Buy Ag Growth for growth and income

Our Investment Planning Committee has added growing agricultural products manufacturing stock Ag Growth International to our list of Key stocks. The stock is a buy for further long-term share price gains as well as attractive, though flat, dividends.

Growth_and_Income We’ve added Ag Growth International (TSX—AFN) to our list of Key stocks. This Winnipeg-based manufacturer of farm machinery and equipment is growing both by product line and geographical region. We’ve consistently rated this stock a buy when we examine manufacturing stocks. AFN is up by 4.1 per cent since we published our November 17, 2017, issue. It remains a buy for further long-term share price gains as well as attractive, though flat, dividends.

AFN operates two businesses. One is Farm products, which “include on-farm storage products such as grain storage bins, portable grain handling equipment and lower capacity aeration products”. In 2017, farm sales were $394 million, or 52 per cent of the total sales of $756 million (all numbers are in Canadian dollars unless otherwise noted).

AFN’s Commercial business is “comprised primarily of high capacity grain handling equipment, larger diameter grain storage, and equipment utilized in commercial fertilizer applications. . . . Offshore, the commercial infrastructure in many grain producing and importing countries remains vastly under-invested resulting in significant global opportunities.” These include investments in port facilities, inland terminals and retail fertilizer distribution, among others. In 2017, commercial sales amounted to $362 million, or 48 per cent of total sales.

In 2017, AFN earned $39.4 million, or $2.44 a share, excluding one-time items from both years. This compared to earnings of $36.9 million, or $2.47 a share, the year before.

Earnings per share slipped as AFN issued 1,379,274 shares in 2017—for a total share count of 16,415,819. AFN has now cancelled its DRIP (Dividend Re-Investment Plan). This will reduce the increase in the number of shares outstanding. Then again, the company’s convertible debentures will likely lead to the issuance of more shares.

Just keep in mind that AFN’s 2017 cash flow of $72.6 million is up by a third from its 2016 cash flow of $54.5 million.

Products manufactured and sold around the world

AFN manufactures its products in Canada, the United States, the United Kingdom, Italy, Brazil and South Africa. The company sells its products around the world.

In 2017, the US surpassed Canada to become AFN’s largest market. US sales of $323 million accounted for 43 per cent of the total sales. Canada is AFN’s second-largest market, with sales of $281 million, or just over 37 per cent. International sales came to $152 million, or about a fifth of the sales.

AFN’s foreign sales are growing much faster than its Canadian sales. In 2017, Canadian sales went up by 17.9 per cent. American sales, meanwhile, jumped by more than 56 per cent. International sales advanced by nearly 49 per cent.

We expect Canadian sales to grow more slowly again in 2018. The railroads’ failure to deliver much of the 2017 grain crop has left Canadian farmers with less cash. AFN writes: “The primary demand driver for . . . Farm business is the volume of grain produced as this dictates on-farm storage requirements and drives the product replacement cycle for portable equipment.”

More important for AFN’s sales growth is its acquisition program. Acquisitions in 2017 and 2016 added $213 million to its sales in 2017. That represented sales growth of 39 per cent last year.

AFN made three acquisitions in 2017. They’ll contribute to its profits for a full year in 2018. On April 4, 2017, AFN paid US$100 million to acquire Global Industries. This company manufactures grain storage bins, portable and stationary grain handling equipment, grain drying and aeration equipment, structural components and steel buildings. In fiscal 2017, Global generated sales of US$112 million.

AFN’s acquisitions should pay in 2018

In December, 2017, AFN acquired CMC Industrial Electronics and Junge Control. CMC supplies hazard monitoring sensors and systems used in agricultural material handling applications and manufactures commercial bin monitoring sensors and systems. This is positive because farming is the most dangerous occupation of all. Junge manufactures automation, measurement and blending systems for the agriculture and fuel industries. The combined sales of both companies were $15 million.

As of February 22, AFN paid $10.2 million for Danmare Group. Danmare provides engineering and project management services to the food industry. It specializes in automated systems for pet food, rice and pasta, confectionery, ready-to-eat foods, sauce and meat processing. Danmare will contribute to AFN’s sales in most of 2018 and throughout 2019.

In 2018, AFN is expected to earn $2.95 a share. That would represent earnings per share growth of 20.9 per cent. This gives the stock a reasonable forward P/E (price-to-earnings) ratio of 18.2 times. Divide this year’s expected earnings growth by the P/E ratio and AFN’s forward MGI (Marpep Growth Index) is 1.15. This suggests that it’s undervalued.

AFN has paid dividends of 20 cents a month—or $2.40 a year—in each of the past five years. The dividend yields an attractive 4.47 per cent. Based on this year’s higher expected earnings, the company’s payout ratio (dividends as a percentage of earnings per share) should improve to 81 per cent. Even so, we do not see it raising its dividend anytime soon.

AFN’s debt is less onerous than it looks

For one thing, AFN carries substantial debt. Indeed, its net debt-to-cash-flow ratio is 7.4 times. That’s well above our usual comfort zone of two times or less. Then again, if you exclude convertible debentures, the net debt-to-cash-flow ratio improves to 3.3 times. Also, cash flow from acquisitions should further improve the ratio next year.

Another reason for the dividend to remain the same is AFN needs the cash flow. If it continues to make acquisitions, as we expect, then it may want to retain any extra cash flow rather than pay it out.

The consensus advice of two analysts is ‘strong buy’. Ours is ‘buy’. Buy it for long-term share price gains and attractive, though flat, dividends.

This is an edited version of an article that was originally published for subscribers in the March 30, 2018, issue of The Investment Reporter. You can profit from the award-winning advice subscribers receive regularly in The Investment Reporter.

The Investment Reporter, MPL Communications Inc.
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