PGW - PGG Wrightson

[Snoopy]

What would Munger say about their use of EBITDA and then an analysts subsequent use due to their use?

May as well just use Revenue!

Unless this business is extremely capital light then makes sense not to use BS earnings.

I use EBITDA to work out the changes in net revenues. After I have done that, THEN I can translate the result to NPAT. That is the plan.

SNOOPY

[SailorRob]

I use EBITDA to work out the changes in net revenues. After I have done that, THEN I can translate the result to NPAT. That is the plan.

SNOOPY

Fair enough, Munger would reluctantly admit that was ok.

[Snoopy]

This means that if animal farming continues in its funk for another year, but horticulture improves back to FY2023 levels, then EBITDA for PGW over FY2025 becomes: $43m + $1m = $44m. yay! (given the magnitude of the potential EBITDA increase, using capital letters to express my joy would seem an overkill.)

I want to open this post by saying I don't try predict where interest rates are going within a two year time horizon. That kind of exercise is too hard, even for a Snoop. But what I am interested in predicting is the quantum of bank borrowing that is likely for PGW over FY2025.

We do know that the full year EBITDA for FY2024 is forecast to be $43m.
We do know that the half year EBITDA for HY2024 was $37m. So that means a forecast EBITDA of $43m - $37m = $6m is expected for the second half.

In round figures the interest bill for the second half year will be $4.7m (see post 5696). That leaves a the princely sum of $6m - $4.7m = $1.3m To pay down debt. great .

Actually the real amount of cash available to pay down debt is different to this. If you look at HYR2024 and the balance sheet on p23, it looks like debt has blown out massively from the full year, by a net more than $30m. (from $65.317nm to $96.833m). But this is an operational seasonal effect. Put simply PGW has to buy in stock to sell to their farmer clients over Spring. So the apparent 'blow out in debt' is offset against a rise in inventory ($107.533m -> $130.769m). As store merchandise is sold down, PGW will need to decide how much inventory to hold for the next farming year. And if the next farming year is going to be difficult then PGW could elect to hold less stock in store, and put that 'saved stocking capital' into reducing debt.

What I am suggesting here is that although at first glance PGW has only $1.3m to pay down their long term debt, the reality could be a lot higher as 'inventory money' gets recycled. I don't think it is possible to know by how much management may seek to pay down debt. But it might be possible to work out by how much the banks would like debt to be paid down. So let's try to get an estimate of that figure. And so we dive into the thorny topic of 'banking covenants.' I have looked at this previously. The main 'covenant of contention' looks likely to be the 'Fixed Cost Coverage ratio' or FCCR for short.

SNOOPY

[Snoopy]

I don't think it is possible to know by how much management may seek to pay down debt. But it might be possible to work out by how much the banks would like debt to be paid down. So let's try to get an estimate of that figure. And so we dive into the thorny topic of 'banking covenants.' I have looked at this previously. The main 'covenant of contention' looks likely to be the 'Fixed Cost Coverage ratio' or FCCR for short.

The interest payments have a dual role in this calculation. One as the interest payment that PGW must make to their banking syndicate (rather obviously), with the second role being the cost base for the 'GoLivestock' loans that I am required to remove from EBITDA as a cost of doing the finance side of the business (because all operational costs of doing business should be removed when EBITDA is calculated). Time to restore the 'GoLivestock Interest Cost' figure back to just the interest cost, not including the banking facility set up cost? Not now.

I call it the 'Go Livestock Interest Cost'. But actually it is a cost derived from the interest paid on the combined short and long term bank loans. You could argue that those loans belong to PGW in general, and are not specific costs that are to be matched up against 'GoLivestock' income. I would argue that it is best not to think like that, because the 'stock loaned against' numbers have gone up with the 'GoLivestock' loan book going up in value. That means it would be possible to pay off all company debt should the GoLivestock program be completely wound down (EOFY2023 perspective). History has shown that to work through retailing business cycles, having no company debt (disregarding all of the retailers lease agreements which are quite onerous enough in themselves) can be smart business practice. So I think it is reasonable to consider at the full year balances date, the retail and agency arms of PGW as 'debt free company divisions', with an add on finance division ('GoLivestock'), which does carry an appropriate level of debt.

Post 5476 gives an indicative cost of funds rate of 7.1% (this figure excludes the bank facility set up costs, and is 'interest only') on an average debt balance of $64.552m. In funding cost terms, this translates to a dollar amount of: 0.071 x $64.552m = $4.583m over the year. We now have the information needed to complete our bank covenant equation.

FCCR= [(EBITDA - 'GoLivestock Interest Cost'] / [Total Interest(less interest income in cash)+ Banking Facilities Charge+(Lease Expenses)]

= [$61.194m - $4.583m] / [($4.565m-$0.485m)+$0.956m+($3.800m+$19.532m)] = 2.0 which is just equal to the targeted 2.0 figure.

All good then. But with a covenant like this going 'so close to the wire', you do wonder what would happen if the EBITDA falls as forecast over FY2024.

We don't have (and won't until the FY2024 results are released) all of the information needed to calculate the Fixed Cost Coverage ratio for FY2024. But we can do a quick approximation by putting the one figure that management has managed to forecast (EBITDA for FY2024) into the FCCR equation for FY2023. We are of course assuming that bank facilities charges and lease expenses are not going to change much year to year when we do this.

FCCR= [(EBITDA - 'GoLivestock Interest Cost'] / [Total Interest(less interest income in cash)+ Banking Facilities Charge+(Lease Expenses)]
= [$43.000m - $4.583m] / [($4.565m-$0.485m)+$0.956m+($3.800m+$19.532m)] = 1.35 which is well less than the targeted 2.0 figure.

As an alternative hypothetical scenario, what would happen if all bank facilities were repaid?
FCCR= $43.000m / [($3.800m+$19.532m)] = 1.84 which is still less than the targeted 2.0 figure.

'Paying back all debt' would also entail winding back the 'GoStock' finance lending program. That is definitely something that PGW would not want to do. Neither would it please their banking syndicate, as this program is very beneficial for both.

My pick is that PGW will be given a waver for meeting their FCCR covenant on the 30th June 2024 reference date, on the understanding that if the GoStock program was wound down on that date, then all of the bank debt could be repaid. But without an improvement in farm commodity prices, things could get 'interesting' at PGW over FY2025.

Traditionally when New Zealand as a nation cannot earn enough to pay its import bill the NZ dollar takes a hit, thus improving farmers returns on an NZD basis. That may indeed happen, which would help out PGW. The other thing that could give PGW a more immediate boost would be 'asset sales'. PGW have sold off most of the family silver. But one jewel does remain that is not so tightly integrated into the group that it could be let go: Fruitfed. As a shareholder I would feel the pain if that were to go. But with prospects looking up at Fruitfed, PGW could get a good price. And if that would eliminate the bank debt worries, such a strategy might be worth pursuing.

Back to the subject of this post. A 10% reduction in inventory levels from the HY2024 peak would allow $13.1m to be directed to paying down debt. Add that to the $1.3m pay down identified in 'Part 1' and I get $14.3m of long term debt 'paid off'. At an interest rate of 7.1%, this would reduce the annual interest bill by: 0.071x $14.3m= $1.0m.

This means the net interest bill for PGW over FY2025 reduces from $4.7m to $3.7m

SNOOPY

[Snoopy]

Finally the post that 'the Sailor' (and Charlie Munger) have been waiting for.

	FY2025	FY2024	Reference
EBITDA	$44.000m	$43.000m
less I	$3.700m	$4.700m	Post 5714
less DA	$28.666m	$28.666m	Post 5696
equals NPBT	$11.634m	$9.634m
less T @28%	$3.258m	$2.698m	Post 5696
equals NPAT	$8.376m	$6.936m
No. Shares on Issue	75.484m	75.484m
eps	11.1cps	9.2cps

Based on a share price of $1.65, this means PGW is currently trading on a PER of 18 on FY2024 earnings and 15 on FY2025 earnings. Based on these numbers, and the ongoing need to reduce debt, I would expect no final dividend, and the dividend to remain suspended over FY2025. Nevertheless for shares at the bottom of an earnings cycle I see value here. Yet with no dividend on the horizon, I feel no urgency to increase my holding.

SNOOPY

[nztx]

An indication of what's going on out there - Rural:


https://www.nzherald.co.nz/nz/rural-...GRJY5VYNV4C5A/

Rural banking: Farming families facing ‘huge pressure’ - Federated Farmers

Farmer confidence in their banks has plummetted to the lowest level in nearly a decade while the government considers the need for an independent inquiry.

Federated Farmers carried out a banking survey of more than 640 farmers in May that found only 51 per cent of them were satisfied with their banks.

This was down from 80 per cent in 2018.

While a quarter of survey respondents were neutral on the topic, more than 23 per cent said they were dissatisfied or very dissatisfied with their banks - a new record high for the survey that has been running since 2015.

The lobby group’s commerce and competition spokesman Richard McIntyre said farmers faced higher interest rates than their urban counterparts.

[blackcap]

Went to my local PGW yesterday to buy a salt block. Store was empty bar one other customer. I did ask the girl at the counter how business was and she said quiet. There is a lot of stuff that PGW etc sell that farmers can easily defer for better times... There are essentials but also not. Hard times at the moment and that is why PGW is trading at cyclical lows. Possibly a good entry point. I am trying to buy more at $1.61 and will keep topping up if it declines further.

[kiora]

If they can't afford to put the inputs in they won't be able to get the outputs

https://www.rnz.co.nz/news/country/5...erated-farmers

This is serious for farmers

One only needs to look at what happened to Sri Lanka when inputs were cut

https://reason.com/2022/09/07/when-s...ntry-imploded/

https://www.rnz.co.nz/news/country/5...fertiliser-use

[Snoopy]

If they can't afford to put the inputs in they won't be able to get the outputs
https://www.rnz.co.nz/news/country/5...erated-farmers

This is serious for farmers

One only needs to look at what happened to Sri Lanka when inputs were cut
https://reason.com/2022/09/07/when-s...ntry-imploded/
https://www.rnz.co.nz/news/country/5...fertiliser-use

Yes the situation is serious for some farmers at least. But there is some relief in those references you posted. I see the global fall in the price of fertilizer over the year to February 2024 was 50%. That will be a massive shot in the arm for farmers. And the article on Sri Lanka was primarily about the banning of synthetic fertiliser. Synthetic fertiliser is not banned in New Zealand.

You seem to be a bit 'nervous nellie' about the state of our farmers Kiora. What is your angle in this? I thought the last two articles you referenced were actually quite bullish for NZ farmers in the medium term at least. Did you even read the articles?

SNOOPY

[blackcap]

Yes the situation is serious for some farmers at least. But there is some relief in those references you posted. I see the global fall in the price of fertilizer over the year to February 2024 was 50%. That will be a massive shot in the arm for farmers. And the article on Sri Lanka was primarily about the banning of synthetic fertiliser. Synthetic fertiliser is not banned in New Zealand.

You seem to be a bit 'nervous nellie' about the state of our farmers Kiora. What is your angle in this? I thought the last two articles you referenced were actually quite bullish for NZ farmers in the medium term at least. Did you even read the articles?

SNOOPY

Correct Snoopy, the Sri Lankan debacle has no relevance to NZ. They fell hook line and sinker for the no fertiliser nonsense and really buggered up their economy.
Farmers are struggling, but they are resiliant and cycles change. PGW should be able to weather this short term storm.