Crookes may reap what it sows

Greenfield projects nearing fruition.

Not many investors would fancy this agriculture company. The immediate deterrent is the lack of predictability in its earnings stream. On the flip side, this shortfall creates an opportunity for speculative investors who can stomach a bit of risk. 

We believe Crookes Brothers has great potential for future earnings growth and share price upside. A number of its greenfield projects are inching closer to revenue generation, which is likely to see profit margins expand. Crookes is predominantly a sugar company, which is its weakest link, but this is likely to change in the medium to long term as management intensifies efforts to diversify the business. That should add value to shareholdings.

crookes recomm

crookes table 1

 

Its growth potential lies in the following:

  • In 2013 the group acquired High Noon deciduous orchards under its accelerated expansion and diversification programme. The purchase increased hectarage in the highly profitable deciduous fruits division to more than 650ha. Close to half of these orchards were replanted and are now approaching maturity. As these new plantings come to the fore, fruit volumes are expected to increase rapidly in the coming years, bumping up earnings. Management expects production to rise to 35 000 tonnes/year, which is about 25% higher than current production. Profit for the division should also take a huge leap.
  • The macadamias project, which the market has been eagerly awaiting, is also inching closer to revenue generation. The group made a sizeable investment towards the development of 1 500ha of land in northern Mozambique for macadamia nuts and other annual cash crops. Plantings for the first 249ha of macadamias is complete and the first marketable crop is expected in 2017. The graduation of this project to revenue generation will have a significant impact on the group’s profitability. It will ease pressure on cash flow as it is currently funded by existing business and help to cover corporate costs, which are taking out a sizeable proportion of group profits. Management is confident of meeting a nominal after-tax internal rate of return exceeding 20%.
  • Also related to the macadamias project are annual cash crops and the greenfield development of a 300ha banana farm. These are going to support the group’s cash flow as it pursues other longer-term projects.
  • The implementation of the Renishaw development, where the group intends to convert its cane lands on the KwaZulu-Natal south coast into prime property sites, is also progressing well. The department of agriculture has approved the rezoning of the major part of the farms for residential, commercial and industrial development. The first project launch is expected in the first half of this calendar year. This project has the potential to be the biggest earnings driver for the group in the medium to long term.

That said, success of these projects depends largely on a number of external factors over which management has little or no control, particularly market prices and weather conditions. This in our view makes the valuation of the stock unstable – hence our speculative buy recommendation.

Crookes share price performance (rebased)

crookes graph

While Crookes’ results for the six months to end-September show an improvement, they are still far from satisfactory. Revenue increased 14%, the major contributors being banana and sugar operations. Sugar operations benefited from higher selling prices for cane in South Africa, as well as earlier harvesting of the cane. The operating margin expanded to 11.1% (1H15: 4.7%), partially helped by improved profitability in the banana operations which benefited from improved yields and fruit quality following the completion of a replant programme. Headline earnings almost tripled to 181.4c/share (1H15: 66c).

Despite a largely challenging year with higher outflows – consistent with the strategy to undertake long-term investment in Mozambique – its balance sheet remains strong. The financial gearing ratio rose to 21.8% (2014: 17%) but is still within manageable levels and will come down as the company plans to retire R100 million of its debt in the current financial year. 

The claw-back offer

Crookes Brothers reported on November 20 that it had finalised a R215 million claw-back offer at R80/share – a 31% premium to its 30-day weighted volume-weighted average price of R60.91. Management said the proceeds of the issue would be used to fund its growth projects. The shares have been fully subscribed for by Silversands (SA) Plantations, a Luxembourg registered company which currently holds 33% of Crookes’ issued share capital.

To increase the success of claw-back offers, shares are typically issued at a discount or market price. In this case, however, the issue carried a hefty premium and was backed by the existing shareholder (normally a third party). The fact that a material shareholder is willing to pay such a hefty premium could be read as a signal that existing shareholders feel that the current share price undervalues the worth of the company.

Segmental prospects

We think FY16 will again be a disappointing year for the group’s sugar operations. The division normally commands operating margins above 30% but with drought conditions and subdued market prices, we slashed our projections for the operating margin to a medium-term average range of 22% to 25%.

While the deciduous fruits operations reported an operating loss of R7.1 million (1H15: loss of R5.9m), management expects a good crop in the coming season. Selling prices are expected to be firmer, driven by the rand weakness, improved quality and international demand pressures.  

We expect the recently completed replant programme to continue yielding positive results in terms of production and quality for the banana operations. This should boost the division’s margins.  

Valuation

We simplified our valuation by focusing on the group’s major earnings drivers that can be predicted with reasonable certainty. We applied conservative estimates on key variables such as sucrose prices, production volumes and market prices for fruits. Relative sucrose percentages for sugar cane and the quality of fruits, which are also key determinants of the group’s earnings, are difficult to predict so we used historical averages.

Using Intellidex’s discounted cash-flow model we arrived at a fundamental price of R73.24/share and a one-year forward price:earnings of 18.1. Our per share projections for the current and subsequent financial years factors in a 22% increase in the number of issued shares caused by the rights offer.

Bull factors

  • Diverse range of crops that are well-spread geographically mitigates climatic, market, resource, regulatory and geo-political risks.
  • Increased focus on non-sugar operations likely to enhance earnings and improve diversity

Bear factors

  • Earnings vulnerable to exogenous factors such as weather and volatile currencies.
  • International sugar prices remain depressed.
  • Drought conditions to materially affect group’s profits.

crookes table 2

Nature of business: Crookes Brothers produces primary agricultural products including sugar cane, bananas and deciduous fruit. It has operations in South Africa, Swaziland and Zambia. It also has a new farming operation under development in Mozambique for the production of macadamia nuts and annual crops.

Disclosures: The analyst has no financial exposure to the instrument discussed.

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