Carr’s Group — Improved performance in challenging environment

Following the appointment of new CEO Hugh Pelham in January 2021, the former Agriculture division has been split into two, with the supplements related activity in the UK and elsewhere becoming the Speciality Agriculture division and the other UK agricultural activities becoming the Agricultural Supplies division. This change has been instigated to create greater operational efficiencies and market focus.

Divisional revenues grew by 9.8% year-on-year to £40.2m and adjusted operating profit by 24.7% to £8.2m. The division has remained fully operational during the coronavirus-related lockdowns. During H120 demand for both feed blocks and Animax supplements in the UK was depressed because of the unfavourable combination of unseasonably mild weather and lower cattle and lamb prices, which disincentivised farmers from pushing to maximise outputs. In contrast, weather patterns were more normal during H121 and livestock prices were strong, boosting demand. Cattle prices in the US were depressed in H120 because of a delayed start to winter feeding, but have remained robust since the recovery noted towards the end of FY20, stimulating demand for feed blocks there as well. Overall, the volume of feed blocks and speciality minerals sold increased by 8.4% year-on-year to 101,000 tonnes.

The strategic review undertaken following Hugh Pelham’s appointment has not changed the overall direction of this division, which will continue to focus on molasses-based feed blocks and specialist animal health products where its patented manufacturing processes provide differentiation. Earlier initiatives to improve productivity, particularly at Animax, and procurement have been accelerated. Management expects that the benefits of automating the production process at Animax will show benefits from FY22 onwards. Management has identified expansion of the group’s sales presence in the United States, particularly Texas, Canada and Germany as the highest priority.

Divisional revenues declined by 0.5% year-on-year to £137.7m, reflecting lower oil prices while adjusted operating profit increased by 33.5% to £3.3m. This division also remained operational during the coronavirus-related lockdowns, though retail outlets shifted to a collection model during the most severe phases of lockdown. Demand for animal feed during H120 was depressed by the unseasonably mild weather, which resulted in plentiful supplies of forage and low livestock prices. A recovery in livestock prices helped support a 0.4% increase in total feed volumes to 318kt in H121. An improvement in UK farmer confidence generally as the prospect of a no-deal Brexit, which would have been ruinous for sheep farmers, disappeared, resulted in an 8.1% increase in like-for-like retail sales (4.3% overall) and a 29.1% jump in machinery revenues. However, fuel volumes reduced by 2.5% year-on-year because customers had stocked up on fuel while it was relatively inexpensive over the summer.

The strategic review has not changed the overall direction of this division either. The division will continue to provide a ‘one-stop shop’ for farmers, differentiating itself though its product range, customer and technical service levels, its local presence and the quality of its compound feeds. The group will continue to make bolt-on acquisitions and open new stores. Earlier initiatives to standardise product ranges and prices, improve supply chain arrangements and improve raw material procurement have been intensified. It is possible that Brexit may encourage the UK government to support its farmers in the interests of shortening food supply chains and improving food security. This would be of benefit to the division.

Divisional revenues reduced by 5.4% year-on-year to £23.6m and adjusted operating profit by 24.1% to £0.9m. This division also remained fully operational through the lockdowns. The engineering solutions segment experienced higher levels of activity during H121 than H120 because of contract phasing on key mechanical stress improvement process (MSIP) projects, which have now reached the delivery phase. The UK part of the segment continued to work through its strong order book and has recently won additional work in the defence sector. The robotics order book was significantly stronger at the end of FY20 than at the beginning, supporting improved performance during H121. Encouragingly, management expects that exports to China will resume in H221, though coronavirus restrictions have led to delays in commissioning equipment on customer sites. Although the major Japanese order that management had expected to receive in Q121 has still not been confirmed, this is expected to benefit FY22, not FY21. However, investment by the oil and gas industry remains low, reflecting uncertainty regarding future demand. This is having a negative impact on some of the UK manufacturing activity, though we note that the segment received a significant level of orders from the nuclear industry. Overall, the divisional order book was £44m at end H121, a 19% increase since the FY20 year-end.

The direction of this division also appears unaffected by the strategic review with growth being driven by cross selling the full range of specialist services and winning new customers in the nuclear and defence industries. We note that management has put a turnaround plan in place for the manufacturing segment and has completed a minor restructuring exercise, which management expects will support improved divisional performance during H221.

P&L

Group H121 revenues were flat year-on-year at £201.4m, with higher sales of feed blocks and other supplements balanced by low oil prices and underperformance in the Engineering activities exposed to the oil and gas market. Adjusted operating profit grew by 5.3% to £10.9m, as improved performances from both the agriculture related divisions were partly offset by the issues in the Engineering division and a sharp increase in central costs attributable to changes in provisions for non-recoverable debts, higher performance related remuneration and CEO handover costs. The non-recurring items totalling £0.2m included a £0.7m credit related to a net decrease in fair value of deferred consideration payable for the US engineering solutions business and £0.2m in restructuring costs. While management decided this time last year to defer payment of an interim dividend until the full effects of the COVID-19 pandemic were clearer, it paid a dividend for the full year, which was maintained at FY19 levels, and has declared an initial interim dividend for FY21 (Carr’s typically pays two interim dividends) of 1.175p (H119: 1.125p/share).

Balance sheet gives resilience

Net debt (excluding £15.1m finance leases) reduced by £8.3m during the period to £10.6m. The movement is primarily attributable to a £4.1m decrease in working capital requirements, which is related to strong working capital management. The retirement benefit surplus decreased slightly, by £0.2m to £7.8m at end H121. The group no longer makes deficit reduction contributions because the pension scheme was fully funded at the last full actuarial valuation.

We make the following changes to our estimates:

DCF methodology

Our valuation methodology is based on a discounted cash flow (DCF) analysis, supplemented with a comparison of peer group multiples. We continue to use a conservative 10.0% WACC and a 1.0% terminal growth rate for our DCF calculation. This gives a fair value of 170p/share, which is unchanged since our last note. We prefer a DCF analysis to a peer-based multiples approach because it looks beyond any short-term issues of unseasonal weather, which the group, like other companies engaged in agricultural supply, is exposed to. We believe that the valuation gap should begin to close as the improved order book in Engineering and turnaround programme at one of the Engineering manufacturing businesses start to convert to improved divisional performance.

Peer-based multiples

In Exhibit 3 we compare Carr’s prospective EV/EBITDA and P/E multiples with those for its listed peers in the agricultural sector. At the current share price (135p), Carr’s is trading below the mean for its peers (excluding Anpario) on all metrics. In our opinion, this discount is not justified because Carr’s feed block activity in North America, mainland Europe and New Zealand reduces the exposure of its agricultural businesses to challenges caused by the UK climate and government policy. This sets Carr’s apart from both NWF and Wynnstay, whose agricultural activities are confined to the UK. In addition, since a material proportion of operating profit (FY20: 44%) is derived from the Speciality Agriculture division, Carr’s Group merits multiples that are closer to the higher values achieved by natural feed additives provider Anpario than agricultural supply companies like ForFarmers or Origin Enterprises.

At the indicative value of 170p/share derived from our DCF calculation, Carr’s would be trading at a small premium to the average for its peers, excluding Anpario, but at a discount when Anpario is included in the mean calculation.