Introduction
American Vanguard Corp. (AVD) averages a "buy" rating from analysts that follow the company with a consensus price target of about $31.28. The company develops, manufactures and markets specialty chemical products focused on agricultural and commercial uses and sells through distributors. The company is presently trading at $24.00 a share and is considered a small-cap stock with a market cap of $687.84 million.
Analysts believe the stock can move another 28.6%. Is the company a good buy? What should investors expect and consider when looking at this company is an investment? Let's take a look at the company's recent performance and what it is up against in the agricultural markets in the near and distant future.
Presently, the stock has been in a long term bearish pattern since October 2012. As you can see from this weekly chart, the stock started to use the 50 day moving average as resistance about Midsummer of 2013. Why has the company been in a consistent downward pattern for so long when the S&P 500 as a whole has been moving up?
It peaked in the middle of the growing season of 2012 when we had that terrible drought. Corn prices went up, but they have continually been coming down since then and the company is still experiencing an over supply of its pesticide products because of this. It is important to understand that this is a cyclical business. Even though corn prices are not expected to move up much over the next few years, the company cannot afford a stellar growing season. This will lead to lower corn prices causing farmers to store their grain. The following growing season will be smaller "acreage wise" which translates into less sales and revenue for AVD.
General Overview- It is not Industry Leading
While the company has been able to finance its growth using capital much better than the industry as a whole (debt/equity ratio- 0.15 to industry's 0.21), it doesn't do as well when we compare current assets and current debt. That does not mean the company hasn't done well itself. It has almost twice the assets than it does debts. The industry as a whole blow has an average ratio of 2.33 which is far better than the company's 1.88.
In terms of value, the company doesn't show an edge of any kind, but falls right in the middle at industry average. With a P/E ratio of 15.3, the industry is at 15.34. We find the same with the price/book value. Vanguard is very close to the industry average, coming in at 2.68 to the industry's 3.11.
It has shown earnings growth over the last 10 years, but that also is average following right along with the S&P 500. The company has averaged yearly growth of 4.49% while the S&P 500 has averaged 4.42% over the last 10 years.
Unfortunately, the expectations over the next five years are not expected to be as good as the last 10. While the company is expected to do far better than the industry, it is still expected to produce below its 10 year average. According to MSN money, earnings over the next five years are expected to grow 18.5% which averages just over 3.7% per year. This is lower than the last 10 years average. But it is far better than the industry average which is forecasted to grow at a paltry 11.4% over the next five years.
A Poor 4Q of 2013 because of Weather
The company's "elevated channel inventories" is expected to have an adverse effect upon its fourth-quarter and full-year performance. The inventory levels were higher than expected because weather in the Midwestern United States was much wetter than anticipated.
Sales in the fourth quarter will be 30% less than the prior quarter because of this. Despite this, the company had a pretty good year increasing net sales by 5% compared to 2012, even with net income expected to go down by possibly 15% in the fourth quarter.
One of the threats the company faces year in and year out is weather conditions. Due to prolonged adverse weather conditions, corn and cotton planting deteriorated during the planting season in 2013. The previous two seasons were pretty healthy and distributors and retailers had inventory stocked expecting another really good year. This resulted in unused products and surplus inventory in the hands of the distribution channels.
Despite lower forecasts and expectations for the fourth quarter, the third quarter was pretty healthy. Not only did the company register profits of $8.9 million (which was up 10% from a year ago) but earnings also rose by 11%.
Nevertheless, an investor needs to consider the huge reduction in sales regardless of the reason. When you have a company like AVD that is "inventory heavy" and they cannot move inventory, that's a big problem. Of the company's current assets according to the third quarter of 2013, inventory made up 47.3% of those assets. The company did not move that much in the fourth quarter and that will really slow down manufacturing.
Corn products have been the main driver for growth in the company for the last three years. Sensitivity to the demand in the corn market has an effect on the company's performance.
Corn Projections (2013-2022)
The corn market is very important for AVD. In fact, it is the main driver for growth in the company for the last three years. Sensitivity to the demand in the corn market will always have an affect upon the company's performance. Corn prices are sharply lower over the last few years and many in this industry has an extreme surplus of inventories. Let's take a look at the corn market for the next 10 years.
Although it's impossible to predict future corn production, the National Agricultural Statistics Service (NASS) does forecast corn projections (2013-2022) for the future. This is important for long-range planning for all businesses related to farm operations.
Corn acreage in 2013 was estimated to be at 97.4 million acres, the highest it has been since 1936.
The Ethanol industry, which relies heavily on corn is expected be quite slow. This is one of the reasons the corn prices are not expected to move much in the next few years. A drought in 2012 led to lower supply and higher costs. This led to lower domestic use for livestock feed and ethanol production as well as exportation. Because of this the supply of corn was expected to double through 2014 pressuring prices to stay low.
Acreage is expected to pull back the average levels of 88/92 million acres and production is expected to balance out around 1.5-1.6 billion bushels for the balance of the decade. This is about what is expected global demand also. The demand for livestock feed, food, and industrial use for corn is expected to increase but just slightly. In terms of pricing, (2013-2014) should seen average of $4.10/bu. and through the decade a range of ($4.40-$4.80).
It looks like the next decade profit margins will be tighter than previous years. The cost of inputting crops in the ground has risen over the last few years. This could also affect AVD's margins. The only thing that would help raise this for the company would be adverse weather conditions. There is always a strong demand for corn on a global level and if one year we have adverse weather conditions this could easily create sharp increases for corn prices. This in turn will lead to a possible oversupply and a reduction in cost, reduction in planning and reduction in sales for AVD just like they are experiencing right now.
What are the short Term Expectations for Corn Planting?
For 2014, the expectations are fairly universal that there will be a reduction in corn acreage. One thing to watch if you are interested in investing in AVD is the weather that Mother Nature brings us in 2014. Corn prices have dropped dramatically over the last couple years and if we have a good year and a bumper crop, we could end up with an oversupply going into 2015. Corn prices are low so farmers are already store in their crop hoping for price increases. The only way prices are going to go back up to the $5.00+ level is if another "drought event" takes place. A good year will bring gluttony of corn which will in turn lead to lower prices, less production and an oversupply of AVD products on distributor shelves. I have mentioned this a few times in this article, but I believe is important to reinforce this point. If one is to invest in this company, the cyclical nature of the industry is important to understand.
Insect Resistance will continue to drive some Products
The repeated use of a certain class of pesticide can cause Mother Nature to create resistance to changes in insect gene pool. Often a small portion of a certain "pest" survives exposure to a pesticide. The genes in this insect are then passed along to the next generation which continues to expand resistance. By nature, the more a pesticide is used the more the next generation of insect population become genetically resistant. Worldwide it is estimated that more than 500 species of insects have developed certain levels of pesticide resistance.
The fight to maintain one step ahead of Mother Nature drives the sales of AVD's granular soil insecticides. Along with these insecticides, genetically modified seeds will continue to fight the insects and drive sales.
This is one of the reasons that Zack's Investment Research upgraded the company to a "strong buy" in December 2013.
Monsanto Company (MON) markets AVD's Impact herbicide with its "Roundup" brands and since Roundup is a top-selling brand, it is a win-win for both companies. All it will take is a good growing season and AVD will see good revenue in 2014. The company has positioned itself well to offer its premium crop protection as producers prepared to deal with intensified weed and insect risks.
Investor Risk and Threats to Consider
Chinese Intentions to Compete in US Ag Market
One possible threat AVD faces is competition from Chinese companies exploring the American pesticide market. There are "ag-chem" companies already developing a base in the Western markets. The timing on this may be sooner than expected. Some major companies that we are familiar with: Monsanto and Dow Chemical (DOW) have already been producing pesticides at plants in China.
The industry in China rivals the industry here in the United States in size and to increase their market share, the companies from China will naturally gravitate toward the United States market.
Over the next five years, the Chinese government is looking to create a group of about 20 Chinese ag-chem firms that have a strong international presence.
Mother Nature
The most important thing investors need to consider with companies like ADV is that they are at the mercy of Mother Nature. When growing seasons are strong, distributors will sell a lot of ADV products and in turn will restock their shelves which translate into good sales for ADV.
The opposite is true though when Mother Nature decides not to cooperate. If planting conditions are poor because of the weather there will be a reduction in sales because less acreage is planted. The challenge ADV runs into is when distributors restock shelves in anticipation of a good growing season and it doesn't happen. They end up with excess product so that not going to reorder is much the next quarter. This is what the company experienced in the 4Q of 2013 when it saw sales drop by 30% from the previous quarter.
Conclusions
Although the company may not be expected to perform as well as it did in previous years, it is still expected perform well above industry standards in the next five years. Analysts expect the stock to grow more than 25% in the near future with a price target of $31.28. As a value investment, the stock doesn't look half bad, but I would encourage investors to make sure that you understand the cyclical nature of the industry. Mother Nature could play a key role in revenue increases for the company, but at the same time she could also wreak havoc.
Author's Note: The chart in this article was taken from MSN Money as were the ratio figures.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)
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