PGW - PGG Wrightson

[Beagle]

What an amazing escape. $6m in cash disappears, and there is no effect on the balance sheet! Ronnie Biggs take note. I guess this is why corporate accountants are paid so highly!

Nevertheless a little look at the balance sheet is in order

	HY2017	FY2016	HY2016
Total Liabilities (A)	$472.236m	$482.166m	$412.917m
Total Assets (B)	$748.148m	$754.128m	$687.216m
Debt ratio (A)/(B)	63.1%	63.9%	60.1%

SNOOPY

Wish that flowed through to suburban bean counters.

When looking at this whole creative accounting exercise one reaches the indicative conclusion they are selling off the silverware to prop up their pension scheme.

Its one thing to take capital profits on property and lease them back and effectively take gains to fund increasing liabilities and thereby apparently magically extinguish them them but here's some disturbing food for thought going forward. What happens in FY19 with the new accounting standard that requires accounting for lease liabilities ? It would appear that while they can temporarily craft an apparent extinguishment of an increased liability, (pension scheme)...the chooks will eventuallky come home to roost. Then what happens to their debt equity level !

[Snow Leopard]

What an amazing escape. $6m in cash disappears, and there is no effect on the balance sheet! Ronnie Biggs take note. I guess this is why corporate accountants are paid so highly!

Nevertheless a little look at the balance sheet for comparative periods is in order:

	HY2017	FY2016	HY2016
Total Liabilities (A)	$472.236m	$482.166m	$412.917m
Total Assets (B)	$748.148m	$754.128m	$687.216m
Debt ratio (A)/(B)	63.1%	63.9%	60.1%
Inventories	$214.251m	$209.163m	$244.074m

Because PGW is a seasonal business, the first half of the year tends to be 'stock heavy'. Less inventory is on hand at the end of the year when the farming season is over, and the inventories have been cleaned out (see above table). The like for like period HY2017 vs HY2016 shows a lower inventory (less of the irrigation system assets on hand?) but also a higher debt ratio. Hmmmm.

SNOOPY

Hmmm indeed.

You have swapped the 2016 half and full numbers around.

Best Wishes
Paper Tiger

[Snoopy]

A slight change in tack to my valuation method. PGW has now largely finished restructuring. They also have a policy of paying 100% of earnings out as dividends. So I shall assume all earnings over the last five years would have been paid out as dividends and make my PGW valuation from that.

eps figures, adjusted for the removal of the finance division over the last five years were as follows:

FY2011 : $5.9m/ 754.8m = 0.8c
FY2012 : $25.2m/ 754.8m = 3.3c
FY2013 : $24.3m/ 754.8m = 3.2c
FY2014 : $33.8m/ 754.8m = 4.5c
FY2015 : $34.8m/ 754.8m = 4.6c

I calculate that as an average earnings rate of 16.4c/5 = 3.3c

For a cyclical like this I would require a 'gross return' of some 8.5%. Given a 28% tax rate (72% reatined earnings rate), my valuation over the business cycle of PGW is that it should average:

3.3 / (0.085 x 0.72) = 54c

Increase that required gross return to 9%, and the valuation drops to

3.3 / (0.09 x 0.72) = 51c

I posted the above on 31st October 2015.

I am now changing my valuation method to reflect the dividends actually paid from years 2012 to 2016 inclusive, representing the whole Alan Lai era.

Year	Dividends Paid 'per share'	Total
FY2012	0.0cps + 0.0cps	0cps
FY2013	2.2cps + 1.0cps	3.2cps
FY2014	2.0cps + 2.5cps + 1.0cps (s)	5.5cps
FY2015	2.0cps + 2.0cps	4.0cps
FY2016	1.75cps + 2.0cps	3.75cps
FY2017(f)	1.75cps + 2.0cps(f)	3.75cps
Average FY2012 to FY2017 inclusive		3.37cps

(f) indicates forecast result.
(s) indicates 'special dividend'

SNOOPY

[Snoopy]

Average FY2012 to FY2017 inclusive

3.37cps

Plugging in a representative yield, one that represents the ups and downs of the farming cycle of PGG Wrightson in its current form, we can now arrive at our 'Capitalised Dividend Model' valuation

(Representative Dividend per Share) / (Acceptable Yield) = Share Price (an algebraeic manipulation of: Dividend per Share / Share Price = Yield )

3.37c / 0.72 x 0.095 = 49.2c

Note that I am using 9.5% as my acceptable gross yield. Some might argue that is high. But I think it is fair given that much of PGW's profit comes from low margin commodities subject to weather event demand. Some years ago PGW paid no dividend at all for several years in a row. This kind of risk is reflected in my selection of a 9.5% acceptable yield, about half as much again more than a tier one utility company.

This 49c valuation is measured at the average point in the business cycle. One might argue that we are now riding high in the business cycle and that this 49c valuation is consequently too low given today's circumstances (sp closed today at 54c). I wouldn't argue with that. If I use my +20% rule of thumb, one might expect a share price of 59c at the top of the business cycle. Likewise 39.5c would be the bottom. Take off the imminent 1.75c fully imputed dividend and PGW doesn't look so overvalued today (remember too that there is a strong case to say that most of the market is slightly overvalued right now). I wouldn't be selling or buying more PGW shares based on these numbers.

SNOOPY

discl: hold PGW

[Snoopy]

Voracious shareholders are milking PGW of all the dividends they can. Yet PGW is not debt free. Could the long term future of PGW be at risk because of the high dividend draw down? This is a question that needs looking into:

	2015	2014
Debt Short Term	$57.195m	$35.573m
Deriv Liabilities Short Term	$3.266m	$0.887m
Debt Long Term	$66.000m	$65.000m
Deriv Liabilities Long Term	$1.980m	$0.005m
Long Term Provisions	$5.597m	$6.609m
Defined Benefit Liability	$14.655m	$13.528m
Change in Receivables/Payables Adjustment (*)	-$5.745m	$1.304m
Total	$143.758m	$120.298m

(*) The Change in Receivables/Payables Adjustment takes into account that you can hide debt by:

1/ not paying your bills OR
2/ by collecting money that is owed to you faster than is normal, when you may not be able to do that in the future.

Alternatively if you do the opposite of 1/ and 2/ (as is the case in both years here) , then the debt is actually smaller than it appears. This is why the adjustment is negative for FY2015 and FY2014.

Taking the above debts and dividing them by normalised profits will give us a theoretical 'minimum debt repayment time - minDRT' (assuming all profits from the current year are directed to paying down debt). This assumption is not management policy. But it nevertheless gives us a measure of the indebtedness of PGW relative to underlying earnings.

min DRT(2015) = $143.758m / $34.8m = 4.1 years

Compare that with last years figure

min DRT(2014) = $120.298m / $33.8m = 3.6 years

Despite the slight deterioration, I rate this as OK. A debt repayment time of under two years I regard as low. Up to five years I would regard as a 'medium sized debt'. Once the minimum debt repayment time gets above ten years, this is a very definite warning flag for me.

I posted the above on 31st October 2015

When looking at this whole creative accounting exercise one reaches the indicative conclusion they are selling off the silverware to prop up their pension scheme.

Its one thing to take capital profits on property and lease them back and effectively take gains to fund increasing liabilities and thereby apparently magically extinguish them them but here's some disturbing food for thought going forward. What happens in FY19 with the new accounting standard that requires accounting for lease liabilities ? It would appear that while they can temporarily craft an apparent extinguishment of an increased liability, (pension scheme)...the chooks will eventuallky come home to roost. Then what happens to their debt equity level !

An interesting question Roger. However most banking covenants seem to be based on 'cashflow'. Cashflow won't be affected by whether long term lease agreements becaome capitalised debt or not. Also these changes in accounting rules have been well signalled. So yes the debt on paper from FY2019 will look higher. But will bank managers be really worried about it?

I want to look at this PGW debt question from a slightly different angle than I did before. Banks often look at EBITDA as a measure of a company's ability to repay a loan. While this is probably the best short term indicator, depreciation and amortization, eventually do have to be paid for in 'cash' as reinvestment is required in software and motor vehicles (for example) if PGW is to keep operating. In the past the figure I have used is 'sustainable profit'. But whether the profit comes from normal customer activity or PGW selling properties and shares in businesses is neither here nor there to a bank manager - as long as the bank gets the money! So I am now thinking, maybe declared net profit after tax is the best figure to look at from a medium to longer term perspective?

The next question is, what company debt figures to use?

1/ Certainly long and short term debt to the bank should be included. BUT
2/ Short and long term derivative liabilities should come out in the wash the bank debt is rolled over. So taking the medium to long term view of PGW, my instinct is to exclude those.
3/ Employee entitlements tend to be paid out ahead of the bank being repaid. So I think the 'Defined Benefit Liability' , relating to the company pension scheme, should be included in the company debt burden. BUT
4/ 'Long Term Provisions' include all sorts of other things as well as current employee entitlements. So my instinct is to include only the current 'employee entitlements' over and above the debts I have listed above.

I am not sure if all my above inclusions and exclusions are 'right'. But I will assume that I am right for today. So what is the net result of measuring the company's ability to repay (declared net profit) against the liabilities I have set out above? Let's see.

SNOOPY

[Snoopy]

i am not sure if all my above inclusions and exclusions are 'right'. But i will assume that i am right for today. So what is the net result of measuring the company's ability to repay (declared net profit) against the liabilities i have set out above? Let's see.

	FY2012	FY2013	FY2014	FY2015	FY2016
Short Term Bank Loans	$29.709m	$47.702m	$35.573m	$57.195m	$36.623m
add Long Term Bank Loans	$111.500m	$62.000m	$65.000m	$66.000m	$97.511m
add Net Defined Benefit Liability (Pension Plan deficit)	$26.264m	$20.819m	$13.528m	$14.655m	$25.729m
add Employee Entitlements	$17.531m	$15.910m	$20.837m	$20.511m	$20.982m
Total Bank Worriesome Liabiliities {A}	$185.004m	$146.431m	$134.938m	$158.361m	$180.845m
NPAT (declared) {B}	$24.5m	$14.6m (*)	$42.3m	$32.8m	$39.6m
Minimum Debt Repayment Time {A}/{B} (in years)	7.55	10.02	3.19	4.83	4.57

(*) Excludes Goodwill Write Down of $321m.

The above table shows that in absolute terms, 'worriesome debt' returned in FY2016 to a level not seen since just after the Alan Lai headed capital raising in FY2011 (that's bad). However the ability to service that debt, the declared Net Profit After Tax, has improved markedly since that time (that's good). Bring the two together and MDRT has improved from a worst of 10.02 (that's bad) to 4.57 today (that is acceptable, anything between 2 and 5 qualifies as 'medium level debt'). While I would prefer to see PGW pay down some of their debt, this isn't going to happen under the Alan Lai regime. Financial discipline will be required from here and fortunately for we shareholders CEO Mark Dewdney (aka 'the Dewd') has it.

The turning point was FY2014. So what happened in FY2014 to turn things around?

SNOOPY

[winner69]

Snoops, as a matter of interest do you do any economic added value stuff?

Why I ask is why does the market value $270m odd of equity at over $400m

[Snoopy]

The turning point was FY2014. So what happened in FY2014 to turn things around?

Going back to AR2014 p6, the high dairy payout (a record) and 'strong prices across many other agricultural categories' are listed as reasons for the big jump in NPAT.

The new ethos of PGW based around the 'One PGW' theme was taking hold in FY2014.

"At its core, the One-PGW 'way of thinking' encourages our people to consider our wider business from the customer's perspective. and to utilise the diverse resources within the company to to better service our customers needs."

IOW staff, keep your ear to the ground, and pass any leads on to the appropriate 'other' department. Staff Engagement Performance is listed at an all time high of 72% (AR2014, p7) (not sure what that means but it sounds good). Interestingly, no mention of this statistic has been made in subsequent reports that I can find! Has it dipped a bit? Customer satisfaction measured at 89% (so 11% of farmers are grizzlers, I guess we knew that!) During FY2014 the training spend was $1.469m up 283% on FY2010. So PGW are spending money on their staff, staff are feeling valued and performing.

Subsequent to FY2014, we have had the dairy bust, wool price collapse and beef prices not going so well. But horticulture has at least partially come the resucue. A key part of the PGW story is to be across all sectors so that PGW will not experience the same boom and bust cycle that seems evident when focussing on one rural sector alone.

To summarize, yes PGW debts are uncomfortably high in historical terms. But the step up in staff performance has enabled them to handle this debt. If you believe in the strategy of 'the Dewd', and the strict financial discipline imposed by Alan Lai, then I can see no reason why the PGW story cannot continue along current lines. This is one of the highest yielding shares on the market, not without risk, but one that can earn a place as part of a balanced share portfolio. And best of all you don't have to try and ride the waves of each agricultural sector as you agonise the best timing to buy and sell your agricultural share. Because PGW covers all sectors.

Of course if you believe that the whole ethos of 'the Dewd' will unravel in time, then you might have cause for concern.

SNOOPY

discL: holder, and not worried by the debt position of the company

[Snoopy]

Snoops, as a matter of interest do you do any economic added value stuff?

EVA = Net Operating Profit After Tax - (Capital Invested x WACC)

Capital invested is zero (all spare cash paid out to Alan Lai).

So all I need do is to consider NPAT (done).

Why I ask is why does the market value $270m odd of equity at over $400m

Because a 'high interest bond' is priced favourably in this market?

SNOOPY

[Snoopy]

Nevertheless a little look at the balance sheet for comparative periods is in order:

	HY2017	FY2016	HY2016
Total Liabilities (A)	$472.236m	$412.917m	$482.166m
Total Assets (B)	$748.148m	$687.216m	$754.128m
Debt ratio (A)/(B)	63.1%	60.1%	63.9%
Inventories	$214.251m	$244.074m	$209.163m

Because PGW is a seasonal business, the first half of the year tends to be 'stock heavy'. Less inventory is on hand at the end of the financial year (June 30th) when the farming season is over, and the inventories have been cleaned out. However this was not true as at 30th June 2016. This might be reflecting excess stock from irrigation systems not installed, and seeds not sold due to flooding in South America, specifically Uruguay. The 'like for like' period HY2017 vs HY2016 shows a greater inventory in FY2017 (more of the irrigation system products from last season and more seeds still on hand?) but also a (slightly) lower debt ratio. Hmmmm.

I have decided that a look over a longer timeframe at the seasonality of the PGW business would be useful for shareholders.

Here is what PGW says about the seasonality of their business, the disclaimer printed in the annual report each year:

"The group is subject to significant seasonal fluctuations. In particular Livestock and Seeds activity are significantly weighted to the second half of the financial year. Seed revenues reflects the fact that the group operates in geographical zones that suit Autumn harvesting and sowing (March to May). New Zealand generally has spring calving and lambing and so livestock trading is weighted towards the second half of the financial year (January to June) in order for farmers to maximise their incomes. Other business units have similar but less material cycles. The group recognises that this is the nature of the industry and manages its business accordingly."

Expanding on the small table I have previously created:

	HY2017	FY2016	HY2016	FY2015	HY2015	FY2014	HY2014	FY2013	HY2013	FY2012	HY2012
Total Liabilities (A)	$472.236m	$412.917m	$482.166m	$385.585m	$467.190m	$364.800m	$438.826m	$363.402m	$402.887m	$402.698m	$498.956m
Total Assets (B)	$748.148m	$687.216m	$754.128m	$652.953m	$728.460m	$634.502m	$700.380m	$619.508m	$987.272m	$980.472m	$1,066.012m
Total Assets {Goodwill write off removed} (C)									$666.129m	$659.329m	$744.869m
Debt ratio (A)/(B)	63.1%	60.1%	63.9%	59.1%	64.2%	57.5%	62.3%	58.7%	40.8%	41.1%	46.8%
Debt ratio (A)/(C)									60.5%	61.1%	67.0%
Inventories	$214.251m	$244.074m	$209.163m	$246.313m	$202.551m	$229.498m	$210.108m	$243.650m	$202.643m	$239.440m	$208.446m

There was a large write off of goodwill in 2HY2013. Projecting this write off back into previous results creates a better 'like with like' comparison picture. Contrary to my previous explanation, it seems that the higher indebtedness at financial half year (the end of December) is quite normal. In tandem with the higher indebtedness at half year is lower inventory. This seems counterintuitive, so what coudl the explanation be?

PGW explain that the two most seasonal effects are livestock sales and seed sales both weighted to the second half.

1/ Livestock are more often than not sold on an agency basis. PGW does not need to own whole herds of cows themselves to make sales. Some livestock get on the books as 'biological assets', but these are not part of inventory.
2/ Seeds although peaking in stock before autumn are largely 'grown' by PGW, not 'bought in'. If PGW grows seeds, do they appear as inventory on the books if no cash is laid out? I don't know the answer, but I would guess 'no'. If that is true, it means that the main 'inventory' on the books for the seed stock is the packaging, perhaps relatively low value in dollar terms compared to the money made from selling the seeds themselves.

Taking 1/ and 2/ together, this could explain why 'inventory' on the books appears seasonally low, just as PGW are entering their high sales period (January to June).

The second point to note from my table is that, when corrected for the 2HY2013 goodwill write off, the indebtedness of the company as measured by the debt rationo has not changed much outside of the seasonal variations since the Alan Lai headed recapitalisatiuon.

SNOOPY