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Stockwatch: Deals will drive this share

Since January, when I drew attention to stake-building in this AIM-listed British potatoes and daffodils supplier Produce Investments (PIL), its shares have risen from 175p over 200p and notably, a new chairman is accumulating them up to 200p. 

On 28 March, soon after the interim results, he bought a maiden 35,000 shares at 176p, then 10,000 on 24 April at 194.5p, 37,500 on 4 May at 193p, 26,000 shares at 200p on 5 May, and lately, on 12 May, he added 21,900 shares at 20p - a total £249,225 outlay before transaction costs.

Admittedly, it would be odd if a chairman didn't establish equity exposure, but this extent is meaningful in context of the stock available for a £52.5 million company. His buying and the growth agenda set out at the half-year results offers encouragement after the stock initially dropped from over 210p to about 175p, then clawed nearly all the way back.

Potato price volatility

A chief reason why produce shares have traded on an average annual price/earnings (PE) ratio multiple as low as 5 in recent years, is potato prices subject to supply/demand swings including weather issues.

After results for the group's year to 25 June 2016 showed a 14% improvement in operating profit to £9.2 million, on revenue up 4% to £185 million, the second half of 2017 was hit by delays in an expected recovery in in potato prices, plus the cost of implementing new IT.

Like-for-like operating profit slumped from £3.4 million to £0.2 million, and a £1 million non-cash write-down was taken "to ensure all balances transferred into the new ERP system (enterprise resource planning) were correct." All this, despite the retiring chairman saying last October he felt "the business model is more resilient, more diverse and well-placed to handle any pressures that it might encounter."

The story shows not only why advisers insist such declarations are made in terms of "feelings and beliefs", but also that Produce needs a radical development move to avoid being rated as volatile potato business.

As the market settled down, more attention has been paid to trading being "well ahead" of last year, with raw material cost increases being passed on via higher prices. "The year-end trading result will depend on that rate of price recovery, the outcome of the daffodil season now in full swing, and the Jersey Royals new potato season which is only just beginning... underlying trading profit likely in line with original expectations, pre-tax profit lower due to non-cash write-offs."

The table below shows the expectation of a 40% drop in normalised earnings per share (EPS), then a recovery in the year to 25 June 2018. While this only appears to regain 2013 earning power, the stock did trade in a 210p to 320p range during that period.

Produce Investments - financial summary           Consensus estimates
year ended 25 Jun 2012 2013 2014 2015 2016 2017 2018
Turnover (£ million) 154 206 192 178 185    
IFRS3 pre-tax profit (£m) 6.0 7.6 8.6 7.3 3.5    
Normalised pre-tax profit (£m) 5.6 7.7 10.2 6.1 10.8 7.8 9.2
Operating margin (%) 4.4 3.7 5.8 3.9 6.3    
IFRS3 earnings/share (p) 23.1 26.9 31.7 19.8 11.6    
Normalised earnings/share (p) 20.4 27.3 38.1 15.6 36.7 22.0 26.1
Earnings per share growth (%) -0.2 33.7 39.7 -59.1 135 -40.1 18.9
Price/earnings multiple (x)         5.5 9.1 7.7
Annual average historic P/E (x) 6.9 7.9 7.2 6.8 5.0    
Cash flow/share (p) 37.0 15.6 42.4 34.4 32.6    
Capex/share (p) 12.5 12.5 29.0 13.6 14.3    
Dividend per share (p) 5.5 3.6 5.9 6.9 7.2 7.8 8.3
Yield (%)         3.6 3.9 4.1
Covered by earnings (x) 4.0 7.8 7.0 2.3 5.2 2.8 3.2
Net tangible assets per share (p) 71.5 72.7 117 128 129    
Source: Company REFS                   

Better visibility for the next three years

Interims also offered a carrot by way of "good visibility on likely volumes for the next three years" after the outcome of various retailer supplier reviews, "this in turn will improve efficiencies at our two fresh potato sites after a three-into-two factory rationalisation last year... also significant efficiency benefits from ERP implementation."

While the chief executive remains the same since 2006 (who floated the business on AIM in 2010), overseeing his actions is a revitalised board since last October: the new chairman, Neil Davidson, is ex-chair of Cherry Valley Farms and a director of Morrisons since 2015, and there are two new non-executive directors with relevant experience e.g. at Northern Foods, Tesco (TSCO), Safeway and Express Dairies.

Also, and partly why I drew attention to the stock, a new finance director - Jonathan Lamont - took office from 1 January. Such extensive change in the board of a smaller plc can herald radically new prospects.

New development strategy is chief appeal

The strategy is described in the interims release as "Acquire, Develop, Trade the Portfolio...which will make the most of our collective experience in turning around and developing profitable food businesses." The criteria being "UK-headquartered private or public businesses with enterprise values up to £500 million," which implies reverse takeover potential.

"We believe there are many potential acquisition opportunities that meet these criteria, including non-core subsidiaries, "stranded" private equity-owned assets, and private family businesses. Our financing will be prudently structured, targeting leverage of 2.0x net debt to EBITDA."

So, unless the board has delusions of grandeur, this implies a far more substantive business than the current, vertically-integrated base in potatoes - encompassing seed production to growing, processing and supplying major retailers also wholesalers. "We look forward to pursuing this to generate significant incremental value for our shareholders as suitable acquisition opportunities arise."

Investors with long memories will recall the likes of Hillsdown Holdings and Albert Fisher in the 1980s, which performed very well, buying up mainly fresh food supply operations, though became over-stretched in the takeover boom of the times, also accounting rules that rewarded opportunism.

At least they show how "acquiring in fresh produce" can generate value if excesses are avoided; moreover, if vegetables/fruit are involved, it's what people are being told to eat more of nowadays than meat. One of the fastest-growing lifestyle choices is vegan, e.g. with supermarkets introducing such ready-made meals.

There's also precedent in bakery where AIM-listed Finsbury Food (FIF) I've drawn attention to since 2012, has multiplied seven-fold in total value with acquisitive development - supplying supermarkets with specialty bread/cake - which defied a sense that powerful retailers would screw down suppliers on price and there wasn't worthwhile margin.

Diversification and placings will likely follow

As I stated last January, the balance sheet doesn't tally with acquisition plans, and the March interims showed end-2016 cash of £381,000 (down from £927,000) versus total debt of £29.4 million - which screams out for equity if serious development moves are to be made. Net assets were quite similar at £49.5 million with £15.9 million constituting intangibles.

The appointment of Numis as nomad/broker affirms a sense that acquisitions will be linked to institutional placings. That's potentially frustrating for private investors, although with a modest 26.9 million shares issued and a slight premium to 184p net assets per share, dilution should be mitigated.

The chairman's share buying can therefore be seen as "getting in on the ground floor" versus the development objective. By all means consider the single-figure PE, circa 4% prospective yield and decent asset-backing, but this stock is henceforth mainly tied to what deals unfold. For what the chairman's experience is worth, clearly he thinks they are achievable.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.


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