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Smart money willing to play the waiting game on AGT
Special to The Globe and Mail

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Saturday, November 11, 2017 – Page B11

The shares of AGT Food and Ingredients Inc. are down 15 per cent this week, setting a new three-year low, and the stockholders are probably lucky.

After all, you will likely see few earnings misses as awful as Monday's numbers from AGT, a Prairie producer of pulse crops (lentils, peas, beans). The company's thirdquarter "adjusted EBITDA," or adjusted earnings before interest, taxes, depreciation and amortization, was less than half what analysts expected. Sales of $341-million missed by 25 per cent, more than $100-million. Name a key performance measure and AGT blew it, bigtime. (AGT removes what it views as non-recurring and other expenses, as well as foreign exchange losses, to arrive at its adjusted EBITDA figure; it lost money in the quarter on an EBITDA and net income basis.)

The fact that the market didn't punish AGT more suggests there may have been an inkling that things were going to be bad. (Indeed, AGT was the fifth-most-shorted stock in Canada last month, with 17.5 per cent of shares shorted, according to data from IHS Markit.)

Or, investors are buying the AGT message, which was summarized in its quarterly shareholders' report under the heading, "earnings constraints seen as cyclical."

This, then, raises the question of how long this cycle will last and how long investors will have to wait to be rewarded for AGT's efforts to refashion itself as a modern food company. In all likelihood, it will be quite some time, making this stock appropriate only for the long-term investor - of which AGT has several prominent new ones.

Some background: AGT once stood for "Alliance Grain Traders," a Saskatchewan income fund that converted to a corporation, then bought a company that produced one of the leading pasta brands in Turkey. The company now acquires crops in six countries and sells food products, packaged and canned, in 120 countries.

As with many food companies, AGT has seized on the idea that the branding and value-adding of the consumer-products business is the way to go. And the results demonstrate why: Its "food ingredients and packaged foods" division has produced 53 per cent of the company's "adjusted EBITDA" so far this year even though it represents just 15 per cent of the tonnes of food it sold.

The company still has its processing and distribution businesses, however, meaning it's still buffeted by the vagaries of the commodities market. And this is what's happening, an all-too-familiar cycle for ag investors: Record lentil prices in past years led to heavy planting across the world, which yielded an unusually large 2017 crop in India and big amounts of high-quality pulses in Canada. Supply is up, demand is more stable, prices fall.

Keith Carpenter of AltaCorp Capital said investors already had concerns about AGT's earnings for the remainder of 2017. Given government data about Canadian exports, planting levels in India, and AGT management's own commentary, Mr. Carpenter says, he is even more concerned about the length of the problem, with the potential that AGT's numbers will be depressed into 2019. The pace of the recovery "will disappoint shareholders over the next several quarters," he wrote, cutting his rating to "underperform," with a target price of $17.50.

How low can the stock go? Jacob Bout of CIBC World Markets Inc. notes AGT hit $10 in the last commodity trough in 2012, but he thinks, yes, this time it's different.

Unlike 2012, AGT now has its Turkish pasta business, as well as an operation in Minot, N.D., that produces food for humans and pets.

He's maintaining his "outperformer" rating, but his target price keeps falling, trying to catch up with AGT's actual share price. His 12- to 18-month target price is now $24.

If you care to get in on AGT now, you'll be joining one of Canada's most famous investors, Prem Watsa of Fairfax Financial. Be forewarned, however: Fairfax got a better deal than you will. AGT issued Fairfax $190-million of preferred securities that will pay Fairfax interest of 5.375 per cent for each of the next 99 years. Fairfax also got stock warrants that allow it to buy more than 5.7 million AGT shares at $33.25 apiece any time in the next seven years.

That looked a little more realistic when the deal closed in August, when AGT was a little under $26, but nonetheless any reasonable valuation of these warrants makes it a multi-million-dollar sweetener.

And if Fairfax exercises them, it will own nearly 20 per cent of AGT. Fairfax gets one board member now, and a second if it exercises the warrants.

AGT used the money to pay off borrowings under lines of credit that had an average interest-rate of 3.6 per cent, as of Sept. 30. The neat trick with the Fairfax deal is that the preferred securities allow AGT to deduct the interest payments from their taxes, but call the unsecured obligation stock in the capital structure - and report a steep drop in debt and various liquidity ratios. Analyst Steve Hansen of Raymond James Ltd. said in July that AGT's debt-to-EBITDA ratio fell from 5.2 to 3.0 - but, of course, if the third-quarter profit fiasco flows through to the next few quarters, that ratio will jack right back up again.

AGT must have made the calculus that the extra interest costs on the Fairfax securities were worth the superficial change in the leverage picture and the Watsa imprimatur.

Mr. Hansen acknowledged that he "struggled with the timing/ merits of this deal" before coming to his conclusion that it's worth it, in large part because Fairfax is "a high-quality new strategic partner," given its extensive business dealings in India and long-term investing track record.

Fairfax is joined by others. PointNorth Capital, which has conducted activist campaigns at Extendicare Inc. and Liquor Stores N.A., said in July it had bought 9.75 per cent of AGT's shares. Early indications were that the relationship was good, with PointNorth saying it had "confidence in the existing management team." (Friday, PointNorth said it stands by its July statement.)

And Montreal-based Letko Brosseau and Associates Inc. said on Thursday in a securities filing that it now owns 12.6 per cent of AGT, or just over three million shares.

The stake is worth $55.7-million at Thursday's closing price of $18.23.

An awful lot of smart money is in on AGT and the thesis that a growing world will demand more foodstuffs, and the companies who can provide it will see their earnings, and share prices, grow. It is a long-term thesis, however, and for the next year, AGT stock may barely register a pulse.

AGT Food Ingredients (AGT)

Close: $18.16, down 7¢

Associated Graphic

AGT has seized on the idea that the branding, value-adding of the consumer-products business is the way to go.


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