Updated: Jun 12, 2022
Ever since Russia’s invasion of Ukraine on February 24, much has been said about the threat to the upcoming planting/farming season in the very fertile farmlands of the Black Sea region. As millions of Ukrainians have fled the country, wheat and corn futures (among others) have surged by between +15.0% and +12.0% respectively since the start of the invasion. Russia and Ukraine together provide nearly one-third of the world’s wheat and barley exports, with Ukraine also being a leading exporter of corn and sunflower oil. Europe is already bracing for shortages and increased prices which would trickle down to prices of livestock feed and into the meat and dairy industry. This food insecurity will also reach Egypt (the world’s largest wheat importer), Lebanon and as far as Indonesia, throwing more people into poverty. That said, fertilizers have also surged with companies such as Nutrien (NTR), CF Industries (CF) and Mosaic (MOS) adding +32%, 23% and 31% respectively in that very same timeframe since the invasion. On the longer term, sanctions could restrict Belorussian and Russian Potash which account for nearly 35% of global capacity. Nitrogen prices are also expected to remain high given the current high natural gas prices. Fertilizers aside, anything Ag related has rallied in the last three weeks with the MSCI Global Agriculture ETF (VEGI) advancing +10.3%. In light of the much higher pricing dynamic and given increased reliance on agricultural commodities from different geographic regions (namely North America), we find that at present, most value can still be found with the grain handling companies. Companies such as Bunge (BG) or Archer-Daniels-Midland (ADM) have increased by +9.5% and +12.0% respectively since the Russian invasion. We feel that the sector laggard - Ag Growth International (AFN.TO), +7.0% is worth a re-visit.
Ag Growth has largely underperformed the sector since the initial Covid shutdown in March 2020 and has not recovered since, largely due to the negative overhang surrounding a commercial bin grain storage collapse in September 2020. Investigations into the bin failure and corresponding litigation has dragged over the course of the next two years but in light of the recent Q4/2021 financial results disclosed on March 9, 2022, management believes that they have finally fully provisioned for the costs associated with the bin failure. Accruals to date have amounted to $86.1M. The accruals are expected to cover any potential settlement costs related to the legal claims which amount to nearly $200M, however it is believed that the chances of those charges materializing are relatively low. It is not expected that any additional provisions will be taken later in 2022, as was stressed on the quarterly conference call.
On the operating front, Q4/2021 sales of $327M and EBITDA of $44.7M grew by 44% and 66% and beat consensus by approximately 13% each. International sales posted the highest growth rates with quarterly sales and EBITDA in Brazil increasing by 270% and 630% respectively. Overall EBITDA margins increased by 150 bps to reach 13.7% with management expecting an increase to 17% for FY/2022 (14.7% in FY/2021) resulting in an EBITDA of at least $200M. Negative correlations to diversified Ag sector peers can be attributed to the 2+ years of company specific underperformance. We believe that the solid fundamentals going forward (record backlog, margin expansion, balance sheet deleveraging) coupled with the waning overhang of the bin failure provides for a solid entry point at the current levels. We believe that reversions to mean (positive correlations to peers) will gradually re-establish itself going forward.