PGW - PGG Wrightson

[Snoopy]

I have always liked the company but I do feel the next results won't thrill, the last one's didn't. My reasoning is the RE division will be down and quite possibly the retail side as well with farmers under huge cost pressure. I would expect the company to have expenses rising as well.
I would rather be in than out but I am expecting a bit of a down cycle which was showing on the last results.

I can't help but agree with you Mike2020. The rural real estate business is a bit feast or famine. The one saving grace is that rural land is valued by the income that can be earned from it. So as long as commodity prices hold up, the price of the land producing those commodities should hold up too.

Labour cost pressure is an issue for all companies in a inflationary environment, But as of two years ago, PGW had a policy of paying all employees the 'living wage'. I guess the living wage has gone up since that time. But it should mean the wage cost pressures are not as intense, in the short term at least, as those companies with many workers on the minimum wage.

I concur with your comments that FY2023 may be a the start of a 'down cycle'. But the thing I like about PGW is their exposure to a wide range of farming commodities: Dairy, beef, lamb, fruit - including the prized kiwifruit-, and other field crops like wheat and forage. In my experience it is very rare for all commodities to sink to a low price point at the same time. So PGW sales have a built in cross commodity 'averaging effect' across different commodity cycles. I never try to predict what the individual commodity cycles are. Instead I 'react' to expected low commodity prices, and use such situations as an opportunity to add to my PGW shares cheaply. I have been on the Wrightson (as it was then) share register since 1995 in a small way. However around 2014 was when I got serious about it. My average buy in price is $1.78, plus useful divvies in most years along the way. So I guess you could say my strategy is working !

SNOOPY

[Snoopy]

	EBITDA	add Associate Profit	less D&A	less Net Interest	less Income Tax	equals NPAT	less Property sales	equals Adjusted NPAT {A}	No. Shares on Issue {B}	eps {A}/{B}
FY2014	$58.747m	$2.521m	$11.242m	$6.262m	$8.472m	$35.312m		$35.312m	754.8m	4.7c
FY2015	$69.500m	$0.181m	$7.948m	$7.921m	$16.172m	$37.640m	$0.960m	$36.680m	754.8m	4.9c
FY2016	$70.181m		$9.170m	$9.016m	$8.832m	$43.163m	$4.990m	$38.173m	754.8m	5.1c
FY2017	$64.499m		$10.733m	$6.540m	$10.428m	$36.728m	$8.740m	$28.058m	754.8m	3.7c
FY2018	$70.174m		$12.974m	$9.986m	$12.460m	$34.754m	$1.700m	$33.054m	754.8m	4.4c

Notes

1/ (New) I have looked at the 'Interest- Finance Income and Expense' note (7 in AR2018) and removed the foreign exchange effects when calculating the net interest bill.
2/ I have removed the contribution of property sales from the result as these are not indicative of operational performance.
3/ Associate profits are included in Operating EBITDA from FY2016 forwards.

After trending upwards for the first three years of our comparative periods, there was a sharp drop in normalized profit in FY2017, after which there has been just a partial recovery. Normalised profit is lower than five years ago.

Conclusion: Fail Test

There is only one 'crossover year' (FY2018) in the above referenced post with this one. However results for FY2018 in this post have been restated to include only those from the NZ based farm service business. The seed business, now sold, has been removed from the profit figures in this post.

Profit Normalisation table	FY2022	FY2021	FY2020	FY2019	FY2018	Reference
Declared Profit	$24.286m	$22.720m	$7.133m	$4.510m	$9.004m
less (add) Fair Value Gains (Losses) net of Impairments	0.72x$2.182m	0.72x($1.832m)	0.72x$0.807m	0.72x$3.187m	0.72x$1.086m	AR Note 5
less (add) Foreign Exchange Gains (Losses)	0.72x($0.430m)	0.72x$0.094m	0.72x($0.178m)	0.72x($0.812m)	0.72x$1.035m	AR Note 6
less (add) Standardbred Business Profit (closed business unit)					($0.707m)	Post 5341
less (add) IFRS16 adjustment	0.72x($0.613m)	0.72x($0.613m)	0.72x($0.027m)			Post 5347
less (add) Non operating gains (losses)	0.72x($0.699m)	0.72x($4.456m)	0.72x($0.132m)	0.72x$2.170m	0.72x$7.024m	AR Note 4
equals Normalised Profit	$24.603m	$17.819m	$7.471m	$7.782m	$14.881m

Notes

1/ I don't believe there is sufficient disclosure in AR2022 to allow us to calculate an IFRS16 profit adjustment for FY2022. In the absence of this, I have rolled forward the IFRS16 adjustment for FY2021 into FY2022, assuming it to be the same.
2/ Earnings per share calculations (below) have been adjusted to take into account the 9th August 2019 10:1 share consolidation, reducing the number of shares on issue to 75.484 million.


Earnings Per Share Calculations

FY2018: $14.881m / 75.484m = 19.7c
FY2019: $7.782m / 75.484m = 10.3c
FY2020: $7.471m / 75.484m = 9.9c
FY2021: $17.819m / 75.484m = 23.6c
FY2022: $24.603m / 75.484m = 32.6c

The extraordinary drop in profits between FY2018 and FY2019 had me diving back to my FY2019 annual report to see what went wrong.

From AR2019 p5.
"Reflecting on FY2019, we believe it was one of the most operationally challenging of recent years. Farmer confidence in parts of the agriculture sector remains subdued, constraining farm spending and therefore our revenue for the year. This has also been evident in recent months with a discernible tightening of the credit environment"

From AR2019 p6:
"The impact of mycoplasma bovis (present in NZ since mid-2017) was felt across the livestock and rural supplies business. Most particularly with reduced dairy herd settlements, a reduction in tallies, a softening in demand for dairy beef and and a more cautious approach to spending in the dairy sector across a range of farm inputs."
"Market conditions continued to challenge both our Real Estate and Wool businesses with results down on last year."

That all seems like a reasonable 'excuse'. But I guess it reflects the view that when the dairy industry catches a cold, it is hard for the rest of the farmers in NZ in other sectors to make up the lost income. Two down years in a row is enough to sink this test result.

Conclusion: Fail Test

SNOOPY

[Snoopy]

ROE here is defined as: (Adjusted NPAT) / (End of Year Shareholder Equity)

FY2014 : $35.312m/ $269.7m = 13.2%
FY2015 : $36.680m/ $267.4m = 13.7%
FY2016 : $38.173m/ $274.3m = 13.9%
FY2017 : $28.058m/ $289.7m = 9.7%
FY2018 : $33.054m/ $287.5m = 11.5%

Conclusion: Fail test

ROE here is defined as: (Adjusted or Normalised NPAT) / (End of Year Shareholder Equity)

FY2018: $14.881m / ($123.7m + ($292m-$234m)) = 8.19%
FY2019: $7.782m / ($398.264m-$234.000m) = 4.74%
FY2020: $7.471m / $156.702m = 4.77%
FY2021: $17.819m / $173.538m = 10.3%
FY2022: $24.603m / $172.684m = 14.2%

Notes

1/ A retrospective balance sheet for FY2018, assuming the Seed Business was already sold at the 30-06-2018 balance date, was prepared in the Korda Mentha October 2018 report (p36, p49). This provided a view of what a stand alone balance sheet for the PGW rural servicing business would look like. This was based on a projected capital return, following the purchase of the seed business by DLF Seeds A/S of Denmark, estimated at $292m. In fact the capital return would end up being only $234m. The difference between these two capital return numbers - equalling capital not paid out - I have added to shareholders equity as at 30-06-2018 for the purpose of calculating return on the total equity for FY2018.

2/ The $234m capital return eventually took place in FY2020, on 09/08/2019, following the settlement of the 'seed deal' on 01/05/2019. These two dates straddle the PGW end of year reporting date of 30-06-2019. A capital return was well signalled. So I believe it would be most representative to remove the capital return from the shareholder equity held on the books at the 30-06-2018 balance date for the purposes of making a 'Return on Equity' calculation.

An interesting observation to note is how far the return on equity figure has fallen in 2018, as the transition to the 'new PGW' was made in divesting the seeds business. The seeds business was where most of the intellectual property of PGW was held. And successfully exploiting intellectual property will generally yield a higher commercial return on assets than selling commodities. Given this, it is no surprise that the ROE over 2018 has dropped with the removal of the seed division. But it is quite sobering to see ROE almost cut in half!

None of the above makes a difference to the 'Buffett ROE picture', as ROE is consistently below the 15% goal for all years under consideration. But given the sharp improvement in the fortunes of the PGW rural servicing business over the last couple of years, I do wonder how high the ROE would have risen if the seeds business had not been sold.

Conclusion: Fail Test

SNOOPY

[Snoopy]

This test does not mean that PGW will always be able to raise margins above the rate of inflation. But it does mean that under certain market conditions it can, thus avoiding an eventual commodity price spiral to the bottom. The revenue associated with the now sold finance division has been removed from the appropriate years

Margin here is defined as: (Adjusted NPAT)/(Sales)

FY2014 : $35.312m/ $1,219m = 2.89%
FY2015 : $36.680m/ $1,203m = 3.05%
FY2016 : $38.173m/ $1,182m = 3.23%
FY2017 : $28.058m/ $1,133m = 2.48%
FY2018 : $33.054m/ $1,194m = 2.77%

Three years of improving margins from FY2014 to FY2016 inclusive shows that sustained margin improvement is possible.

Conclusion: Pass Test

This test does not mean that PGW will always be able to raise margins above the rate of inflation. But it does mean that under certain market conditions it can, thus avoiding an eventual commodity price spiral to the bottom. The revenue associated with the now closed down Standardbred division has been removed from the appropriate year (FY2018).

Margin here is defined as: (Adjusted NPAT)/(Sales)

FY2018: $14.881m / ($808.695m - $10.421m) = 1.86%
FY2019: $7.782m / $798.834m = 0.974%
FY2020: $7.471m / $788.036m = 0.948%
FY2021: $17.819m / $847.815m = 2.10%
FY2022: $24.603m / $953.700m = 2.58%

Notes

1/ AR2020 p35 states "The 2019 comparatives have been restated to represent the 'Standardbred' business as a discontinued operation. Now we know that in AR2019 overall revenue was listed as $809.965m. The restated comparative figure for FY2019 was $798.834m. So I am making the assumption that the comparative difference:

$809.965m - $798.834m = $10.431m

represents the turnover of the now closed 'Standardbed' operation over FY2019. The turnover for 'Standardbred' over FY2018 has not been revealed. But as a best guess I am assuming it was the same as over FY2019.

------------------------

Three years of improving margins from FY2020 to FY2022 inclusive shows that sustained margin improvement is possible.

Conclusion: Pass Test

SNOOPY

[Snoopy]

The table below reflects the dividends actually paid during the years in question.

Year	Dividends Paid 'per share'	Sub Total	PGW Rural Servicing Normalised Earnings 'per share'
FY2018	20.0cps + 17.5cps	37.5cps	19.7cps
FY2019	12.5cps + 7.5cps	20.0cps	10.3cps
FY2020	7.5cps + 9.0cps	16.5cps	9.9cps
FY2021	0.0cps + 12.0cps	12.0cps	23.6cps
FY2022	16.0cps + 14.0cps	30.0cps	32.6cps
Total FY2018 to FY2022 inclusive		116.0cps	96.1cps

Notes

1/ For FY2018 and FY2019 I have adjusted the 'dividends per share' and 'earnings per share' to be consistent with the subsequent 10:1 share consolidation,

----------------



Discussion: What is a sustainable business cycle dividend range from 'the new PGW'?

The farming years from FY2018 to FY2022 certainly cover a business cycle. But that time period also spans perhaps the most significant restructuring ever of PGW itself. What insight into future farming cycles might we take from this historical earnings and dividend record? Because PGW is such a mature business, the past can reflect on the future. I think it is best to examine what has happened 'year by year'.

FY2018 (Ending 30th June 2018)
The acquisition of PGG Wrightson's seed division by DLF seeds of Denmark was announced on 5th August 2018. However, it is safe to assume that preliminary negotiations were going on for months before that. Nevertheless the dividends paid over FY2018 would have been from the old PGW 'combined business'. For this pre-split PGW business over FY2018 (see post 5352, referred post), I would consider 'eps' to be:

$33.054m / 75.483m = 43.8cps

Earnings of 43.8cps would see the actual dividend paid over FY2018 of 37.5cps well covered. But such earnings will not be coming PGWs way in the near future. So it would not be reasonable to expect the level of dividend paid over FY2018 to be indicative of any future dividend payments.

FY2019
Re-reading the Chairman's and CEOs commentary for FY2019 (AR2019 p5), much is made of the $138.1m NPAT (even though only 5.6% of that - $7.782m, or 10.3cps - was from continuing normal operations). There must have been considerable reserve in the imputation credit account to allow for the annual dividend paid over FY2019 to be nearly twice the continued operating earnings figure! How was this even possible? It may have just been prudent management using up any imputation credits previously accumulated by the seeds division and set to expire when its controlling shareholder changed. Furthermore, it may have been that some of the funds that were on the books for FY2020's 'capital repayment', (the capital repayment that eventually ended up being less than forecast), were instead directed towards a higher dividend over FY2019 than any reasonable shareholder might expect (A $7.32m cumulative higher dividend based on continuing operational profitability). My conclusion, given that actual dividends paid were nearly four times remaining operating earnings, is: "As a 'forward indicator', the actual dividends paid over FY2019 should be ignored."

FY2020
It is disappointing to see a small pull back on net profit margin over FY2019. But this could be explained by the higher holding costs associated with getting more stock in earlier to try and get around Covid-19 induced supply chain issues. This means I am not convinced a new downtrend in net profit margin has started.

This year saw a big improvement in operational cashflow. Included in that is a $15m (or 19.8cps) turnaround in the trade creditor balance (AR2020 p63). Perhaps this is what gave the company the confidence to pay yet another dividend well in excess (+67.7%) ahead underlying earnings? I am not sure where the imputation credits to cover the hyper dividends of FY2020 came from. The Agria friendly board has been very assiduous in extracting as much cashflow as they can from PGW over the years: fully imputed dividends matching profits. So it seems very unlikely that, since Agria became a controlling shareholder, a stash of unused imputation credits at PGW has been building up over an extended time frame - particularly so given the previous years apparent 'clear out of imputation credits'. How to explain it then? Perhaps there was some clever part of the seed division sale deal where new imputation credits were generated on the sale of seed stock to DLF seeds of Denmark's NZ Branch? That explanation sounds contrived. But when more likely explanations are eliminated, then the less plausible explanations are what remain. I am happy to be proved wrong, if someone can come up with a better explanation of where all of those excess imputation credits to fill out the hyper FY2020 dividends came from! Nevertheless, my conclusion is that FY2020 was also a financial outlier in terms of indicating where future dividends might go.

FY2021
In this 'new era of PGW' (i.e. after shedding the seeds division), there were only two years, FY2021 and FY2022, where earnings exceeded dividends. FY2021 ended in June 2021. So the first half of FY2021 covered the second half of CY2020. CY2020 was the year New Zealand went into 'Covid panic'. The pandemic arrived in New Zealand in early 2020, with Major Alert Level 4 restrictions imposed on 30th March. By that point PGW had already committed to their April 9th 2020 dividend, paid for by payments from farmer customers and already in PGW's bank. However, as 2020 progressed, logistical concerns of getting NZ farm product to international markets became a real concern. PGW became 'conservative' (rightly so IMO) and did not pay their customary October (2020) dividend. Dividend payments were back on stream by April 2021, as it became clear that even in a Covid-19 affected world, international buyers were prepared to 'pay the freight' for quality NZ farm produce. This explains why FY2021 was an 'outlier' in terms of the extra low 'dividend payment ratio'.

FY2022
The dividends paid during FY2022 represent the recent high water mark in operational earnings, and are certainly sustainable if profits hold up. The cyclical nature of farming though, would suggest that the FY2022 'good times' may not last forever. Nevertheless as a portent of future 'good times', I believe the FY2022 level of dividend is indicative.

Conclusion
Only the FY2022 dividend payments qualify as future dividend indicators. In the past, in exercises like this, I have used all of the previous five year dividend payments as 'future dividend indicators'. That was using the assumption that management generally know more than we shareholders, and could 'look through' any unusual single year events to provide a smoothed multi-year dividend stream. However, if you read through some of the individual dividend report years above, there are events that have happened that cannot be 'looked through'. In this special instance I propose to use historical earnings, rather than historical dividends, to forecast future dividend payments as part of a 'capitalised dividend valuation' model.

SNOOPY

[Snoopy]

Underlying NPAT for FY2019 was $10.987m (my post 4642) based on EBITDA of $28.725m. That is equivalent to eps of 14.6c. Dividend over the last year was the equivalent of 15cps. So dividends are already greater than underlying earnings, albeit 'in the ballpark'. If EBITDA rises to something above $30m that corresponds to an EBITDA increment of $1.175m. If all of that flows through to profit, then the incremental eps is:

($1.175m x 0.72) / 75.484m = 1.1cps

The forecast increase in interim dividend from 7.5cps to 8cps will be covered by this. As will an increase in final dividend to the same. So no real news in this mornings announcement, except that it looks like all earnings will be paid out as dividends into the future. The influence of Agria continuing?

It is a mathematically dodgy thing to do to extrapolate from a small number of data points. But if we take last years dividend of 15cps and link that in to a possible dividend of 16cps for FY2020, that makes for a 15.5cps average. If I use my pre-established gross required yield for this company of 8.5%, we can calculate a 'gross dividend capitalised valuation' of PGW as follows:

15.5c/ (0.72 x 0.085) = $2.53

That is fairly close to where the company is trading right now. The MDRT threat that I outlined in 4657 is real. But it will only become apparent if interest rates start to rise again. And as Stephen Guerin has announced a new lower more competitive interest rate he has negotiated with the banks, he has effectively kicked this 'debt threat' down the road.

The above quoted post is based on the FY2019 dividend viewpoint. As per the previous post (5355), I have now reverted to past earnings to give us the best forecast of a 'capitalised dividend valuation' from here going forwards.

The five year earnings per share average for FY2018 to FY2022 inclusive is: (19.7c+10.3c+9.9c+23.6c+32.6c) / 5 = 19.2c

The capitalised dividend required rate of return I have selected is 8.5%. I believe that this is appropriate for a retailer with a relatively weak moat that services a set of customers at the mercy of the weather gods. This means my 'fair value' centre of business cycle valuation is now:

19.2c / (0.72 x 0.085) = $3.14

At $3.14, PGW would be on a normalised historical PE of 314/32.6 = 9.5. That sounds about right for a no growth high yielding share. However PGW closed on the market today at $4.49. That implies of PE of: 449/32.6 = 13.8. Yes I know the share price has traded a whole dollar higher than this within the last twelve months. But $4.49 does seem a lot of money to pay for an agricultural share riding into the high of a business cycle wave.

My 'rule of thumb' is to both add and subtract 20% from the centre of business cycle valuation, to get an idea of where the share price should sit as the business cycle fluctuates.

Upper Cycle Value: $3.14 x 1.2 = $3.77
Lower Cycle Value: $3.14 x 0.8 = $2.51

I notice one area of agriculture where PGW do not have much of a presence is forestry and logging. But if one shareholder were to start chopping at that $4.49 share price and another shareholder cried 'timber', could that be the start of it?

SNOOPY

discl: Still holding, and thinking about what to do.

[Snoopy]

“BAIC have advised that their investment in PGW is strategic in nature and has been made with the aim of exploring future closer ties between New Zealand and China as a major export market for agriculture."

PGW is a retailer selling supplies to NZ farmers. All the IP went out of the door with the sale of the seed division. How will China owning a share of PGW help develop China as an export market for NZ farmers? To me the reason for acquisition by BAIC of the now 11% stake in PGW is vague and doesn't really stand up to scrutiny.

The recent peak in PGW share price prior to the seed division divestment was 71c on 8th June 2018. Following the sale of the seed division, a 31cps capital distribution was made. So the equivalent highest PGG Rural Rump price was: 71c - 31c = 40c. There has been a 10:1 share consolidation since. So the PGG Rural Rump price at its highest was the equivalent of $4. At the time it was speculated that Elders might be interested in buying PGW. But that price was judged too high and no bid came.

I find it doubtful that BAIC would pay an equivalent price to what Elders would have paid as I can see fewer synergies. Take 20% off $4 (a price that Elders was not prepared to pay) and I get $3.20. To me that would be the upper bound of any takeover price from BAIC for PGW. With no takeover bid we might expect PGW to trade at a price 15-20% below $3.20. That translates to an indicative price range of $2.56 to $2.72. With PGW shares trading at $2.98 today, the risk/reward buying in at that price looks marginal.

Interesting speculation from me 2.5 years ago, questioning the reasons for Chinese Government interest in PGW. Elders have quite recently bought the Chinese government stake and are now on the PGW share register at $4.35 (although $4 was judged too high a price for Elders to pay back in 2018). The Chinese government are now out of PGW for quick profit of more than $1.50 per share in just 2.5 years. So which side was a winner on this deal? Reprising the international comparative valuation exercise drawn up by KordMentha in October 2018 - using 2022 values - might give us a clue.

I have redone the figures for PGW and its nearest Australian equivalents, Elders (Australia) and Ruralco (Australia). In the case of 'Ruralco', the comparison is not so straightforward because it was taken over by Canadian multinational Nutrien on 30th September 2019. Nutrien is the world's largest provider of crop inputs and services, and own their own production facilities. Nutrien produce 27 million tonnes of potash, nitrogen and phosphate products for distribution world-wide. But Nutrien's multi-nationally scattered ''rural serving distribution outlets" (the equivalent of the PGW business) made up only 16% of turnover in 2021. So Nutrien is not strictly comparable to PGG Wrightson, Elders, or indeed Ruralco before it was absorbed. More sales emphasis on undifferentiated commodities would suggest lesser earnings multiples at Nutrien might be expected. Readers should bear this in mind when looking at the comparative ratio multiple numbers.

To enable a more suitable comparison between 2018 and 2022, I have adjusted the 2022 EBITDA and EBIT figures for all three protagonists back to what they would have been had IFRS16 on property leases not been introduced.



Comparable Companies

Year	Company	Share Price	Enterprise Value	EBITDA	EBITDA multiple	EBIT	EBIT multiple
2018	Ruralco (Australia)	$A2.82	$A425m	$A67.5m	6.3x	$A54.5m	7.8x
2022	Nutrien (Canada)	$C100.66	$C64.02b	$C11.63b	5.2x	$C10.75b	6.0x
2018	Elders (Australia)	$A6.34	$A780m	$A75.7m	10.3x	$A71.6m	10.9x
2022	Elders (Australia)	$A9.91	$A1,712m	$A268m	6.4x	$A229m	7.5x
2018	PGG Wrightson (NZ)	$NZ2.60	$NZ212.7m	$NZ34.5m	6.2x	$NZ19.5m	10.9x
2022	PGG Wrightson (NZ)	$NZ4.49	$NZ371.7m	$NZ44.49m	8.4x	$NZ33.86m	11.0x

Notes

1/ Enterprise Value = Market Value + Total Debt - Cash. The market value must be taken at a particular date. For the 2018 valuations, this date was 23rd August 2018. For the 2022 valuations the date was 13th January 2023. 'Total Debt' and 'Cash' are items from the respective balance sheets.

a/ For Elders this was 30th September,
b/ For PGG Wrightson this was 30th June
c/ For Nutrien I have used information from the third quarter report, 9 months ending 30th September. This includes a forecast EBITDA for the whole year of between $C12.2m - $C13.2m (I picked the middle $C12.7m before IFRS16 adjustments).
d/ For RuralCo (now delisted) this was 30th September.

2/ Earnings (EBITDA, EBIT) and payments (Interest on leases and capital repayments on leases) accumulated over a year used to construct the above table are from the respective annual reports. The exception being Nutrien where I have used the nine month figures and annualised those by taking the previous full year result and subtracting from that the previous year's nine month result and adding that difference.

3/ EBITDA multiple = Enterprise Value / EBITDA

4/ EBIT multiple = Enterprise Value / EBIT

5/ Figures for PGW for 2018 have been altered to remove the (subsequently sold) seed division from the capital and earnings figures.

---------------------



Discussion

With the exception of the Elders EBITDA multiple in 2018, PGW sits at the top of the multiple class. What happened at Elders over FY2018? 2017 was a drier than average year for much of inland Queensland, most of New South Wales, eastern and central Victoria, and all of Tasmania. So with gross underlying earnings looking to go lower, there can be a situation where present day market multiples become high as shareholders anticipate a recovery. This may explain the 10.3xEBITDA multiple that the market was prepared to pay for Elders shares in August 2018, approaching the 30-09-2018 balance date. By contrast, Ruralco (on only a 6.2x EBITDA multiple), and also Australia based, claimed in their annual report for 2018 that with diversification into Western Australia and more emphasis on 'water products', they were able to grow profits (+12%) in a drought year. When you are 'on a roll' in an ultimately cyclical market, it follows that Mr Market will not pay a high multiple for your shares.

There are a couple of reasons that I can think of to explain why Mr Market seems OK with paying a high multiple for PGW shares, both connected to the valuation reference dates. The first reference date of 20-08-2018 was only a couple of weeks after the announcement of the sale of the seed division on 06-09-2018. So the expectation of a significant capital payout would be at the front of share buyers minds. Likewise the second reference date of 13-01-2023 was only a month after Elders took over the Chinese Government stake on 14-12-2022. Such a chunky share transfer always brings with it rumour of perhaps more corporate activity, and speculative shareholder interest. Personally, I am not anticipating more corporate activity (see my posts 5336 and 5337 for an explanation). More generally PGW have been riding the farming 'headline trend' since Covid-19. Other global farmers struggle to replicate in efficiency, quality and 'greenness' of technique, of the produce from NZ farms. And PGW has become very good at servicing our farmers.

In summary, there are lots of reasons to like PGW, particularly when stacked up against other rural service providers. But is it 50% better than the others, as suggested by the FY2022 EBITDA multiples? NZ investors today who can take full advantage of the NZ dividend imputation system:

PGW historical gross yield = ($0.16+$0.14) / ($4.49 x 0.72) = 9.3%

would have no obvious reason to sell out of share with a gross yield like that. But is this kind of gross yield sustainable? Read my post 5355 again, looking at the commentary on dividend payments back beyond two years. I have a lot of respect for the way PGW as a company is run. But successful investing is all about buying into a good company at a good value price. When taking a broader multi-year view, I think PGW could be a value trap at $4.49. I think it is the Chinese government who came out looking smart on the sell side of this share sale deal to Elders.

SNOOPY

[Snoopy]

We cannot apply a Warren Buffett style growth model to valuing PGW because it has failed:

a/ test 2, the increasing 'eps' year on year test AND
b/ test 3, the 'Return on Equity' test.

These failures are not unexpected as these are tough hurdles for companies that must

ai/ weather the effects of the weather (sic) AND
bi/ carry a high level of stock and sell that stock a relatively low margins to pass. The risk here of having a large amount of stock on hand that spoils or must otherwise be heavily discounted below cost is very real in companies that sell commodities.

This doesn't necessarily mean that one should avoid PGW as an investment though. It means that you should probably use a more conservative evaluation method. The method I prefer in these circumstances is an (at least) five year average of dividend flows, with the underlying assumption of a steady rather than a growing market. This is otherwise known as the 'Capitalised Dividend Valuation Method'. Luckily for you readers I have already done this (my posts 4310 and 4311).

Multi-year trend results show a creditable rise in return on shareholder equity (test 3). This is particularly so over FY2022, when international logistics issues required higher than normal product stocking rates to ensure supply. Nevertheless the improvements fall short (albeit tantalizingly close) to the minimum Warren Buffett return on equity target. This means, in practice, that when farmers suddenly snap their cheque books shut, PGW will likely struggle to clear any 'surplus stock' at a profit. Hence the predictability of profit, so crucial for longer term Buffett style profitability forecasting, goes out the window. Normalised earnings per share was trendless, resulting in failure at Buffett test 2. None of this undermines the other business strengths which saw solid pass marks in Buffett tests 1 and 4. But it does mean alternative 'non-Buffett' ways to value this business will likely yield better results.

Capitalised dividend valuation is conservative (a zero growth assumption model) that makes the current share price look satisfactory, based on current dividend payout rates. Less so when you back track out the 'seed division sale hype' from earlier dividend payments made in the business cycle.

The PGW business is currently rated at the top of valuation metrics in relation to international peers, which is justified because NZ farmers never have down cycles - farm profitability always goes up every year. La Nina weather from here on in means more moisture in eastern NZ and no more drought. NZ has come out of climate change as the only global perpetual winner - a miracle country in fact. And my nose hasn't grown that much longer in telling you this. For those who 'believe this story', then at any price under $4.50 per share, PGW looks cheap. But for me PGW is a well managed company that Mr Market is currently pricing too highly.

Yes we are well down on our highs of over $5.50 from early in calendar year 2022. But I believe those were freak prices, based on an almost zero background interest rate outlook. The Chinese government 'smart money' has exited at a share price lower than today's. The new PGW chairman Joo Hai Lee has already lowered EBITDA expectations from $67.2m in FY2022 to $62m over FY2023, - a 10% fall. That 18th October 2022 announcement saw the PGW share price slip to under the $4 level, before rising again towards $4.50 - apparently based on 'corporate activity' expectations. For those of us who don't hold those corporate activity expectations, there is a good chance that PGW priced at $4.50 is currently a dividend trap. Consequently any share price strength that might happen into the expected late February first half year profit announcement might be an opportune time for overweight shareholders in PGW to reduce their holdings. I intend to do so, should that opportunity arise.

SNOOPY

[Snoopy]

Moving forward to FY2022, this new finance business is going from strength to strength with $66.109m of 'GoLivestock' loans on the books at the 30-06-2022 balance date.

$66.109m is an overstatement of the loan book on an annual basis. Livestock loans are seasonal. To get a representative loan balance over the year it is best to take an average of the three loan balance date points across FY2022 that we have: 30-06-2021 ($45.869m) , 31-12-2021 ($35.805m) and 30-06-2022 ($66.109m):

Averaged GoLivestock loan balance over FY2022: ($45.869m+$35.905m+$66.109m)/3 = $49.294m

One thing I am not sure I made clear when discussing 'GoLivestock' before is that on the balance sheet 'GoLivestock' is listed as an asset. That is because PGW retains ownership of the animals in the 'GoLivestock' scheme. So those 'GoLivestock' assets on the balance sheet really are live animals. However, this is where things get a little complicated. These animals are 'loaned' to farmers all around the country in the expectation that they can be fattened up, sold and the initial capital (dollar value of the animals delivered to the farmer) will be recovered, plus a 'financial loan fee'. You can think of the 'financial loan fee' as 'interest paid' on the (animal) capital borrowed.

Now go one step further back. Where did PGW get the money to buy the animals in the first place? I would argue that they borrowed it. Or at least borrowed some of it. Why do I say that?

We need to calculate PGW's bank loan 'borrowing costs' as a percentage of bank funds borrowed. The borrowing costs over FY2022 were $1.832m (AR2022 p55). Once again we will use our three time stamp data points to average the funds borrowed across the year.

Reference Date	30/06/2021	31/12/2021	30/06/2022
Cash & Cash Equivalents	($3.367m)	($1.113m)	($4.676m)
Short Term Debt	$9.900m	$18.000m	$7.500m
Long Term Debt	$0m	$30.00m	$30.000m
Total Net Debt	$6.533m	$46.867m	$32.824m

=> Average Debt over Year = ($6.533m+$46.687m+$32.824m) / 3 = $28.681m

So the interest rate charged by the banks on the funds loaned was: $1.832m / $28.681m = 6.4%.

One thing I have noticed is that the average GoLivestock balance over the year is greater than the average funds borrowed by PGW over the year ($49.294m>$28.681m). So one way of looking at this is to say that all of the funds borrowed by PGW from the banks are on lent as livestock loans to farmers (but from a PGW viewpoint their 'livestock placements' are seen as assets to the company, so appear as assets on the PGW company balance sheet).

PGW have a right to charge a 'competitive interest rate' (which includes a margin on the money PGW themselves borrow form the bank) to their animal guardians (the farmers). Since the company loan balance is less than the value of animals on the balance sheet 'loaned out', one way of looking at this situation is to consider that all bank money borrowed by PGW is on loan to farmer animal guardians. Thus my analysis tells me that PGW is immune from market interest rate rises, because any costs of higher interest rates are passed directly through to those farmer 'animal guardians'.

Am I right here, or is this another example one of my late night thinking screw ups?

SNOOPY

[nztx]

All the Superannuation Fund financing issues goneburger, done and dusted - Snoopy ?