Ag Growth International Inc T.AFN.DB.J

Scotia Analysis - $55.00

[SunsetGrill]

Agriculture

Ag Growth International Inc.

• AFN-T: C$34.53
• Target: C$55.00
  Old: C$52.00
• Rating: Sector Outperform

It's all Coming Together

OUR TAKE: Positive. After deploying growth capital of ~$550 million (organic + M&A) over the last five years (or >$900 million since 2015), EBITDA and financial returns are inflecting as Brazil, India, and the U.S., in particular, scale. That success is reflected by the increase in the company’s 2022 EBITDA guidance of “at least $215 million” from “at least $200 million”. This growth has been funded primarily with debt. The one ‘weak point’ to the AFN story has been its FCF as growth has consumed capital. While organic growth is expected to remain healthy through the 2H (and into 2023), internal initiatives to drive efficiencies in working capital (and maximize throughput), should help the company generate FCF of >$150 million (or >$7.50/share; +20% yield) in the 2H.

A focus on integration, efficiencies, and organic growth (i.e. much less M&A than before) will help balance organic growth and FCF generation going forward. In effect, we believe AFN can consistently generate FCF of >$90 million (>$4.50/share; 12%) and mid-single to low double-digit top line growth each year. While still a “show me” story, we believe its nearing transition to a higher FCF generator will trigger multiple expansion (and material upside).

KEY POINTS

AFN reported 2Q sales and adjusted EBITDA of $390 million and $66.1 million versus consensus of $358 million and $57.1 million. On a consolidated basis, sales and EBITDA grew 29% and 43% compared with last year. EBITDA margins came in at 16.9%, reflecting a 160bp increase compared with last year. Margin expansion was driven primarily by higher operating leverage and internal initiatives in its Commercial segment. The company highlighted revenue growth in each of its end-markets and geographic regions.

AFN raised its 2022 adjusted EBITDA guidance to “at least $215 million” (from >$200 million) as execution has been solid to date and orders/backlog have provided further confidence in the anticipated performance in the 2H22. The share price increase of ~8% following the results essentially reflect the increase in the guidance. AFN trades at 7.4x EV/EBITDA on our 2023E, near its lowest level in over a decade and ~20% below its historical average. On the call, management noted that they believe the growth achieved to date, and going forward, is structural based on recent investments (e.g. Brazil, Digital, U.S. Farm) rather than cyclical tailwinds – and as such, anticipates continued positive momentum into 2023.

2Q FCF was -$12 million, driven by a $44 million drag from working capital. On the conference call, management indicated that they believed they could drive efficiencies that will reverse working capital investment YTD of $125 million, despite generating higher sales. Net debt to EBITDA was 4.9x as at 2Q; we expect a material decline to 4.0x by the end of the year.

• 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
2021A	$39	$46	$46	$45	$176	8.1x
2022E	$41	$66	$65	$47	$219	6.8x
2023E	$41	$69	$67	$49	$226	6.2x

AFN reported sales and adjusted EBITDA of $390 million and $66.1 million versus consensus of $358 million and $57.1 million (see Exhibit 1). On a consolidated basis, sales and EBITDA grew 29% and 43% compared with last year. EBITDA margins came in at 16.9%, reflecting a 160bp increase compared with last year.

The company raised its 2022 outlook for consolidated adjusted EBITDA guidance to “at least $215 million” (from >$200 million) with growth weighted towards 3Q. The backlog was up 19% y/y at near record levels and towards the high end of its typical four to six month range. Further, with significant quoting activity across many regions and a strong pipeline with climbing win rates, management expects the momentum to continue into 2023. Management also reiterated its expectations to improve margins by 100bp to 200bp over next 18 to 24 months back to historical levels.

On the call, management noted that they believe the growth achieved to date, and going forward, is structural based on recent investments in organic and strategic projects (e.g. Brazil, Digital, U.S. Farm) rather than cyclical tailwinds. The company has sufficient capacity to take on the growth without requiring substantial capex investments (at least through 2023).

Exhibit 1 - 2Q22 Results

Source: Company reports; FactSet; Scotiabank GBM estimates.

From a segment perspective:

• Farm sales (55% of consolidated sales) rose 28% driven by strong growth in all regions, including International (+127%), the U.S. (+25%), and Canada (+11%), which rebounded from 1Q22 and 2021 as the effects of a drought began to dissipate. By product line, demand for portable farm equipment continues to be very robust. Farm EBITDA (margin) was $52.4 million (24%), reflecting a 23% increase.
• Commercial sales (42%) increased 31%, once again, with strength across the board, with a sizable rebound in Canada (+112%), and strength in the U.S. (+39%) and International (11%). In EMEA, sales growth was flat as the loss of sales in Russia and Ukraine was offset by other opportunities in the region. Brazil continues to grow significantly with sales up 80% y/y, while the backlog was up 91% and the sales pipeline remains at record levels (the company still has some excess capacity). Commercial EBITDA (margin) was $23.8 million (15%), reflecting a >100% improvement.
• AGI Digital EBITDA was -$1.1 million versus -$1.9 million last year. The segment befitted from increased sales/backlog, but continues to face supply chain challenges.
• Other EBITDA was -$9.0 million, versus -$6.3 million last year.

Net debt to EBITDA was ~4.9x as at the end of 2Q22 (from 5.0x in 1Q). The company expects 1H working capital investments to fully reverse through the balance of the year. AFN did not provide an update relating to the bin incident, which we believe has been fully provisioned for and will be resolved in 2022.

Exhibit 2 - Room for Multiple Expansion as FCF Generation Ramps

Source: Company reports; FactSet; Scotiabank GBM estimates for AFN.

Exhibit 3 - Financial Forecast (in C$ million, unless noted otherwise)

Source: Company reports; Scotiabank GBM estimates.

Company Overview

Company Description

AGI is a leading shortline agricultural equipment manufacturer. The company is a provider of the physical equipment and digital technology solutions required to support global food infrastructure including grain, fertilizer, seed, feed, and food processing systems. AGI has manufacturing facilities in Canada, the United States, Brazil, India, France, and Italy and distributes its product globally. In 2021, 44% of sales were based in the United States, 22% in Canada, and 33% in the rest of the world.

Investment Thesis

The setup for AFN may be as good has it has been for a while. The shares trade at near its 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. 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 and ROIC, accelerating the prospects for delevering and, therefore, aiding the shares to re-rate higher.

Key Risks

Farm economics, crop and trade flows, weather, FX (US$), steel prices, competition