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Table Scraps and Cast Offs

George C. Fisher

American Vanguard Corp (AVD $41 Basic Materials) is an interesting company build from the table scraps of much larger specialty chemical companies. While potentially not fundamentally undervalued at its current stock price, management has proven its ability to provide long-term shareholders ample rewards. American Vanguard was recently added to the Overlooked Stocks portfolio for 2005 that I maintain for CMS. I discovered American Vanguard in September, 2003, and have been buying shares periodically ever since. I currently own about 250 shares.

We all know about product life cycles. Most products follow a cycle starting with its invention. The product gains popularity creating imitators or competitors, then begins to decline in popularity as the next best version is invented, and finally dies off to obscurity. We all learned in high school about the product life cycle of the buggy whip just before the invention of the automobile. Such is the way of life for most all products. Agricultural and commercial specialty chemicals are no exception to this cycle.

Many large companies have their own product life cycles that do not include holding on until obscurity. As a specific product and brand name travels down its predetermined life span, many times it will spun-off or sold prior to anonymity by the company that invented it or made it successful. Companies are always in the process of restructuring and exiting businesses, inventing new products, along with divesting manufacturing and distribution assets of existing products. New and improved versions, along with supplementary products using the same brand name, will begin to appear under the stewardship of these innovative owners. High overhead structures of the jettisoning larger company are often replaced with leaner management costs, improving overall profit margins. It is not uncommon for reinvigorated marketing plans to forge fresh strategic alliances between the new owners and major clients. Under first-class management, acquiring behemoth’s table scraps and cast-offs can be a very efficient and profitable model for building a business.

An example of an extremely successful company built from larger company’s table scraps and cast-offs is the S.C. Johnson (Wax) Company. A large privately held firm, S.C. Johnson heavily advertises its collection of cast-off consumer goods purchased over the years from other companies, such as Ziploc, Windex, and Raid. American Vanguard is the SC Johnson of the farm world.

American Vanguard has also built a successful business from cast-offs from larger competitors. Formed in 1969, American Vanguard manufactures and formulates chemicals for crops, human and animal health protection. These chemicals include insecticides, fungicides, molluscicides, plant growth inhibitors, and soil fumigants. The products are available in liquid, powder and granular forms. Rather than focus on new research, AVD has built its business by acquiring strategic chemical products unwanted by larger competitors and by improving their marketing and profitability.

Examples of some of their recent product acquisitions follows: In December ‘03, AVD acquired products and production of the trade name Nuvan from Novartis Animal Health, Inc. used in the animal health business. Also in 2003, the company acquired five product lines from Pace International: a line of snail and slug control products used in agriculture and in commercial landscaping; a plant growth regulator used in citrus; a deer and rabbit repellant; streptomycin antibiotic used to control Fire Blight, a bacterial disease of apples and pears that kills blossoms, shoots, limbs and sometimes entire trees; and a horticultural oil insecticide for aphids, mites and scale. In early 2003, AVD acquired assets associated with the US cranberry herbicide business of Syngenta.

In addition to specially chemicals, American Vanguard manufactures a proprietary chemical delivery system for agricultural applications. In July 2002, AVD purchased the SmartBox closed delivery system from Flowserve. The SmartBox system electronically dispenses granular agricultural chemical products, replacing older technology that utilizes mechanically driven sprockets and chains. The SmartBox approach allows for prepackaging of chemicals at the factory in uniquely designed release containers that are directly loaded into the delivery system on the back of a tractor. Transfer of chemicals from production to application is completed in a totally closed system, virtually eliminating chemical exposure to the middlemen and farmers before and after application. SmartBox containers are returnable to the factory for refilling and reuse.

American Vanguard is building its business not only through an expanding specialty chemical product offering but also a proprietary application system as well. These two businesses seem to go together like cake and ice cream. In addition to their own chemical production, AVD is becoming more successful in offering its SmartBox closed transfer application system to other agro-chemical manufactures. For example, in Dec 2004, AVD announced it had entered into an exclusive agreement with giant chemical manufacturer Bayer Cropscience to distribute Bayer’s soybean pesticide in the SmartBox delivery system.

The management team at American Vanguard has proven their ability to provide shareholders with outstanding long-term results. As measured by the fundamental ratios below as of Sept 2004, AVD top-quality management excels in the specialty chemical industry:

 

American Vanguard

Industry Average

Sales 1-yr growth

22.4%

14.5%

Sales 5-yr growth

13.2%

5.4%

 

EPS 1-yr growth

38.5%

31.3%

EPS 5-yr growth

36.3%

5.7%

 

Return on Assets 1-yr

11.3%

5.7%

Return on Assets 5-yr average

8.4%

4.5%

 

Return on Equity 1-yr

25.2%

14.7%

Return on Equity 5-yr average

17.6%

11.7%

American Vanguard’s ratios for revenues and net income per employee, along with receivable and inventory turnover, should be the envy of the industry. AVD’s five-year return on capital is a very acceptable 11 percent, due to the combination of a 17 percent return on equity and a low debt-to-equity ratio of 0.56. I believe executives at AVD have shown the investment community their ability to successfully implement their long-term business plan.

Revenue and earnings continued their growth trends in 2004. For the year, revenues grew by 21 percent, operating income by 51 percent and net earnings by 41 percent. Earnings per share chimed in at $1.51 a share, up 37 percent from 2003’s $1.10 per share. American Vanguard, based on an 11 percent return of capital trend line, could conservatively earn in excess of $1.75 in 2005 and $1.90 in 2006. If the trend line were to reflect a more aggressive 25 percent earnings growth (discounted from the most recent five-year average of 36 percent), earnings could zoom to over $2.35 by the end of 2006. However, investors should note the impact of potential weather-related events to the entire agricultural sector. As with all agro-businesses, AVD is subject to potentially fickle climatic trends.

At $41 a share, however, the stock is not particularly cheap. It is selling at a trailing 12 month PE of 27, a forward PE of 23, and 2.3 times’ sales. I would consider this expensive for chemical manufacturing industry valuations. On a positive side, the 2005 PEG ratio of 0.92 (based on 25 percent earnings growth) indicates the current price may not be over valued, as long as earnings growth remains strong. I am betting with management that they can continue robust profit growth over the next few years. Institutions own less of AVD than their average holdings for the chemical industry. Mutual funds, pension funds, and the like, own 32 percent of the outstanding shares versus an industry average of 48 percent. Insiders own a huge 44 percent of the outstanding stock. An up tick of institutional investor interest could have long-term positive effects on the stock price.

American Vanguard is starting to get noticed. According to its website, out of 10,000 public companies, only seven achieved a “triple crown”. American Vanguard was included in the 2004 listings of:

In July, 04, AVD was added to the Russell 3000 Index (largest 3000 US companies) and the Russell 2000 (smallest 2000 companies in the Russell 3000 Index). Even with this additional awareness, there is no major stock brokerage coverage of American Vanguard. With a market capitalization of $335 million, American Vanguard is still flying under the radar of most investors.

I like American Vanguard’s business model as a growth platform. Management has delivered outstanding shareholder value, and I anticipate their history of steady expansion will continue. At its current share price, American Vanguard is not a “value play” as much as just a good, old fashion overlooked small-cap growth stock in a profitable, but boring, niche market. Patient investors looking to diversify with the addition of a Basic Material sector company should find lots to like with American Vanguard.

Sept 1, 2005 Update:

American Vanguard split their stock 2 – 1 on April 15, 2005. 2006 EPS estimates have been reduced a bit to $1.00 a share, up from a projected $0.88 in 2005. The stock is trading about $20, and is still fairly valued. It remains one of my favorite undiscovered growth companies.

George C. Fisher is a 30-year veteran in DSP/DRIP investing. He is author of All About DRIPs and DSPs (McGraw Hill, 2001) and The StreetSmart Guide to Overlooked Stocks (McGraw Hill, 2002). Mr. Fisher is an avid dividend reinvestment advocate and utilizes the strategy with all dividend paying stocks, both at the broker and direct with the companies using their DRIP programs.