$15 million) will flow through opex, capex should be in the range of $55 million to $75 million.
• Due to the anticipated mix shift towards Commercial sales, the company expects higher working capital investment in 2024, as Commercial sales tend to be more working capital intensive.
• Management expects Farm and Commercial mix to be largely unchanged in the 1H24, but then skew toward Commercial in 2H24. For U.S. Farm, the company expects dealer replenishment cycles to provide sales momentum in 2Q24. In the EMEA region, the company continues to secure long-term project work from emerging markets such as Africa and Middle East.
• The company continues to progress its product transfer initiatives. In February, it announced orders of ~$55 million, meaning it will contribute sales growth of >3.5% in 2024 (likely more as orders build). Management expects product transfer sales to ramp in the 2H24. The company also plans to initiate new product transfers through the year and build additional momentum into 2025 and 2026.
• International growth is expected to continue to outpace growth in North America. In 2023, sales in International was $500 million — or about 34% of consolidated sales. In the medium term, management expects International sales to contribute 40% to 45% of sales. Emerging markets such as Africa and Southeast Asia are expected to be incremental to growth of the international business, providing diversification benefits.
• Finally, its emerging platforms such as Digital, Food, and Feed are expected to benefit from the restructuring and growth initiatives in 2023. Digital is expected to expand market share within and outside the U.S. market, having recorded positive adjusted EBITDA in 2023, while the Food platform is expected to rebound strongly in 2024.

 

Exhibit 2 - Multiple Compressed, Despite Growth Potential

Source: Company reports; FactSet; Scotiabank GBM estimates.

 

Exhibit 3 - Financial Forecasts (in CAD million, unless noted otherwise)

Source: Company reports; Scotiabank GBM estimates.