PGW - PGG Wrightson

[Snoopy]

The next task is to work out what the profit margin is on these GoLivestock loans. To work that out, 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%. We know from part 1 of this analysis that the return on funds loaned by PGW was 8.6%. The difference between the borrowed and lent loan rates, multiplied by the average GoLivestock loan balance is the NPBT earned by PGW from these GoLivestock loans:

(0.086-0.064)x $28.861m = $0.635m.

Of course it is likely that PGW earns a commission on the buying and selling of this animal stock via its own sale-yards as well. But such a commission would have been earned whether the animal stock was financed by PGW or not. It is the financing risk we are interested in here. It is only the $0.635m that is directly connected to that.

The $0.635m of profit earned on the funding aspect of the GoLivestock loans is taxable. The associated after tax profit figure was: 0.72 x $0.635m = $0.457m.

Now the declared profit for FY2022 was $24.286m. I would subtract from that the after tax effect of the impairment reversals on saleyards and the impairment reversal on the right of use assets related to the water business (AR2022 p54).

$24.286m - 0.72($0.414m+$0.695m) = $23.488m

The next task is to work out what the profit margin is on these GoLivestock loans. To work that out, we need to calculate PGW's bank loan 'borrowing costs' as a percentage of bank funds borrowed. The borrowing costs over FY2023 were $5.521m (AR2023 p74). Once again we will use our three time stamp data points to average the funds borrowed across the year.

Reference Date	30/06/2022	31/12/2022	30/06/2023
Cash & Cash Equivalents	($4.676m)	($2.484m)	($4.643m)
Short Term Debt	$7.500m	$48.000m	$19.960m
Long Term Debt	$30.000m	$50.000m	$50.000m
Total Net Debt	$32.824m	$95.516m	$65.317m

=> Average Debt over Year = ($32.824m+$95.516m+$65.317m) / 3 = $64.552m

So the interest rate charged by the banks on the funds loaned was: $5.521m / $64.552m = 8.6%. We know from part 1 of this analysis that the return on funds loaned by PGW was 10.8%. The difference between the borrowed and lent loan rates, multiplied by the average GoLivestock loan balance, is the NPBT earned by PGW from these GoLivestock loans:

(0.108-0.086)x $64.552m = $1.420m.

Of course it is likely that PGW earns a commission on the buying and selling of this animal stock via its own sale-yards as well. But such a commission would likely have been earned whether the animal stock was financed by PGW or not. It is the financing risk we are interested in here. It is only the $1.420m that is directly connected to that.

The $1.420m of profit earned on the funding aspect of the GoLivestock loans is taxable. The associated after tax profit figure was: 0.72 x $1.420m = $1.023m.

Now from the 'Consolidated Statement of Profit and Loss'', the declared profit for FY2023 was $17.518m. We can think of this $17.518m as money available to pay down debt, if the banks demanded that debt be fully repaid (in general this is a hypothetical situation).

SNOOPY

[Snoopy]

We now have enough information to do our two alternative MDRT calculations

MDRT (old way) = (Total Worrisome Debt) / (Declared NPAT) = $59.413m/$23.488m = 2.53 years

MDRT (new way) = (Total Worrisome Debt - Seasonally Adjusted 'GoLivestock' Debt) / (Declared NPAT - GoLivestock NPAT)
= ($59.413m - $49.294m) / ($23.488m - $0.457m) = 0.44 years

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My rule of thumb for the MDRT answer in years is:

years < 2: Company has low debt
2< years <5: Company has medium debt
5< years <10: Company has high debt
years >10: Company debt is cause for concern

That means my revised modelling has seen PGW drop from what I had classed as a 'medium debt' company back to a 'low debt' company. And because PGW works in a turbulent sector like agriculture, this is good to see.

We now have enough information to do our two alternative MDRT (Minimum Debt Repayment Time) calculations. Note the 'old way' assumes all of that livestock loan debt is just company debt (not realistic IMV).

MDRT (old way) = (Total Worrisome Debt) / (Declared NPAT) = $86.327m/$17.518m = 4.93 years

MDRT (new way) = (Total Worrisome Debt - Seasonally Adjusted 'GoLivestock' Debt) / (Declared NPAT - GoLivestock NPAT)
= ($86.327m - $61.048m) / ($17.518m - $1.023m) = 1.53 years

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

My rule of thumb for the MDRT answer in years is:

years < 2: Company has low debt
2< years <5: Company has medium debt
5< years <10: Company has high debt
years >10: Company debt is cause for concern

That means my revised modelling has seen PGW drop from what I had classed as a 'medium debt' company back to a 'low debt' company. And because PGW works in a turbulent sector like agriculture, this is good to see.

Looking out into FY2024, I can see that MDRT figure deteriorating. But at this point I would not be concerned about that. It is something that I would expect as more rural commodities head toward their cyclical market lows.

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,

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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'.

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.

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.

I have decided the best capitalised valuation technique to use for PGW from a FY2023.5 perspective is a hybrid technique using normalised earnings (2HY2019.5, FY2020 and FY2021) and actual dividends paid (FY2022, FY2023 and HY2023.5). I am effectively using normalised (post restructuring) earnings as a proxy for dividends, because recent history has shown that PGW pay out all of their operational earnings as dividends.

Year	Dividends Paid 'per share'	Sub Total	PGW Rural Servicing Normalised Earnings 'per share'
FY2019	12.5cps + 7.5cps	20.0cps	9.2cps+1.1cps (1)
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
FY2023	16.0cps + 12.0cps	28.0cps	23.0cps
FY2024	10.0cps + ?cps	10.0cps	?cps
Total FY2022 to FY2023.5 inclusive		68.0cps
Total FY2019.5 to FY2021 inclusive			34.6cps

Notes

1/ Total FY2019 earnings of 5.8cps were not distributed equally throughout the year. I have apportioned the 5.8cps of earnings over FY2019 by considering the NPAT for the 'Agency' and 'Retail & Water' for FY2019 and HY2019 (see Segmented Profit Section of each report) as follows.

	Agency {A}	Retail & Water {B}	{A}+{B}
FY2019	$9.600m	$11.645m	$21.245m
less HY2019	$2.249m	$16.728m	$18.977m
equals 2HY2019	$7.351m	($5.083m)	$2.268m

This means the total portion of 'Agency' and 'Retail & Water' profits earned in 2HY2019 was: $2.268m/$21.245m= 10.68%
0.1068 x 10.3c = 1.1cps

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

The total return I am capitalising over a period of five years is: 68.0c+34.6c= 102.6c. This works out to be 105.5c/5=20.5cps on average every year. Due to interest rates rising and forecast to be higher for longer, I am raising my required capitalised rate of return to 9.0% gross. I had considered raising that rate even further to 9.5%. However, due to the strong operational performance over the last couple of years reflected in PGW gaining market share and having a relatively stable and well thought of workforce, I thought the company had earned half a percentage point 'required return credit' when I set the required yield rate. Now what does a 9.0% required gross yield on 21.1c of annual payments imply for the share price?

20.5c/ (0.72x0.09) = $3.16

PGW closed at Friday 20th October at $3.42. Given the market share gains made by PGW over the last couple of years, perhaps such a growth premium of $3.42-$3.16= 26cps is justified (remember capitalised dividend valuation assumes zero growth) ? Yet despite the heady price falls from the $5.50+ share price peaks of a couple of years ago, I do not believe this share is 'cheap' at $3.42. I calculate the current year normalised historical PE ratio to be 342/24.1= 14.2. However, if the share price were to continue down toward, and maybe just under, that $3 mark? Then I think PGW would hit that share price point of 'good business cycle buying'.

SNOOPY

discl: holding

[Snoopy]

Inexplicably, PGW did not report and post a prior IFRS16 adjustment over FY2022. The way I see it, that means it is no longer possible to calculate what the PGW profit would have been prior to IFRS16 being introduced. And why does that matter? Because when considering banking covenants, the banks always remove the effect of IFRS16. And I think we shareholders should be allowed to evaluate our company the same way a bank does.

No progress made on this IFRS 16 puzzle as yet. So let's reprise the puzzle in the form of a scenario

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

Imagine you are the finance director based in PGW's ivory tower (actually now PGW's head office is based at Christchurch International Airport so it might be more correct to call it the 'control tower' - but I digress). The bill comes in from your farthest flung landlord asking for their monthly payment. You open the envelope and out drops two bills, not one. The first bill is titled "Partial Repayment of Lease Liability Principal" and the second bill is titled "Interest due on Lease Liabilities." You scratch your head and wonder what happened to the old days of when you simply got a demand for "rent". However, 'that was then' and 'now is now'. Under the now current IFRS16 reporting standard all rent bills have to be separated into two parts, as described in the two separate pieces of paper that fell out of the single demand envelope.

How realistic a scenario is this? I would say unlikely as in the real world, bills for rent still get sent out. IFRS 16 is merely an accounting reporting construct, which does change the way in which the rent is reported, but not the way the bill is received. It is accepted practice to report "Partial Repayment of Lease Liability Principal" and "Interest due on Lease Liabilities." in the income statement, while the actual rent paid is reported in the cashflow statement.

EXCEPT in the case of PGW both "Interest due on Lease Liabilities." and "Partial Repayment of Lease Liability Principal" are reported in the CASHFLOW statement. And that in turn would suggest the rent bill did indeed arrive in two parts as I suggested in my scenario, with two separate bills falling out of the demand envelope. Could this be true? What the heck is going on inside the control tower for reporting to happen like this? Ideas?

SNOOPY

[Snoopy]

A reality check update for my November 2019 forecast projections for FY2020:

Senior Debt Coverage Ratio" (SDCR) ="Senior Debt"/EBITDA
=( -$16.868m + $30.000m + $20.000m ) / $23.446m = 1.41 < 3.00 (good)

That is the balance date figure.

Three years on and with the trading position of PGW going into more difficult times, a reassessment of the Senior Debt Coverage Ratio (SDCR) is in order. We will look at the 30th June balance date first. The cash balance (offsetting debt) together with the long term company debt and short term company debt come straight from the balance sheet. The operating EBITDA figure is from the Consolidated Statement of Profit and Loss.

Senior Debt Coverage Ratio" (SDCR) ="Senior Debt"/EBITDA
=( -$4.643m + $19.960m + $50.000m ) / $61.194m = 1.07 < 3.00 (very good)

So all looking very good then, EXCEPT, these figures are not what they seem. The "Senior Debt"/EBITDA hurdle was set up in pre IFRS 16 days. IFRS 16 mandates the transfer of rent from what was an operating expense to a finance expense, an operation that inflates the EBITDA figure accordingly. That means if we make the adjustment to a comparable pre IFRS 16 figure, by removing the 'interest paid on lease liabilities' and 'repayment of principal portion of of lease liabilities' (both figures may be found in the cashflow statement), then the comparable EBITDA figure reduces to this:

$61.194m - ( $3.800m + $19.532m ) = $37.862m

This is not the end of the adjustment exercise, unfortunately. This is because the the EBITDA figure quoted includes income from the 'GoLivestock' financing operation, the liabilities of which I have not included in the debt picture. It follows then that if I am not including 'GoLivestock' debt in this exercise, I must also exclude any income associated with that debt. So what is the interest revenue associated with 'GoLivestock'? $6.573m (AR2023 p71). That has to come off the EBITDA figure as well.

$37.862m - $6.573m = $31.289m

That means the adjusted Senior Debt Coverage Ratio calculation becomes:

=( -$4.643m + $19.960m + $50.000m ) / $31.289m = 2.09 < 3.00 (good, but no longer very good)

Looking out into FY2024, investors might want to consider what might happen if EBITDA reduces further in FY2024, while debt remains at today's levels. But that couldn't happen, could it?

SNOOPY

[winner69]

Farmer said going into a Farmlands or a Wrightsons store is like going into a supermarket …..’all the prices have doubled’

Isn’t that higher $ margin for PGW?

[BlackPeter]

Farmer said going into a Farmlands or a Wrightsons store is like going into a supermarket …..’all the prices have doubled’

Isn’t that higher $ margin for PGW?

I guess it depends on whether PGW's cost doubled as well ;

[Snoopy]

Farmer said going into a Farmlands or a Wrightsons store is like going into a supermarket …..’all the prices have doubled’

Isn’t that higher $ margin for PGW?

I am having a little trouble with my net profit figures Winner, because I am having to guess on removing the IFRS 16 adjustments that are distorting the cashflow of the reported figures. FWIW here is where I have got to so far:

	FY2023	FY2022	Reference
Net Profit (declared)	$17.518m	$24.286m	AR2023 'Consolidated Statement of Profit and Loss'
add back/ subtract Impairment / Fair Value Gains	0.72x ($0.051m)	0.72x $2.182m	AR2023 Note 5
add back/ subtract Forex Losses / Forex Gains	0.72x $0.737m	0.72x ($0.430m)	AR2023 Note 6
subtract IFRS 16 rent cost correction	0.72x ($0.613m)	0.72x ($0.613m)	See table Note 1/
subtract Non Operational Gains	0.72x ($0.327m)	0.72x ($0.699m)	AR2023 Note 4
equals Normalised NPAT	$17.335m	$24.603m
divided by Operating Revenue	$975.692m	$952.700m
equals Normalised Net Profit Margin	1.78%	2.58%

Notes

1/ This figure is a guess. I have simply repeated the figure from FY2021 when we were able to calculate what it was. I don't believe there was sufficient disclosure in the FY2022 and FY2023 annual result releases to calculate this unfortunately.

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

If these results are not exactly right, I can still claim they are comparable because I have made the same IFRS16 'adjustment error' in both years. So yeah all good for PGW with their 'doubled prices', provided their input costs have not doubled in sympathy. Which is I think what this table is telling us is it not ;-P ?

SNOOPY

[mike2020]

Im astounded at the cost of processing home kills since I left the farm mid 2020. If that is the type of cost being incurred across the sector farmers are going to struggle.

[Snoopy]

That means the adjusted Senior Debt Coverage Ratio calculation becomes:

=( -$4.643m + $19.960m + $50.000m ) / $31.289m = 2.09 < 3.00 (good, but no longer very good)

Looking out into FY2024, investors might want to consider what might happen if EBITDA reduces further in FY2024. But that couldn't happen, could it?

When debt and earnings are lumpy, as they are at PGW, sometimes it is useful to look at covenants over more than one period. I have used my annual report and half year report collection to compile semi-annual earning periods over the last two years, as below:

	2HY2023	1HY2023	2HY2022	1HY2022
EBITDA (quoted)	$13.350m	$47.844m	$19.725m	$47.428m
less Lease liability Interest payment	$1.892m	$1.908m	$1.878m	$1.908m
less Lease liability principal payment	$9.966m	$9.566m	$8.952m	$9.291m
less GoLivestock Income	$3.199m	$3.374m	$2.359m	$1.895m
equals EBITDA (Covenant calculation adjusted)	-$1.507m	$32.996m	$6.356m	$34.334m

I can use the above table to look at how the SDCR stacks up over the 12month period made up of 2HY2022 and 1HY2023 as an example.
Note that the 'Senior Debt' as at HY2023 was: -$4.676m (cash) + $48,000m (current bank debt) + $50,000m (non-current bank debt) = $93.324m. (Reference HYR2023 'Interim Consolidated Statement of Financial Position').

Senior Debt Coverage Ratio" (SDCR) ="Senior Debt"/EBITDA
= $93.324m / ($32,996+$6.356m) = 2.37 < 3.00

That SDCR is still OK, although closer to 'the standard' edge than the same calculation made six months later at EOFY2023.

SNOOPY