Thursday, March 24, 2016

Agrofresh Solutions (AGFS): a bad apple crop and poor management communications makes it undervalued

Agrofresh Solutions (AGFS) is a former subsidiary of Dow Chemical. The company makes chemical products that are applied to various crops (85% apples) that slows the ripening process thereby extending shelf life and minimizing waste.

The cost to apply the product is low compared to the benefit to farmers and packers. This is a big deal because around 40% of apples are lost to spoilage. The mechanism on how the product works can be found on the company website.

The company was spun out from Dow Chemical in 2015 into a Special Purpose Acquisition Company (SPAC). A SPAC is basically a company that raises money for the specific intent of buying an already existing business.

After Agrofresh was acquired the management went on a roadshow to get the name of the company out to investors. The management put out some financial forecasts of $177 million of revenue and $100 million of EBITDA for the year of 2015.

After the deal was completed the management guided EBITDA down to $87 million on the low end. Timberrr went the share price and management's credibility. The shares fell 30% in one day.

However that is not the whole story. The North American apple crop was down 8-10% last year and the apple crop in the Northern hemisphere was down 20%. The company is a great business as 50% of revenue ends up as EBITDA. The company still had $49 million in cashflow last year even with the lower apple crop which led to lower application of the company's product.

This is the opportunity in my view. Farming is notoriously volatile both on the upside and the downside. This years dismal crop is next years bumper crop. If the apple crop returns to normal than more of company's product will be consumed and presumably sales and EBIT will go up. This should push up the stock price.

The company is not without risk. It is a one trick pony with only one product. They are working to expand into additional geographical locations and into other crops. Another risk is that this product will lose patent protection in 2018. They already operate in some countries without patent protection and as of yet have not been affected by competition. I think this risk is low because the product works and saves farmers money. The cost/benefit is such that for a farmer to change to an unproved product is too much risk. The competitor's product would really need to outperform Agrofresh's product in order for farmers to risk it. This is also a niche product so how valuable is the franchise to a major chemical company?

Insiders seem to think the shares are undervalued and have been making ongoing purchases. The company is buying back shares and with around $50 million in cashflow per year the company could buyback a significant number of shares each year. The management has also stated that they are looking for bolt on acquisitions in order to diversify away from being a one product company. This is a two edged sword as management could squander funds on a dumb acquisition.

In summation I think that a poor apple crop along with management's fumbling of communication to the market gives me a great opportunity to acquire a great business realatively cheap. I added Agrofresh to my portfolio today.

Yes the bottom is in

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