Here is some unsolicited advice for the folks at Agrium Inc.: If you have an activist investor who argues the company is improperly run and the shares undervalued, you had better beat, not miss, earnings expectations.
Alas, the Calgary-based company did the latter earlier this month, sending its shares down nearly 11 per cent in a day; they have yet to recover.
Were it not for the miscue, investors might be less inclined to consider the argument for breaking up the company. Jana Partners LLC, a New York hedge fund, thinks Agrium could boost its stock value by splitting its fertilizer business from its network of farm-products stores. To push that plan, Jana has put forward a slate of five new directors for Agrium’s 11-person board.
Jana says Agrium’s retail division, which sells agricultural products directly to farmers, isn’t getting its due from the market because it’s underperforming and is yoked to the company’s wholesale fertilizer business. Jana argues splitting the two units could unlock significant shareholder value – perhaps $50 a share on a stock that is trading around $100.
There isn’t much evidence that Agrium’s big shareholders are lining up behind Jana, as the shares, even before their recent tumble, weren’t priced to suggest a 50-per-cent gain on the horizon. At the same time, however, a few more earnings misses and Agrium won’t be able to dismiss Jana as easily as it’s done so far.
Much of the Jana argument rests on the issue of what is the proper valuation for Agrium’s retail business, built through a series of acquisitions, including the 2008 deal for Colorado-based United Agri Products.
Jana notes that Agrium chief executive Michael Wilson contended, at the company’s 2011 investor day, that Tractor Supply Co. — a Tennessee-based company that operates 1,150 “retail farm and ranch” stores — is “a very close model” to Agrium’s retail business. Since Tractor Supply’s shares traded at an enterprise value — market capitalization plus net debt — of about 11 times its EBITDA, or earnings before interest, taxes, depreciation and amortization, Mr. Wilson said he believed Agrium’s retail business should be afforded the same multiple. Pressed by Jana, Agrium hired financial advisers who now say Agrium’s retail EV/EBITDA multiple of roughly eight is appropriate and Tractor Supply, which arguably resembles a mini Home Depot, isn’t really the best comparable after all.
The problem with all this quarreling over the multiple, however, is that Agrium’s retail business provides less than a third of the company’s profits. In the last 12 months, the retail business posted EBITDA of $907-million. Adding one point to the retail EV/EBITDA multiple adds just $907-million to the company’s enterprise value; with about 149 million shares outstanding, that increased value translates to an extra $6 a share.
If you argue, as Jana does, that the retail segment could be more profitable, and the multiple should be significantly higher, you can suggest Agrium shares could add $20 to $25 in value. (Mind you, that would require Agrium’s retail arm to produce results similar to Tractor Supply; the Tennessee firm has earned its multiple by increasing its profits by 30 per cent or more in each of the last two calendar years.)
Instead, it is the wholesale business, and its outsize profits, that drive much of Agrium’s overall value. Agrium gets nearly $2-billion in EBITDA from its wholesale business, an industry that has much smaller multiples.
CF Industries Holdings Inc., which gets more than 80 per cent of its revenue from selling nitrogen fertilizer, has a forward EV/EBITDA multiple of 3.7. Mosaic Inc. with 70 per cent of its revenue from phosphate, trades at about 5.4. And Potash Corp. of Saskatchewan Inc., which gets about half its revenue from its namesake product and the rest from nitrogen and phosphate, trades at 8.1.
Applying any one of these multiples, or some blend of the three, has far more impact on Agrium’s total valuation than tinkering with the retail multiple. (If you believe Agrium’s retail business has a trailing EV/EBITDA multiple of 8, Agrium’s current share price implies a trailing multiple for the wholesale business of just 4, akin to CF Industries.)
But looking at each of Agrium’s parts, separately, makes you wonder whether Jana has a point questioning why they’re together. After all, the lower bound of the retail multiples is the upper bound of the ones for wholesale. The market places greater value on dollars of earnings in the retail segment than it does in the wholesale business; that effect is diluted when they’re wrapped up in one.
Agrium says the two businesses have important synergies (which Jana disputes). Agrium also says the retail business provides its shareholders with protection from volatility in commodity prices. You know what else would provide that protection, for shareholders who wanted it? Holding one share of Agrium Wholesale, and a share of a separate, publicly traded Agrium Retail.
In a statement Monday, Mr. Wilson said Agrium’s shareholders have embraced its “highly successful integrated strategy” and rejected Jana’s ideas. It’s a shame, then, that Agrium opened the door to a re-examination with an earnings miss. A few more problematic quarters, and shareholders may decide “highly successful” no longer applies, and “integrated strategy” should not.