AVD - American Vanguard Corporation: Large Declines In Price Don't Always Mean Value

2023-12-24 22:06:34 ET

Summary

• American Vanguard Corporation is involved in the development, production, and marketing of specialty chemicals for consumer, business, and agricultural demands.
• The company's expansion into South America has led to significant financial benefits, tapping into the growing demand for agricultural products in countries like Brazil and Argentina.
• This expansion has diversified American Vanguard's financial portfolio, reduced reliance on the North American market, and enhanced its global competitiveness in the agricultural chemicals industry.
• The firm is currently overvalued based on my DCF projections, resulting in a hold rating.

Since my last article on American Vanguard ( AVD ), I rated the stock a hold due to overvaluation and the share price has been down over 35% since then. Although the price has reached my previous fair value calculation, changes in the firm's cash flow expectations from volume declines have led to a reduced present value on its future cash flows resulting in a maintained hold rating.

Business Overview

American Vanguard Corporation and its subsidiaries are involved in the development, production, and marketing of specialty chemicals. These goods meet consumer, business, and agricultural demands domestically and internationally. Their assortment of chemicals comes in liquid, powder, and granule form and includes insects, fungicides, herbicides, and molluscicides in addition to items that support soil health and plant nutrition, growth regulators, and soil fumigants. These are intended for use on decorative plants, lawns, and crops in addition to safeguarding the health of people and animals.

The business produces and formulates these goods in addition to marketing, distributing, and selling finished chemical and biological products meant for agricultural use. It also offers chemical delivery services for the turf and ornamental markets. Through a variety of channels, such as national distributors, buying groups or cooperatives, and its own sales offices and distributors, which are run by a group of sales executives and agents, American Vanguard guarantees product availability.

American Vanguard holds a market capitalization of $317.4 million and has a 2% Return on Invested Capital. Over the past 52 weeks, its stock has experienced fluctuations, ranging from a high of $23.67 to a low of $8.41. At present, the stock is valued at $11.17, accompanied by an EV/EBITDA ratio of 14.02. One noteworthy aspect of the firm is its EV/EBITDA ratio, which stands above that of its industry peers, indicating overvaluation when compared to its peers as shown below.

American Vanguard also pays out a dividend of 1.09% representing a payout ratio of 80.11%. Although the firm's income is currently reduced leading to this high payout ratio, I believe that prioritizing debt payments with available funds would be best suited as it would make the risk-reward more favorable by decreasing the risk of holding American Vanguard's equity. This will allow the firm to reduce debt payments and enable the firm to take on debt to expand in lower-cost environments when interest rates do not weigh down the firm's growth. American Vanguard can also reestablish solid profitability while paying down debt which can justify its current price leading to shareholder value as there are financials to back up value.

Performance Compared to the Broader Market

American Vanguard has also underperformed the S&P 500 in the last 5 years when adjusting for dividends. With the S&P returning 82.83% and American Vanguard losing 32.31% in that same time frame, it demonstrates that American Vanguard must improve profitability and solve financial concerns before being able to have competitive returns.

Balance Sheet

American Vanguard's balance sheet is rather leveraged. Although I do believe that this cyclical downturn will recover due to macro headwinds subsiding, I still think that income at stable levels still presents some risk due to taking on debt at high costs. This will decrease FCF in the long term and result in a higher cost of debt even in expansionary macroeconomic cycles which puts them at a disadvantage compared to competitors. With an interest coverage of only 1.66 and a Current Ratio of 2.49, I believe that although American Vanguard can pay short-term liabilities, signs of recovery must be seen before I invest in the company as cash flows are more unpredictable than usual chemical companies.

Earnings

American Vanguard Corporation encountered some difficulties in Q3 2023 , but it was nevertheless able to keep sales levels close to those of the prior year. The company reported net sales of $149.52 million, which were nearly identical to the $152.27 million recorded in the same period the prior year, despite clients worldwide destocking to lower inventory costs. But compared to the same quarter last year, when the company's net income was $6.74 million, it now saw a $325,000 net loss. As a result, profits per share were -$0.01 as opposed to $0.23 in the previous year.

While some aspects of the company, such as sales of the corn soil insecticide Aztec and soil fumigants in the Pacific Northwest, continued to be strong, this performance is a reflection of lower inventory levels and competitive pressures in other overseas markets. Analysts predict that EPS will rebound over the next year, and I agree with their forecasts because lower inflation will lead to more volume, which will boost profitability.

Analyst Consensus

Analysts currently rate American Vanguard as a "Strong Buy" due to the firm's expected recovery due to macro headwinds subsiding presenting an upside. With an average price target of $15.5, the stock presents a potential 38.76% upside. Although I agree with analysts in regards to a recovery, I still believe that the stock price is trading at a premium because, with those future cash flows, it is still expensive given current risks.

Valuation

Before finding a fair value for American Vanguard, I decided to find the firm's Cost of Equity using the Capital Asset Pricing Model. Assuming a risk-free rate of 3.87% based on the current 10-year treasury yield , I found a Cost of Equity of 7.7%. This represents the return expected when holding American Vanguard's equity.

I then decided to use a 5-year Equity Model DCF based on net income to find the present value of the firm's future cash flows. To do this, I assumed a discount rate of 9% which implies a 1.3% risk premium due to the current debt load and strain of volume on the firm's core business. I also estimated revenues and margins to continue to grow in line with guidance. This resulted in a fair value of $9.14 representing an 18% overvaluation.

Global Expansion Could Improve Competitiveness

The effectiveness of American Vanguard Corporation's strategic approach is supported by the substantial financial gains that have resulted from its global development into emerging markets, particularly in South America . The corporation capitalized on the rapidly increasing demand for agricultural products by entering nations such as Brazil and Argentina, which have thriving agricultural industries. This move was intended to increase their market share as well as access new areas where crop protection and soil health solutions are becoming more and more necessary.

This expansion approach has shown to be financially advantageous. It created additional sources of income, which enhanced the company's financial portfolio's diversification and stability. Because it lessens the company's dependence on the North American market, this diversification is essential for reducing the risks associated with market volatility and local economic downturns. Furthermore, American Vanguard made sure that there was effective market penetration and steady revenue development in these new territories by building a strong distribution network through local partnerships and acquisitions.

I also believe American Vanguard's global competitiveness was improved as well as its global market presence with its growth into South America. By catering to regional requirements, the firm has established itself as a key player in the worldwide agricultural chemicals sector. By having a larger market share, higher revenue, and a stronger core business model that can withstand variations in local markets, the firm can have a greater influence on pricing power and can offset some of the declines due to the fluctuation of volume being different based on the current economic situation.

Risks

Increased Debt and Interest Expenses: Due to high interest rates and debt levels, American Vanguard has reported greater interest expenses. Changes in consumer buying habits and the strain of working capital management are the main causes of this debt increase.

Cost Pressures and Gross Profit Decline: The company experienced a decline in gross profit and a rise in total cost of sales. Reduced sales, worldwide destocking, the absence of essential items, and competition from inexpensive generics were blamed for this. With these cost pressures, there is a risk of remaining profitable in the medium term.

Conclusion

To summarize, I believe that American Vanguard is still a hold because even though the stock hit my previous fair value, performance has continued to decline which has damaged future cash flows resulting in the firm being overvalued.

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