AVD - American Vanguard: Acquisitions Creating Growth And Reducing Cyclicality

2023-07-11 10:34:46 ET

Summary

• American Vanguard Corporation, a specialty chemicals company, develops, produces, and sells a range of products, including insecticides, fungicides, and herbicides through its subsidiaries.
• The company's strategic acquisition of TyraTech in 2017 allowed it to diversify its product range, expand its market reach, and tap into new customer segments.
• The company holds a solid balance sheet which protects it even during cyclical declines and has room to leverage.
• Assuming my DCF figures, American Vanguard is currently overvalued, resulting in a hold rating.

American Vanguard Corporation (AVD) has recently experienced a fall in share price due to earnings misses due to cyclical declines. I believe that American Vanguard is currently a hold because although the company holds a solid balance sheet, future earnings expectations, and synergies through acquisitions, American Vanguard is currently overvalued assuming my DCF assumptions with a risk premium to account for macroeconomic headwinds and cyclical declines.

Business Overview

American Vanguard Corporation sells goods for industrial, commercial, and consumer applications in the specialty chemicals sector. Insecticides, fungicides, herbicides, molluscicides, soil health products, plant nutrition solutions, growth regulators, and soil fumigants are just a few of the specialty chemicals that the firm develops, produces, and sells through its subsidiaries. These compounds are offered in a variety of forms, including liquids, powders, and granules, to meet the requirements of diverse crops, turf, and decorative plants, as well as to safeguard the health of people and animals.

American Vanguard Corporation produces and formulates chemicals in addition to marketing, selling, and distributing end-use chemical and biological products primarily for crop applications. Additionally, the business sells chemicals to the turf and ornamental markets. The corporation uses a variety of distribution methods, such as wholly owned distributors, buying groups, co-ops, sales offices, sales force executives, and national distribution companies, to reach its clients.

Financials

With a market capitalization of $526.83 million and a return on invested capital of 4%, American Vanguard is currently trading at $17.27, which is in proximity to its 50-day moving average of $17.63. The company's GAAP P/E ratio is 27.14, indicating that the stock is priced higher than many of its industry peers. This suggests a possible overvaluation, as discussed further in this analysis.

American Vanguard also yields a dividend of 0.67% representing a payout ratio of 16.91%. Although this yield is rather small in regard to income for shareholders, I believe that the choice to focus on utilizing FCF to improve the company's core business model will result in long-term value. This value is derived through the outperformance of competitors and the compounding growth of new segments through methods such as acquisitions as discussed later in the article.

With a $15 million stock buyback program on the way, I believe that American Vanguard has committed to providing further value in multiple ways in the near future.

Earnings

With Q1 2023 earnings missing on top and bottom, American Vanguard must find a way to pivot and recover large misses as it would be costly in times of macroeconomic headwinds to underperform as recovery is much more difficult once FCF is negative and debt or issuance of shares is used to raise cash. Earnings came in at $0.08 per share compared to the expected $0.29 and revenues missed at $124.88 million compared to $158.45 million showing a -16.4% year-over-year decline. But, earnings guidance seems to remain comparatively positive as EPS would grow at a rapid pace along with high single-digit revenue improvements.

Underperforming the Broader Market

In the last 3 years, American Vanguard has underperformed the S&P 500 when adjusting for dividends. This is due to recent earnings disappointments which have sent the stock falling in the past few months. I believe that as the stock price stabilizes and recovers from cyclical lows, we would see a more accurate picture of performance.

Analyst Consensus

Based on the analysis of 1 analyst within the past 3 months, American Vanguard is rated as a strong buy. The analyst has set a price target of $26, implying a potential upside of 50.55%. It's important to note that this rating is based on a limited number of opinions, but it does reflect the optimistic sentiment among analysts regarding the stock.

Balance Sheet

American Vanguard also maintains a strong balance sheet, with cash and investments experiencing significant growth of 256% in the last 3 years, while debt has decreased by 42% during the same period. This showcases the company's ability to reduce debt levels and transition into a more resilient business model during times of cyclical highs, especially as margins start to compress due to volume declines. Additionally, American Vanguard exhibits a healthy interest coverage ratio of 7.61, indicating that it generates sufficient income to cover interest expenses, even in the event of severe cyclical downturns. Furthermore, the company boasts a current ratio of 1.67 and an Altman Z-Score of 2.7, along with a low debt-to-equity ratio of 0.26, which safeguards the company against potential interest rate hikes and lost confidence for creditors during macroeconomic headwinds. These ratios highlight American Vanguard's ability to maintain financial stability while also having the flexibility to leverage or deleverage as necessary.

Valuation

To accurately estimate the fair value of American Vanguard, it is essential to calculate the Cost of Equity and Weighted Average Cost of Capital as a basis for determining an appropriate discount rate. By considering the current 10-year treasury yield of 4.08%, I computed the Cost of Equity to be 8.56%. This figure represents the expected return that investors demand to compensate for the risks associated with holding American Vanguard's equity.

After finding the Cost of Equity in my previous calculation, I was able to find American Vanguard's WACC to equate to 8.56%. With an industry average of 9.89% , American Vanguard holds a lower cost of capital when considering debt and equity compared to peers.

Now that I have found the appropriate metrics to base my discount rate on, I have computed American Vanguard's fair value using a Firm Model via FCFF. Using a discount rate of 10%, American Vanguard is currently overvalued by 23%. I decided to add a 2.4% risk premium to my assumptions to account for macroeconomic headwinds, current earnings declines, and future cyclical decline risks. My current revenue and margin assumptions are in line with expectations with revenues growing at low single digits and margins improving over the years.

Taking a positive perspective, when using a discount rate of 7.6% (without incorporating a risk premium based on my WACC analysis), American Vanguard appears to be undervalued by ~5%. However, it is important to consider the potential risks associated with the company, including previous share price declines during cyclical downturns and the current macroeconomic challenges. These factors warrant the inclusion of a risk premium to account for uncertainties. Nonetheless, if the macroeconomic conditions improve rapidly, investors may have the opportunity to benefit from compounded returns as shown below in the sensitivity analysis.

Strategic Acquisitions Fostering Long-Term Growth

To spur growth and fortify its market position, American Vanguard Corporation has implemented a strategic acquisition strategy. The 2018 purchase of TyraTech , Inc. is a significant illustration of this tactic. American Vanguard Corporation was able to broaden its product line and improve its services in the pest control market thanks to this strategic acquisition.

American Vanguard Corporation benefited greatly from the acquisition of TyraTech. By combining TyraTech's naturally derived pesticides and pest control solutions, it allowed the company to broaden its product line. These goods matched the rising demand from customers for pest control methods that are sustainable thus entering into a segment with long-term growth. Subsequently, American Vanguard Corporation was able to increase its market reach and tapped into new client segments by adding TyraTech's cutting-edge products to its line-up. The inclusion of numerous items, will diversify the product lineup of American Vanguard and increase its durability during cyclical downturns resulting in the preservation of FCF levels to spark recovery.

The expansion of the product portfolio and client base also resulted in greater revenue, which significantly contributed to the company's top-line development. Cost savings were also made possible by the acquisition as a result of the combined company's ability to simplify operations and take advantage of economies of scale. This increased margins and accelerated the compounding growth of the business's core operations resulting in further shareholder value.

The market positioning and competitive edge of American Vanguard Corporation were also strengthened by the acquisition of TyraTech. The company strengthened its position as a comprehensive provider of pest management solutions by increasing its footprint in the pest control market. As a result, American Vanguard Corporation was able to increase its market share, effectively compete with other companies in its sector, and use the cash generated by its core operations to grow certain market segments. Finally, the acquisition strengthened the business's standing as a forward-thinking, customer-focused corporation, ensuring its continued market dominance. As these acquisitions increase during cyclical highs, American Vanguard will be better equipped to withstand cyclical declines and recover stronger than ever, resulting in relatively consistent growth over the long run when averaged out.

Risks

Market Volatility: The financial performance of American Vanguard is impacted by variables like commodity pricing, world agricultural circumstances, and product demand. Variations in these variables may cause fluctuations in the company's profitability and revenues.

Competitive Landscape: There are many firms competing for market share in the fiercely competitive agricultural and chemical sectors. American Vanguard is up against rivalry from both long-standing businesses and new entrants. Price-setting power, market share, and total profitability can all be impacted by fierce competition.

Conclusion

To summarize, I believe that American Vanguard is currently a hold because although the company holds a solid balance sheet, future earnings expectations, and synergies through acquisitions, American Vanguard is currently overvalued assuming my DCF assumptions with a risk premium to account for macroeconomic headwinds and cyclical declines.

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