PGW - PGG Wrightson

[Snoopy]

Where to start? Note 5 on page 49 of the annual report seems a good place. In calculating your $671k you have included the interest income that PGW gets from charging overdue account fees to their customers. I'm not sure why you would bother calculating that number given they tell you they paid line fees of $683k and interest of $923k for a borrowing cost of $1.6m.

Ah thanks for this. I had no idea that interest charged to customers for overdue bills would likely end up as interest income in the 'net interest and finance costs' note. I had imagined, obviously wrongly, that any 'penalty interest recovered' would go straight towards offsetting bad debts and not appear on the books as interest at all. I also imagined that this interest received as declared was from the banks on short term funds at PGW waiting to be redeployed. So I am grateful to be educated out of my wrong assumptions.

Applying $1.6m to your borrowing figure of $39.145m gives an interest rate of 4.1%. That seems a bit much, so there is likely a problem with the debt number. The first thing that stands out is that you included the $16.868m cash balance in your average debt calculation for the length of your P3 period. That seems like a big concession and likely makes your debt number $8.5m or so low ($16.868m x 6 months).

You are quite right. In reality, as it was announced at the AGM, that cash balance totalling $16.868m only materialised in the last week of the financial year as a series of due accounts were paid up. That means the debt level over that last P3 period (see my post 5044) will be significantly higher than the figure I calculated. And for a given interest payment that means that the actual interest rate being paid is lower than the interest rate I calculate.

However, if one investor had not posed an AGM question to the directors regarding their large cash balance at EOFY2020, we shareholders would be none the wiser that it had all come onto the books within days of those books being drawn up. It would certainly be unusual for any company to disclose cashflow movement week by week. There would be no way to know, from just looking at the end of year accounts of another company, that a last minute cash injection had not happened. So I would go with your indicative interest rate figure of:

($683k + $923k) / $39.145m = 4.1%

This is for consistency of calculation over different periods, even though we know from extra information in this particular case, that this interest rate result will be too high. Perhaps we have different expectations. But I think a 4.1% interest rate charge for a cyclical rural company with not insignificant debt is actually a good figure.

You could always try and reverse engineer the number by breaking it into components though this can be muddied up if PGW use interest rate swaps or other hedging tools. The facility looks to have a line fee component and an interest component, which will be a base rate + a margin. The line fee should be easy as it applies to the whole facility, so $683k / ($50m + $70m) = 0.57%.

Yes that makes sense. Whether the money is drawn on or not at any particular moment, PGW can expect to pay for having that facility available, $50m for short term and $70m for long term (AR2020 p54).

The interest rate will be harder as it only applies to drawn funds, which is why you need the average funds drawn number you tried to calculate. $923k of interest over say $45m of average borrowings = 2.2%. Might be a little high but the base rate will be one of the BKBM numbers (grab whichever one you like from the Reserve Bank, but for the PGW financial year will likely average 1%) meaning the margin is maybe 1.2%. That is probably reasonable so maybe $45m is the right number.

If I stick to my figure of $39.145m of average borrowings (which we have already discussed is very likely too low) I get a borrowing rate of:

$923k / $39.145m = 2.36%

Add that to the 0.57% 'facility fee' calculated above and I get an overall interest rate of:

2.36% + 0.57% = 2.93%

BKBM stands for 'Bank Bill Benchmark Rate' as set by the Reserve bank. It is probably different for 'on call' or 'three monthly', but we can choose 1% if you like as a good guess.

So my margin calculation is:

2.36% - 1% = 1.36%

You say 1.2% as a margin sounds reasonable. I say 1.36% as a margin sounds reasonable (even if I have doubtful ability to make such a judgement). Actually I would consider the interest margin to be the difference between a bank reference rate and the sum of the interest rate charged and the facility fee rate:

(2.36%+0.57%) - 1% = 1.93%

(Mind you I am thinking from a customer perspective not a banking perspective, so I may not know what I am talking about here.)

$1.6m of borrowing cost over $45m = 3.6%. That's higher than your residential mortgage rate, but they have line fees on undrawn facility headroom that a residential mortgage holder doesn't have.

2.2% - 0.57% = 1.6% ?

Sorry getting a bit confused on your last line. The 0.57% is calculated from the $683k facility fees is it not? Why are you subtracting that from the 2.2% derived from the $923k interest charge? Or have a got that wrong? Lost in the home stretch!

SNOOPY

[Somebody Else]

2.2% - 0.57% = 1.6% ?

Sorry getting a bit confused on your last line. The 0.57% is calculated from the $683k facility fees is it not? Why are you subtracting that from the 2.2% derived from the $923k interest charge? Or have a got that wrong? Lost in the home stretch!

SNOOPY

Yes the 0.57% is calculated from the $683k of facility fees. It doesn't get subtracted from the 2.2% rate, but nor does it get added to it while it is a percentage. To use the apples and oranges analogy the line fee is an orange because it applies to the whole facility. The interest charge is an apple because only applies to drawn funds. The only point to breaking them out is to see that they both look reasonable because it is the 2 numbers combined that are important.

Your starting point was the equation Average Debt x Interest Rate = Interest Expense. For PGW it is hard to work out because you only know the Interest Expense part of that equation, which is the $683k plus the $923k that they gave you in the annual report. You are trying to reverse engineer the other 2 numbers from it. $45m x 3.6% = $1.6m is where I came out. If you want to use a $39m debt figure, go right ahead, you just end up with a different interest rate.

[Leftfield]

Upgrade good news for holders....... see here.

[Balance]

Upgrade good news for holders....... see here.

Indeed - another profit upgrade.

Looks like the turnaround is not only gathering pace but is now in full swing.

https://www.nzx.com/announcements/364588

Guidance raised by another 17% and interim dividend guidance raised by 25% (8c to at least 10cps)

So guidance is for profit to increase by 50% in F21 over F20.

[Snoopy]

I will now continue my rework on the now realised capital repayment scenario. I have removed from this iteration a previously stated $3m contribution towards the pension scheme that continued into the future. This is because over FY2019, new CEO Stephen Guerin authorized a one off $10.274m contribution to the Defined Benefit Pension Scheme that brings it into actuarial balance.

	PGWRR FY2019 (EBITDA as reported plus forecast corporate savings)	PGW Rural Rump: Multi Year Average Scenario (excluding Pension Scheme Repair)
eps {A}	12.8c	18.0c
dps {B}	15.0c
PGW Rural Rump: Market Valuation {C}	$2.42	$2.42
PE ratio {C}/{A}	18.9	13.4
Gross Dividend Yield {B}/{C x 0.72}	8.6%
Gross Earnings Yield {A}/{C x 0.72}	7.3%	10.3%

Notes

1/ The PE ratio is now looking looking more reasonable for this type of business, as we seem to be in a lower part of the earnings cycle (that means PE can be higher). Nevertheless a PE of 18.9 is at the upper end of my comfort zone for cyclical agricultural retailer.
2/ The potential dividend yield looks O.K, but is IMO low for this kind of business.. The lesser than expected capital repayment has not made PGWRR debt free after all. This is no doubt because PGWRR has elected to keep spending to invest in the business.

In this low interest rate environment I would be prepared to buy with a gross earnings yield of 8.5%. This implies a 'post capital return and 10:1 consolidated' share price of:

$2.42 x 7.3/8.5 = $2.08

This is a significant fall from the market price of $2.42. I believe this means there is a fair amount of 'earnings recovery' already built into the PGW share price today. If an earnings recovery does not happen this year, then we shareholders might expect to lose around 14% of our invested capital in PGW (the downside risk).

OTOH, if earnings recover to more of a mean value from 'years recent past', that means the fair value share price for a gross earnings yield might rise up to:

$2.08 x 18/12.8 = $2.93

That represents a rise in value from today's quoted price of 21% (the upside risk)

Overall then, given the upside and downside risks, I would judge today's market price of $2.42 as not a bargain, but not overpriced either. $2.42 the epitome of 'fair value'? Looks like Mr Market might have it right with this one.

The above, I wrote in October 2019. It does look like we have since transitioned from a low point in the business cycle to a high point in the business cycle. With the share price closing at $2.88 yesterday (before today's profit upgrade) my upside price forecast of $2.93 looked pretty good too.

With today's announcement we have moved into a trading situation that has exceeded the historical average of recent years. Some may think this is a good time to get on the bandwagon and buy more. Whether that is a good idea or not will depend if this bullish update is a baked in reflection of improved trading from now on, or simply riding the high crest of the top of the business cycle. If the latter then buying today could be thought of as taking an extreme investment risk. I suspect that those buying today on the assumption that 'this is the beginning of a wave of endless growth' will find there are better entry points a few years down the track.

I won't be buying more because I have been bitten by PGW in past cyclical downturns. But neither will I be selling. However, I don't need to buy more because I have already accumulated a balanced stash (OK I am probably a little overweight) at well south of today's prices.

SNOOPY

[Balance]

The above, I wrote in October 2019. It does look like we have since transitioned from a low point in the business cycle to a high point in the business cycle.

High point?

Try reading 'turnaround' story now gathering growth momentum.

Profit growth

plus

high yield

plus

takeover potential

Few stocks in the NZX meet the above criteria.

Thanks for all the scare-mongering, Snoppy - been great picking up stock at $2.55!

[Leftfield]

High point? Try reading 'turnaround' story now gathering growth momentum.....
Thanks for all the scare-mongering, Snoppy - been great picking up stock at $2.55!

Well done Balance. I like turnaround stores. How long have you been collecting this one (and what prompted you?)

[sb9]

High point?

Try reading 'turnaround' story now gathering growth momentum.

Profit growth

plus

high yield

plus

takeover potential

Few stocks in the NZX meet the above criteria.

Thanks for all the scare-mongering, Snoppy - been great picking up stock at $2.55!

Could well get close to $3.50+ in the near term, nice gains on my pick up price of $2.28+ dividends along the way...

[Balance]

Well done Balance. I like turnaround stores. How long have you been collecting this one (and what prompted you?)

I have had PGW for a while and added on more since the capital return and then, since BAIC buy in.

[DDog]

Lack of sellers