Carr’s Group — Update 19 December 2016

Carr’s group serves two diverse sectors: agriculture and engineering. The Agriculture division is increasingly focused on proprietary products developed to improve livestock performance and thus farmers’ profitability. The Engineering division’s portfolio includes highly specialised equipment used in operating and decommissioning nuclear power stations worldwide.

The group operates in relatively defensive markets. Demand for agricultural outputs worldwide is being driven by a rising global population, a switch to Westernised diets in the developing world and the adoption of bio-fuels. Demand for products and services from the Engineering division is primarily related to investment in the global nuclear industry and benefits from the increased concern of employers to remove personnel from hazardous environments. While participating in the beneficial impact of these macro-trends, management’s focus on innovation and internationalisation reduces the exposure to disease and variations in weather patterns or to government farming policies from which agricultural stocks typically suffer.

Although farmgate milk prices have started to improve and there are signs of confidence returning to the UK agricultural sector, management expects it will take several months for farmers to recover from a sustained period of pressure on incomes. This is expected to have a negative impact on demand for feed supplements in the UK and on feed margins, which will more than offset growth in feed block demand in the US following expansion of the Nevada manufacturing facility. On the other hand, the Engineering division has a strong order book following a revival in contracts from the nuclear sector. This improvement in Engineering performance underpins our estimate of a 4% year-on-year increase in group-adjusted profit before tax during FY17 to £14.6m. A return to growth in Agriculture supports similar (5%) growth in both FY18 and FY19.

We adopt a sum-of-the-parts analysis for our valuation as this approach reflects the diversity of activities in which Carr’s is engaged. This arrives at a value of 161p/share (unchanged), which is similar to the 160p/share derived from our DCF (WACC of 10.0%, terminal growth rate of 1.0%).

Carr’s Group is headquartered in Carlisle, UK. Following the sale of its three flour mills at the end of August 2016, it now has two divisions – Agriculture and Engineering – as well as investments in several associates and JVs engaged primarily in agricultural-related activities. It is growing through a strategy that combines internationalisation, investment and innovation. The Agriculture division manufactures and sells high-margin feed supplements to farmers in North America, New Zealand, Mainland Europe and the UK. This international activity complements its UK agricultural activity, which is effectively a one-stop shop for farmers in Northern England, the Borders, South Wales and Scotland. It manufactures and distributes animal feed, operates a network of over 30 stores dedicated to the needs of rural dwellers and distributes fuel in rural areas. The Engineering division designs and manufactures remote handling equipment for the global nuclear industry and bespoke steel fabrications, primarily for the global oil and gas and nuclear industries. This diversification both within and outside the UK agricultural market reduces Carr’s exposure to the vagaries of the British climate, EU farming policy and volatile commodity prices.

Unlike its UK listed peers in the agricultural supply segment, NWF Group and Wynnstay, which have activities confined to the UK, Carr’s is currently active in over 30 countries. Its innovative feed blocks are manufactured in the UK, Germany and North America and sold to farmers on four continents to help them improve productivity. AminoMax is manufactured and sold in the UK and North America. The Engineering division has operations in both the UK and Germany and serves customers in Europe, Russia, the Far East, Australia, South Africa, the US and Latin America. Around half of the group’s profit is derived from international activities, primarily feed block sales.

The group has grown both organically and through a series of acquisitions, most recently that of the STABER engineering business announced in October. This transaction brings key IP used in the Engineering division in house. The acquisition of agricultural merchants Phoenix Feeds in June 2016 strengthened the group’s presence in Lancashire, while the purchase of independent agricultural wholesaler Green Agriculture in September 2015 strengthened the group’s activities in Northumberland.

Management continues to grow the business through the introduction of innovative products, rather than relying on existing product applications to drive growth. Examples of innovation are the Megastart Dry Cow mineral supplement offered by the Agriculture division and a self-propelled vehicle mounted variant of the Telbot robotic arm developed by the Engineering division for use at the vitrification plant in Karlsruhe.

Carr’s agricultural activities (which include substantially all the operations of its associates and JVs) encompass a broad range of services for farmers and other rural dwellers. Carr’s range of agricultural activities provides a level of protection against negative influences affecting one part of the agricultural sector. For example, although demand for feed blocks from UK sheep farmers was weak during H116 because of the mild winter, demand in the US from beef cattle farmers was strong as farmers continued to rebuild stock levels following a period of prolonged drought.

Within the Agriculture division, Carr’s frequently opts to form JVs with established industry partners in regions outside the UK, as this gives an accelerated market entry.

Segmental growth is primarily driven by innovative products such as feed supplement blocks. These address the requirements of more sophisticated farming practices where the calorific, protein, mineral and vitamin content of forage and feed are precisely controlled to maximise return on investment.

Carr’s branded feed blocks are formulated to include key nutrients that increase the utilisation of forage, thus maximising the economic performance of the animal. Other types improve the health of livestock. The patented production process, which was purchased from Pfizer in 1993, means that the top layer absorbs moisture from the atmosphere and is therefore removed when livestock lick it but the underlying layers are too hard to be removed. This regulates the amount of the block that can be consumed by livestock each day and thus the amount of nutrient taken up. The feed block formulation is adjusted for different animal species and specific life-stages such as pre-calving, post-calving or finishing lambs. Feed blocks are made in Cumbria, Germany and North America and sold throughout the UK, Europe, the Middle East, North America and New Zealand. Currently over 130,000 tonnes of feed blocks are sold worldwide each year.

The benefits to livestock have been proven by independent research. For example, research recently carried out at Myerscough College showed that supplementing the diet of cows with Megastart Dry Cow mineral supplement before calving led to a 35% increase in production of colostrum, which is the nutrient-rich milk for newborns. Importantly, provision of the supplement reduced the number of barren cows to a quarter of that in the control sample, saving an average of £1,819 for each animal that did not need to be replaced with a new heifer. The ability to quantify the economic benefit for farmers helps overcome their innate conservatism and also means that Carr’s is able to generate a high margin from sale of the feed blocks.

The feed-block activity is growing rapidly. In June 2013, the Western Feed Supplements plant in Nevada was acquired to gain access to the significant cattle population in California. This area could not be accessed economically from the group’s existing plants in Oklahoma, South Dakota and Tennessee. The first product from the SmartLic feed block plant in Nevada was manufactured in January 2016. This facility gives access to the important Californian dairy market. A new low-moisture feed-block plant is under construction at the Tennessee site, where there is already a high-moisture feed-block facility. This facility will enable the group to sell low-moisture feed blocks to farmers in the eastern states of the US, which cannot be accessed from existing operations.

Having now created a footprint in the US with sufficient scale and geographic reach, Carr’s intends to open feed-block plants in other regions where cattle are reared on forage-based systems. Management continues to evaluate the potential construction of a New Zealand facility in the medium term. It continues to ship feed blocks to farmers in the country, although demand was subdued during FY16 because of low global farmgate milk prices. The first shipment of Crystalyx feed blocks was shipped to South America during FY16. The blocks will be used for two sets of independent trials in Brazil. The trials are an essential precursor to any marketing campaign, as farmers want to see research that has been carried out under local conditions before considering a purchase of a new product. Our estimates assume that any extensive penetration of these new geographic markets will be beyond the period covered by our forecasts.

Carr’s AminoMax, which is manufactured under an exclusive licence from the US patent holder, is a bypass protein that contains soya meal or canola and is treated so that a higher proportion of the protein is assimilated by the animal, thus improving the growth rates of beef cattle and milk yields of dairy cows. Carr’s is the only company in the world that has been able to use canola as well as soybean as a bypass protein ingredient. The north-east area of the US has a dairy cow population of 1.4 million within 350 miles of Carr’s US AminoMax facility. Over half of these cows are on diets that contain plant-based bypass protein such as AminoMax. Around 85,000 tonnes of AminoMax is currently being produced across both the US and UK (Lancaster) plants. Research and development of complementary products is ongoing, as management would like the division to be able to offer a portfolio of value-added items.

Demand for feed blocks in the US is primarily driven by beef cattle farmers and is linked to both weather conditions and consumer demand for quality beef. Demand for feed blocks in the UK is primarily from sheep farmers and is linked to weather conditions at lambing time. Demand for feed blocks in continental Europe and New Zealand is primarily from dairy farmers and is linked to the adoption of more sophisticated feeding regimens that deliver increased output from the same number of animals.

Demand for AminoMax is linked to farmgate milk prices, as there is no incentive for farmers to pursue higher yields when the prices obtainable for raw milk are low. As demand grows, management will evaluate commissioning a second production line in the US and licensing options. Management estimates that the total market opportunity for AminoMax in the US is at least 650,000 tonnes.

There is limited competition for low-moisture feed blocks in the UK, Brazil and New Zealand. The latter two are relatively new markets where farmers are beginning to adopt the more sophisticated feed regimes common in the US. Ridley, which was acquired by animal nutrition and health specialists Alltech in April 2015, is the North American market leader, with an estimated 40% share compared with Carr’s 25%. In the US, Carr’s competes through branding, with its iconic ‘Feed in a Drum’ and SmartLic returnable steel packaging.

Carr’s manufactures around 500,000 tonnes of compound and blended feeds each year. These are sold to sheep, dairy and beef cattle farmers in the North of England, Scotland, Wales and the Midlands. The feed is manufactured by an associate company, Carrs Billington, at compound feed mills in Staffordshire, Carlisle and Lancaster, Cumbria, and at blends plants in Kirkbride, Cumbria and Lancaster.

Carr’s has an estimated 14% share of the UK ruminant feed market, making it the third-largest manufacturer in the UK behind ForFarmers and NWF Group. There are numerous small feed suppliers in the area served by Carr’s, some of which purchase feed from Carr’s. Underlying demand for dairy feed in the UK is linked to the volume of milk produced, which was 4% lower year-on-year for the 12 months ended 19 November 2016 (source: Agriculture and Horticulture Development Board). The numbers of dairy farms and dairy cattle have declined over the last decade, as the industry moves to larger herds and more intensive rearing regimens. This trend favours a more technical approach to feeding cattle, which benefits larger operations such as Carr’s that can offer agronomy services and products such as AminoMax as well as feed. This technical approach is also important when farmgate milk prices are low, as farmers are keen to investigate changes to feed regimens that can help improve profitability. Demand for feed varies from year-to-year depending on weather conditions. Carr’s is less dependent on demand for dairy feed than NWF Group because it also sells substantial volumes of sheep and beef cattle feed.

Carr’s operates a chain of 33 Country Store retail outlets and eight smaller outlets in Scotland, the North of England, Staffordshire, Derbyshire and South Wales. These stores specialise in products for farmers and the broader rural community, including animal health products, agricultural sundries such as fencing and farm consumables, pet and equine products and rural clothing. The products offered vary from store to store to reflect the type of farming in the area. Farmers are typically conservative in nature and cautious about purchasing from brand-new outlets. Carr’s has therefore expanded its retail operations predominantly by purchasing smaller agricultural suppliers with a limited retail offer but a solid customer base such as Greens in Morpeth. Post-acquisition it then broadens the product portfolio to appeal to both farmers and other rural dwellers and expands the retail space, relocating the premises if necessary.

A high proportion of sales at Carr’s Country Stores relates to non-discretionary farming expenditure, so underlying demand, especially for farm machinery, is linked to farm incomes. Carr’s has been able to grow sales independently of this by broadening the product offer to include higher-margin animal healthcare products. Seven of the outlets offer farm machinery, making Carr’s one of the largest Massey Ferguson distributors in the UK.

Carr’s operates eight fuel distribution depots, which service rural premises in Dumfries, Galloway, Cumbria and Lancashire. At over 100m litres/year, the operation is significantly smaller than that of NWF Group (over 470m litres), which is the third-largest supplier in the UK. However, unlike NWF, Carr’s is not intending to become a national player in the sector, but views this as a service within its agricultural supply offer. The operation is highly complementary to the feed and machinery sales operations, providing significant opportunities for cross-selling. Demand for heating oil is dependent on weather conditions. This dependence is reduced by selling tractor fuel as well. Demand for tractor fuel is typically higher over the summer, when demand for heating fuel is weaker.

The Agriculture division’s revenues declined by 4% year-on-year to £284.8m, reflecting lower commodity prices. Divisional operating profit (including share of post-tax profit of associate and joint ventures) rose by 5% to £12.3m. Sales of feed blocks in the US continued to rise, supported by continued recovery in the beef industry following a period of protracted drought and market share gains. Demand for feed blocks in the UK, which is primarily from beef and sheep farmers rather than dairy farmers, picked up in the second half to give a very modest year-on-year volume improvement. Demand in mainland Europe, which is primarily from dairy farmers, was lower year-on-year, reflecting challenges caused by low farmgate milk prices. Volumes of compound feed sold increased by 2% as Carr’s took share in a market that declined by 4% nationally, but margins were under pressure because of the dip in farmgate milk prices. Low milk prices meant there was a reduction in demand for high-margin AminoMax by-pass proteins in the UK during Q1. Although demand picked up in H2, sales were constrained by the loss of two months’ output following the floods in Cumbria. In contrast, demand for AminoMax from dairy farmers in the US increased. Machinery sales were adversely affected by pressure on farm incomes resulting from low milk, meat and grain prices.

Retail sales rose by 16% (5% like-for-like). This growth was supported by the acquisition of Morpeth-based Green (Agriculture) Co, in September 2015, as well as investment in the Country Store portfolio with redevelopment of the facilities in Leek and Oban.

Our estimates assume that the low-moisture block line in Nevada will help boost US feed block sales during FY17. The plant produced its first product in January 2016, at the end of the peak feed block consumption period from August to February, so the benefit of the additional capacity will not be realised until FY17. In the UK, we expect that the acquisition of Lancashire-based Phoenix Feeds in June 2016 will benefit UK feed volumes. We expect further retail sales growth related to the new store in Wigton, Cumbria, which opened during FY16, and the new store in Penicuik, Midlothian, which opened in December 2016. However, even though farmgate milk prices are beginning to improve, we expect that margins on feed will remain under pressure as the price of feed ingredients is also rising. We therefore model a 3% year-on-year rise in divisional revenue to £294.7m in FY17 to reflect an increase in retail and feed volumes, accompanied by a £0.6m year-on-year reduction in divisional profits to £11.8m (including the share of profits from JVs and associate) to reflect margin pressure in the UK and subdued machinery sales.

Our estimates assume that the low-moisture feed block plant in Tennessee, which is scheduled for completion during FY17, will benefit US feed block sales during FY18. We assume further growth in retail sales, backed by a programme of store openings and expansion during the prior year. By this point we assume that the UK farm incomes will have recovered sufficiently for margin pressure on feed to have eased and demand for farm machinery to have recovered. This results in a modest 1% year-on-year increase in revenue and £0.2m rise in divisional profits. In the longer term, we expect the division to benefit from the adoption of more sophisticated feed regimens for dairy and beef cattle across the developed world.

The Engineering division is comprised of UK manufacturing businesses and remote handling businesses. It has been built up through acquisition, most recently of STABER in October 2016. This follows the acquisition of Newcastle-based Chirton Engineering in April 2014, which enhanced the division’s precision machining capability and strengthened its presence in the oil and gas sector; and of Wälischmiller Engineering, which was acquired in March 2009 to complement the existing remote handling business Carr’s MSM, which was itself acquired in 2003.

The German operation, Wälischmiller Engineering, designs and manufactures remote handling equipment such as robotic arms and master-slave manipulator units. These devices are widely used in the nuclear industry in post-irradiation examination laboratories and fuel element reprocessing cells. The ‘slave’ part, which is in contact with radioactive material, mimics the actions of the ‘master’ part, which is moved by an operator who is protected from the radioactive material by heavy shielding. Wälischmiller’s customers are primarily engaged in the nuclear industry in France, Germany and the Far East. The UK operation develops a complementary range of master-slave manipulators. Its main customer is Sellafield, though it is involved in some export activity. In calendar 2012 it was awarded a ‘life of plant’ contract with Sellafield, under which it supplies master-slave manipulator parts for the major operating plants at Sellafield. This contract extends until at least 2020 and generates revenues of over £2m each year.

Wälischmiller’s robotic arms incorporate specialist gearing systems that permit the very precise control of movement required for remote handling applications and are unusual in that they have no external cabling or hydraulic systems so there is no restriction on rotational movement. The robotic arms are typically customised for deployment in specific applications. For example, under a three-year contract with Statoil and Shell, Wälischmiller developed the Demo 2000 Telbot robotic arm that is controlled remotely, can move loads of 5kg to 150kg with great precision and is suitable for use in the highly explosive environments inside fuel storage tanks so it can be used for remote inspection of welds inside gas tanks and tank cleaning. This is a large potential market. Another variant, the V1000 power manipulator, mounts a robotic arm on crawlers to create a fully remote-controlled handling vehicle. This variant has been designed with radiation-proof components and easy to decontaminate surfaces for use in the nuclear industry. A single Telbot sale may be around €1m.

The specialist gearing systems used in Wälischmiller’s remote handling equipment is designed and manufactured by another German engineering business, STABER. The two companies have worked closely together for over 50 years, with Wälischmiller being STABER’s principal customer. STABER played a key part in helping Wälischmiller develop the Demo 2000 Telbot. In October 2016, Carr’s Group acquired STABER, thus securing the IP. In addition, bringing STABER within the group enables the design and development teams to work together even more closely on both near-term Telbot opportunities and longer-term strategic development projects, such as light-weight variants for use on off-shore platforms.

The largest business in the group’s manufacturing portfolio is Carlisle-based Bendalls Engineering. This designs and manufactures bespoke steel fabrications such as pressure vessels up to 5.0m in diameter, process columns, chemical reactors, tanks and tidal and wind turbines. These are typically sold to customers in the nuclear, oil and gas, petrochemical and process industries. Safety is critical in these sectors, so full material traceability along with radiographic weld testing, hydraulic testing and documentation packages are offered as standard. Customers include Aker Kvaerner, BP, Chevron Texaco, Chiyoda, Costain, KBR, Pfizer, Roche, Royal Dutch Shell and Sellafield. During FY15, Bendalls opened its own design business. This is intended to help it become engaged in projects earlier on, enabling Bendalls itself to win a greater variety of work and promoting the capabilities offered by the other engineering businesses in the group.

Before becoming part of the group, Chirton had focused on the offshore oil and gas industry. As this sector has suffered from a lack of investment caused by low oil prices, during FY15 Bendalls was given overall responsibility for Chirton. This has made it easier for them to work together on joint projects requiring both fabrication and significant precision machining capabilities and accelerated Chirton’s entry into the nuclear sector.

A high and rising proportion (69% FY16, 62% FY15) of the division’s contracts are related to the nuclear energy industry in the UK and overseas. The UK government’s reaffirmation of the decision to build a new nuclear reactor at Hinkley Point represents the first order for a new reactor in the Western hemisphere since the disaster at Fukushima in March 2011, and is likely to provide opportunities for the division in the longer term. The new Hinkley Point reactor is part of the government’s energy policy, which sees new nuclear power stations as a vital part of the portfolio, potentially providing up to 30% of low-carbon electricity during the 2030s. In addition, NuGen, a joint venture between Toshiba and ENGIE, has recently completed the second phase of the public consultation regarding its proposal to construct a new nuclear power station (Moorside) near to Sellafield. Meanwhile, decommissioning activities on their own provide a good base level of activity for the group. Western Europe has 150 plants to decommission by 2030 (Global Data, Washington Post). Considering the UK alone, the cost of decommissioning 17 sites across the UK, some dating back to the 1940s, is estimated by the National Audit Office to exceed £70bn, with the work extending over several decades. For the year ending March 2017, the Nuclear Decommissioning Authority’s planned expenditure on site programmes is expected to be £3.2bn.

The acquisition of Wälischmiller gave Carr’s access to markets outside the UK, primarily Germany, France, Japan and China, reducing the group’s dependence on investment in the UK. During FY16 Wälischmiller won two contracts in the US. This is a key potential market going forward. The Japanese market is showing signs of a revival. Four of the reactors that were turned off following the Fukushima disaster have returned to service, though one is currently offline following a court injunction from anti-nuclear activists; a fifth has been cleared for restart but is still idle and application to restart another 22 reactors have been filed. The Russian market remains difficult because of sanctions.

There are half-a-dozen competitors worldwide for Carr’s MSM and Wälischmiller and none of these have as broad a product range as that offered by the two group companies combined. The group has approximately 45% share of the global powered master-slave manipulator market, and 35% for smaller manipulators. Bendalls is in a good position in the UK nuclear market when contracts are awarded because it is able to offer the full traceability required and has good relationships with Sellafield. The oil and gas sector is more competitive. Bendalls’ primary competitors here are based in South Korea, hence the lower margins attributable to contracts for this sector. Within the group, Chirton has the greatest exposure to the oil and gas industry. The continued weakness in oil prices has resulted in a lack of capital investment in the oil exploration sector. This has had an adverse impact on Chirton’s order intake, hence management’s decision in FY15 to give Bendalls direct responsibility for Chirton.

Divisional revenues reduced by 10% year-on-year to £30.1m. The remote handling business performed in line with management expectations, completing two major contracts for Sellafield, the Demo 2000 Telbot project for Statoil and a contract worth c £1.8m with Cavendish Nuclear for the supply of master-slave manipulators into Sellafield. However, the UK manufacturing businesses experienced low utilisation levels at the start of the year while waiting for significant nuclear projects to commence. In addition, demand from the oil and gas industry remained subdued because of the lack of capital investment by customers in the oil exploration sector. Divisional EBIT reduced very slightly (£0.1m) year-on-year as work for the nuclear industry is typically higher margin than that for the oil and gas industry.

The order book relating to nuclear related projects is strong, giving high levels of utilisation throughout FY17 for the remote handling businesses and Bendalls. The remote handling business is working on follow-on orders to develop a lightweight version of the Demo 200 Telbot for use on offshore platforms, to supply a second Telbot to assist in the removal of high-level toxicity waste at Sellafield and to supply a self-propelled vehicle mounted Telbot for use at the vitrification plant in Karlsruhe. The STABER acquisition will be instrumental in fulfilling these significant orders. The UK manufacturing business is working on a contract to design and manufacture Sellafield’s highest complexity vehicles for the next 10 years. This was worth £48m at the time of the tender and underpins the division’s growth in the medium term. This underpins our estimate of a 25% rise in revenues during FY17 to £37.5m giving a £0.4m (16%) increase in divisional EBIT to £2.9m, followed by a 2% rise in revenues to £38.4m during FY18, giving a £0.7m (24%) increase in divisional EBIT to £3.6m.

Prior to the disposal of the division at the end of August 2016, Carr’s Food division had three mills located in Cumbria, Kirkcaldy and Maldon, Essex. The division was operating in a difficult market environment. The UK flour market continued to suffer from overcapacity, despite the closure of three Premier Food mills. Demand for flour was static and bread manufacturers were under constant pressure from supermarkets to reduce prices. Revenues dropped by £8.8m (11%) and divisional profit dropped by £0.3m (8%) during FY16. Under current market conditions, it would have been difficult to increase divisional profits significantly. Moreover, the division was reliant on a relatively small number of customers at some locations, making it vulnerable to them changing supplier. The disposal, which was initiated by Whitworths, frees management to concentrate on the two divisions capable of delivering strong growth.

The board composition has changed to reflect the group’s shift to higher-margin, IP-rich activities. On April 2016 Robert Heygate, who had been a non-executive director of Carr’s since 1991, retired. Robert was also an executive director of Heygate & Sons, the UK’s fifth-largest independent flour miller, which is also engaged in animal feed compounding and other agricultural activities and is Carr’s largest shareholder. Non-executive director Ian Wood, who joined the board in October 2015, is the commercial director, international business development in Centrica (previously British Gas) and has held a number of positions with the company, covering various aspects of the business including engineering, customer services, industrial and commercial marketing, and energy trading within the UK, Continental Europe and North America.

The key sensitivities as we see them are:

Group revenues (continuing businesses) reduced by 5% year-on-year to £314.9m as a result of lower commodity prices. Reported profit before tax from continuing businesses grew by 3% to £14.1m. Adjusted profit before tax for continuing businesses (adjusted for amortisation, share-based payments and exceptionals) reduced by 1% year-on-year, reflecting a switch from a £0.5m share-based payment cost to a £0.1m share-based payment credit. A modest improvement in the Agricultural activities driven by growth in feed block deliveries in the US offset a small decline in the Engineering activities caused by a slow start to some contracts during H116. If the reported profit before tax from the Food division is included, total reported profit before tax totalled £17.6m, which is very slightly ahead of the record £17.5m achieved in FY15. DPS was raised from 3.7p to 3.8p, excluding an additional special dividend payment of 17.54p/share (see below) related to the disposal of the Food division.

Our group estimates were revised in October to reflect the STABER acquisition. These show revenues rising by 5% during FY17, reflecting an increase in feed block volumes in the US and improved utilisation in the Engineering division. We model a small drop in interest payable during FY17 to acknowledge the reduction in net debt, though note there will still be charges on the working capital facility. We model a reversion of share-based payments charges to FY15 levels. Combining this with the decline in profits from Agricultural activities resulting primarily from margin pressure and the improved performance from the Engineering division gives a 4% rise in adjusted profit before tax and flat reported profit before tax. EPS is estimated to grow by only 1% on account of the dilutive impact of stock options being exercised. Our estimates do not model any supplementary contributions to the pension scheme, which shows a modest surplus (see below), going forward. (Note: Central costs, including supplementary contributions to the pension scheme to address a previous deficit, are split between the two divisions rather than being shown separately as in our previous Outlook note.) Our estimates show adjusted PBT growing slightly more rapidly, by 5% in both FY18 and FY19 as the Agricultural division returns to profits growth.

The group moved from a net debt position to a net cash position because of the proceeds from the disposal of the Food division. Net capital expenditure was higher at £5.4m (FY15: £4.2m) because some of the costs of completing the Nevada Springs facility were deferred until FY16. The retirement benefit surplus reduced from £1.8m at end FY15 to £0.3m at end FY16.

Looking forward, we expect FY17 capex to be a relatively high £7.8m in order to cover development of the Country Store site at Morpeth, a new showroom at the German engineering facility and new equipment for the UK manufacturing businesses to support some of the new projects, which require the ability to machine very large components. During early FY17 £16.0m of the £24.9m paid by Whitworths for the Food division was returned to shareholders via a special dividend of 17.54p/share. We expect this payout, which has already been made, together with the £4.2m initial consideration payable for the STABER acquisition, to return the group to a net debt position at the end of FY17. Putting this in context, we estimate that gearing at the end of FY17 will be only 8%, while debt/EBITDA will only be 0.5x. This gives the group sufficient headroom to make further small acquisitions and to invest in additional feed block capacity, potentially funding any larger acquisitions through equity.

We continue to use a sum-of-the parts calculation to value the company. We apply a weighted average prospective P/E multiple of 15.1x, which is a blend of peer group derived target P/E multiples for agricultural and engineering divisions, to our FY17 EPS estimate. This calculation gives an indicative value of 161p/share, which is the same as in our September and October notes.

This analysis is backed up by a DCF valuation, which gives a fair value of 160p/share when applying a conservative 10.0% WACC and 1.0% terminal growth rate.

A comparison of Carr’s EV/EBITDA and P/E multiples for the year ended August 2017 with calendarised multiples for listed peers in the agricultural sector is shown in Exhibit 8. At the current share price, Carr’s is trading at a discount to the peer mean with regards to EV/EBITDA (7.7x vs 8.8x) and in line with the peer mean with regards to P/E (14.3x vs 14.4x). At the same time, German engineering companies are trading at a premium multiple compared to the agricultural sector (FY17e P/E of 16.0x vs 13.5x). We believe that an uplift to our blended peer group P/E of 15.1x, which is mainly driven by the re-rating of the engineering peers, could be justified to reflect Carrs’ increasing strategic focus on the engineering business and the division’s solid earnings growth (2015-19e EBIT CAGR of 11%). At our indicative value of 161p/share, Carrs’ implied EV/EBITDA multiple is still at a discount to the agricultural peer average, while P/E is at a moderate premium. Overall, we believe that the triggers to close the remaining valuation gap include continued improvement in farmgate milk prices (although Carr’s is less affected by this than its closest peers) and news of further engineering contract wins.