Carr’s Group: Cautious Optimism
Edison Group | Jan 02, 2024 14:00
Cyclical weakness in Carr’s Group’s Speciality Agriculture business has affected the company’s fortunes of late. However, the new management team, a strong net cash balance sheet and a record order book in the Engineering division offer optimism. Operational progress, particularly a reversal of fortunes in Speciality Agriculture, should rebuild confidence and a reduction in the current discount to our view of the underlying value.
Sales increased 15% to £143m primarily due to strong positive pricing in the Speciality Agriculture division (sales +19%) although volumes were lower, while Engineering (sales +10%) benefited from a strong H2. Group operating margins declined 400bp to 5.6% primarily due to lower volumes in the Speciality Agriculture division, down 16%, and input price pressure, whereas Engineering profitability was broadly flat. Underlying PBT of £7.5m was 33% lower and underlying EPS of 6.2p declined 38%. The dividend was held at 5.2p. The balance sheet improved to net cash of £4.2m, primarily due to the disposal of the Agricultural Supplies division. A further £4m of deferred consideration has been received since the year end.
Outlook and forecasts
The Engineering division has a record order book (£60m) and c 85% cover for the current year, underpinning expectations of good progress. Speciality Agriculture had an improved first quarter of FY24 with UK volumes up 20%. However, cost pressures remain, which suggests a prudent view is needed. To reflect this, we have reduced our FY24 forecasts (PBT £9.7m to £8.8m -9.9%, EPS 7.8p to 7.5p 3.5%, DPS 5.3p to 5.2p -1.9%) and introduced estimates for FY25 (PBT £10.6m, EPS 9.0p, DPS 5.4p).
Our discounted cashflow valuation (DCF) is 149p per share, while our peer group derived sum-of-the-parts (SOTP) is lower at 124p. This reflects the current weakness in the Speciality Agriculture business and the short-term profitability metric used within our SOTP valuation. We believe our DCF valuation is more reflective of the true underlying value of Carr’s. This discrepancy also highlights what we see as the key catalyst to value appreciation, the performance of the Speciality Agriculture division, which was also a clear driver of the shares’ underperformance in 2023.
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Sales increased 15% due to positive pricing in the Speciality Agriculture and a strong H2 in Engineering. Margins declined 400bp, primarily due to softness in volumes and cost pressures in the Speciality Agriculture division, leading to a 33% decline in underlying EBIT and PBT. Reported PBT included amortisation of intangibles of £0.9m, restructuring and cloud configuration/customisation costs of £1.2m and goodwill and intangible impairment of £3.8m. The full-year dividend was held at 5.2p. The balance sheet improved to a net cash position, due to receipt of the majority of the proceeds from the sale of the Agricultural Supplies division.
Sales increased 9.6% although profits declined 1.5% to £5.3m due primarily to the mix of business, with fabrication and precision engineering strong, up 16%, while robotics sales were weaker. The business had a particularly strong H2 when profits were 24% higher and the order intake increased to a record £59.8m, up 47%. While the order book includes multi-year contracts such as the £10m contract for the UK’s National Nuclear Laboratory, it provides a very healthy c 85% coverage for expected FY24 sales.
h2 Speciality Agriculture division/h2Sales increased 19% due to strong pricing, with the average feed block pricing up 21%, while volumes declined 16%. In the UK, farmers reacted to wide-ranging cost inflation (in diesel, fertiliser etc) and used warmer weather to extend outdoor grazing to reduce the requirement for feed blocks, while the US business continued to suffer from a reduced calf headcount of up to 40% due to prolonged drought conditions. Margins declined by 570bp as a result of the lower volumes and input cost pressures. A new management team is largely in place, targeted to deliver improved performance. The first three months of FY24 have seen volumes in the UK up 20%. With agriculture costs and input prices appearing to have peaked, this provides a reason to be cautiously optimistic for FY24.
h2 Cash flow/h2 h2Operating cash inflow of £2.0m reflected lower profitability and £4.7m of working capital outflow due to increased inventories for the Speciality Agriculture division and increased receivables reflecting the strong second half in Engineering. Receipt of the disposal funds left the group with net cash of £4.2m, up from net debt of £14.1m at the end of FY22. The cash balance has been enhanced since the year end by receipt of a further £4m of deferred consideration.
h2 Outlook/h2The new financial year has started positively. The strong order book in Engineering (£60m) provides 85% cover for the year, with margins expected to benefit from additional volume and mix towards the higher value-added robotics activities. Speciality Agriculture had an improved Q1 in the UK with volumes up 20%. With management expecting a more normal seasonal pattern, that is, no repeat of the losses in H2, and cost pressures in agriculture abating the fundamentals point to an improved performance. However, this starts from a low point given the difficult H2, which suggests there should be a degree of caution.
h2 Forecasts/h2We have reduced our FY24 forecasts to reflect a shallower recovery profile in the Speciality Agriculture business, but we note the positive start to the current financial year. We have also introduced forecasts for FY25.
After the disposal of the Agricultural Supplies business, the focus is now on operational improvements and growth in the core Engineering and Speciality Agriculture divisions. In Engineering, this involves contract execution and addressing growth opportunities. In Speciality Agriculture, the focus is on returning to previous operating margins (FY21 operating margin ex JVs 12.4% versus FY23 4.5%) through both internal actions and leveraging the business’s strong brands in the market to promote volumes and pricing. These actions are supported by new management, including a new position of group transformation officer, and a new team in the UK Speciality Agriculture business. We expect to hear further details of the actions being undertaken in due course.
h2 Management changes/h2The board and executive management have been refreshed since the strategic review and disposal of the Agricultural Supplies division. The key appointments over the last year have been:
- Non-executive chair. Tim Jones joined the board as chair in February 2023.
- Non-executive director and senior independent director. Gillian Watson joined as NED in October 2023, subsequently taking over the role of senior independent director.
- Chief executive. David White was appointed in November 2023, having joined the group as CFO in January 2023.
- Chief financial officer. Gavin Manson joined the group as CFO in November 2023 in a nonboard position.
- Executive director of transformation. Martin Rowland was appointed in November 2023 having been a non-executive director since March 2023.
The different operating profile of the two divisions provides an added complexity to valuing the group, particularly from a relative peer group perspective. Hence, we use an ‘activity agnostic’ discounted cashflow valuation alongside a peer group valuation that considers the two activities separately.
h2 Discounted cashflow/h2Our DCF is based on a five-year forecast cash flow and terminal valuation. Exhibit 8 shows our DCF valuation per share relative to two key variables: the cost of capital (WACC) and terminal growth rate assumptions. Using a 10% WACC, relatively high due to the positive cash position, and a 2.0% terminal growth rate gives an indicative value of 149p per share.
Our peer group valuation considers the two divisions separately before combining them to generate an overall valuation for the group. The valuation is based on EV/EBIT multiples to ensure there is no impact from the financial structure of the peers.
Both methodologies suggest a valuation above the current share price. We also note that the DCF valuation is somewhat higher than the SOTP. This reflects the current weak performance in the Speciality Agriculture business. This hinders the SOTP valuation, which is based on short-term profitability, whereas the DCF longer-term valuation takes into account the expected recovery to historic levels of profitability. Hence, we see our DCF valuation as more reflective of the group’s inherent value.
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