Carr’s Group — Engineering recovery sustained

Divisional revenues increased by 6.2% y-o-y to £42.7m while adjusted operating profit (including JVs) declined by 21.1% to £6.5m. The revenue increase was attributable to commodity price inflation. Overall, the volume of feed blocks increased very slightly (0.8%) because modest growth in the UK (2.5%) supported by high livestock prices was offset by a 5.9% reduction in the United States (excluding JVs) relating to the drought affecting the northern part of the country and the resultant reduction in cattle numbers. The drop in profit reflects lower utilisation of the feed block plant serving the northern US and a reduction in margin because of a lag in passing through increases in raw material prices. This situation has stabilised with both prices and input costs now higher.

Our revised estimates (Exhibits 1 and 2) model a sharp reduction in divisional profits during FY22 on the basis that the drought in the United States will have an adverse impact on sales of feed blocks in the region. Moreover, although livestock and farm gate milk prices in the UK remain strong, a situation that typically encourages farmers to invest in feed blocks and supplements to enhance farm outputs, the high price of inputs such as fertiliser may cause farmers to limit discretionary purchases such as feed blocks. Since feed blocks help cattle utilise forage more efficiently, farmers may choose to graze their herds more intensively rather than supplement feed with feed blocks. We then model a partial recovery in divisional profits during FY23 to reflect the positive impact of strengthening the group’s sales presence in the United States, particularly Texas, and in Canada and Germany, and of completing the automation project at Animax, as demand for its bolus-based supplements currently exceeds supply. We assume that the northern US states will still be afflicted by drought during FY23.

H122 divisional revenues grew by 15.3% y-o-y to £158.7m and adjusted operating profit (including associates) by 19.1% to £3.9m. Although feed volumes were 2.5% lower, reflecting the mild winter, selling prices were 26.3% higher as the group passed on rising input costs in a timely manner. The mild winter also resulted in an 8.5% fall in volumes of fuel sold, though fuel price volatility supported good margins. Retail sales were up 4.1% in both absolute and like-for-like terms and machinery revenues remained strong. Operating margins improved very slightly, from 2.4% to 2.5%.

The outlook for this division is favourable because livestock prices remain high and Carr’s Billington and other UK feed manufacturers are expected to reset their prices in April/May, as they do each year, which should restore margin per tonne. While the war in Ukraine is likely to result in shortages of some commodities, management expects that the division will be able to reformulate feeds using alternative ingredients as it has done in the past. Our estimates model improvements in divisional profits growth during FY22 and FY23. This is based on management’s comments that it has created a new central buying team, recruited new sales managers and introduced a programme to ensure that the management teams spend more of their time with customers. We also expect the division to benefit from the opening of a new machinery branch in Stranraer, Scotland during H122 and in Thirsk, England later in H222.

Engineering revenues fell by 9.6% to £21.3m while adjusted operating profit jumped by 58.2% to £1.5m. The divisional order book continued to strengthen during H122, finishing at £44.2m, which was 13.8% higher than end FY21 and 8.6% higher than end H121. In December, management noted that during H221 there had been a big jump in orders for fabrication work from the nuclear industry as well as good order intake in the precision engineering business, which was driven by a recovery in the oil and gas market. As anticipated, this resulted in a strong performance in both businesses during H122. The Remote Handling and Robotics performance was also better than the prior year period, which was expected because of the strong order book. The group achieved a significant milestone by securing its first contract to supply a power manipulator in the United States to an internationally renowned research institution. It also completed development of the A150, a new, small-scale telescopic manipulator for the growing nuclear medicine market. As anticipated, although both the UK and US Engineering Solutions businesses won major contracts during FY21, contract phasing meant that levels of activity for both businesses were lower than during the prior year period. In addition, there were delays and higher costs associated with a major defence project, and delays on a service contract for the nuclear industry following a technical fault, so the overall divisional performance was below management’s expectations.

The strengthening order book, especially for the precision engineering business, supports our assumption of a substantial improvement in divisional profitability during FY22 followed by more modest improvement in FY23. We assume that there will not be a repeat of the delays to the Engineering Solutions businesses during H222 and that the global oil price will be at average levels or above during the remainder of the forecast period, supporting precision engineering activity. The division is able to pass on higher steel prices to customers. The Robotics business is experiencing some impact from the sanctions on Russia, which is one of its export markets, but this is already factored into our estimates.

P&L: Order book supports recovery of the Engineering division

Group H122 revenues grew by 10.6% y-o-y to £222.7m, with higher commodity prices offsetting a reduction in feed volumes and lower revenues from the engineering solutions business. Adjusted operating profit decreased slightly, by £0.2m to £10.8m. A strong performance from the Agricultural Supplies division and recovery in the Engineering division, combined with lower central costs, were offset by a reduction in profits from the Speciality Agriculture division. Non-recurring items totalling £0.8m included a £1.3m credit related to a net decrease in fair value of deferred consideration payable for the UK engineering solutions business, £1.2m in costs attributable to the implementation of the group and associate’s cloud-based enterprise resource planning (ERP) system, which had previously been capitalised, and £0.4m in costs associated with the ongoing strategic review. The initial interim dividend (Carr’s typically pays two interim dividends) was maintained at 1.175p/share.

Balance sheet: Commodity price inflation drives working capital increase

Net debt (excluding finance leases of £15.3m) jumped by £19.9m during H122 to £29.9m at the half-year end. The movement is primarily attributable to an £8.9m increase in inventories and a £19.7m rise in receivables. Most of the increase is attributable to the Agricultural Supplies division where receivables are higher because of commodity price inflation and some slower collections related to the roll-out of the new ERP system. Inventories are higher because of higher commodity prices and a decision to hold more machinery inventory, which was partly to mitigate supply chain issues and partly to stock the two new outlets. Management expects both receivables and inventories to reduce by the end of the current financial year. We note that the group had £20.4m in undrawn facilities at end H122 and the relatively high level of net debt does not cause an issue with any covenants. The retirement benefit surplus increased by £0.6m to £10.0m at end H122. The group no longer makes deficit reduction contributions because the pension scheme was fully funded at the last full actuarial valuation.

Management notes that the FY22 outlook is in line with expectations, so we leave our FY22 and FY23 estimates broadly unchanged, with no revisions to group adjusted EBITA or group adjusted PBT. However, we have modified the composition of the profits so that a higher proportion of the profits in both years are attributable to the Engineering division and a lower proportion to the Speciality Agriculture division. The individual changes are as follows:

While the board continues to see potential for growth in each of the three divisions, there are limited opportunities to exploit inter-divisional synergies. Consequently, in December 2021 the board announced that it was carrying out a strategic review. The board expects to provide an update on this process during H222.

In line with the succession plan announced in August 2020, Hugh Pelham became CEO when the previous CEO, Tim Davies, stood down at the group's AGM in January 2021. Hugh left the group in October 2021. Chairman Peter Page has moved from a non-executive to an executive role while a new CEO is found. The board expects to complete this process by the end of FY22.

DCF methodology

Our valuation methodology is based on a DCF analysis, supplemented with a comparison of peer group multiples. We continue to use a conservative 10.0% WACC and 1.0% terminal growth rate for our DCF calculation. This gives a fair value of 170p/share, which is unchanged since our December 2021 note. We believe that the valuation gap should begin to close as the improved order book in Engineering converts to an improved divisional performance.

SOTP analysis

In Exhibit 4 we compare Carr’s prospective EV/EBITDA and P/E multiples with those for its listed peers offering speciality products to livestock farmers (Speciality Agriculture), companies engaged in the supply of more commoditised inputs to livestock farmers (Agricultural Supply) and a sample of UK engineering companies. At the current share price (152p), Carr’s is trading at a relatively modest discount to our sample of companies engaged in agricultural supply and our sample of engineering companies on all metrics. The level of discount is much more pronounced when comparing Carr’s with the mean for the sample of companies offering speciality agricultural products. This suggests that Carr’s current share price does not attribute any uplift in value compared with agricultural suppliers such as ForFarmers for the Speciality Agriculture division.

We base our SOTP analysis (Exhibit 5) on the EBIT attributable to each division, including the contribution from the associate and JVs where appropriate, applying multiples derived from the peer comparison in Exhibit 4. Obviously, this is a relatively small peer group and the calculation is sensitive to the multiples used. Despite these limitations, the exercise illustrates the value in the individual divisions. Our calculation produces an indicative group value of 268.8p/share, suggesting that any strategic activity that released the value of individual divisions would be beneficial for shareholders. This is lower than the 292.7p/share calculated in our February note because the proportion of profit attributable to the Speciality Agriculture division, where margins are substantially higher than in traditional agricultural supply business, is less.