• Weather affecting crops or any significant increase in insurance expense. This risk is mitigated as CGC has crop insurance (hail, wind, fire) and structure insurance.
• Any power outage causing crops to be destroyed per incident.
• Any significant increase in costs of power, affecting earnings.
• Any disruption to operations from health and safety issues.
• Any disruptions or issues associated with water, irrigation and water recycling.
• Negotiations with supermarket giants Coles (Wesfarmers), Woolworths and independent grocers result in erosion of margins.
• Pricing pressures arising from either competitors, or insufficient demand.

Figure 1: CGC revenue by segment 

Source: Company

Figure 2: CGC Produce revenue split 

Source: Company

ANALYST’S NOTE

Costa Group Holdings (CGC) FY18 result missed analyst estimates with NPAT before SGARA and excluding material items of $76.7m below estimates of $80.2m and revenue of $1bn was below market expectations of $1.1bn, which saw the share price decline by -9.0%.

Further, management forecasted “low double digit NPAT pre SGARA” for FY19. The results were impacted by lower pricing across most of the segments and adverse weather conditions which affected the produce volume and quality.

On a positive note CGC significantly improved its cash flows, with free cashflows rising by +42% and an improved cash conversion ratio of 85%.

Whilst CGC is trading in line with the price target in our last report (of $7.40 per share) and headline trading multiples appear expensive (PE-multiple of 23.4x), we again don’t doubt the quality of CGC and concede that management’s guidance may be conservative (and as is our numbers); indeed should management continue to supplement organic growth with inorganic, we see upside risks to our revised valuation and recommendation.

• FY18 results summary.
  1. revenue grew by +10.2% to $1,002m and transacted sales were up +13.3% to $1,336m, with avocado and citrus sales being the largest growth contributors. EBITDA before SGARA and material items was up +30.9% to $150.8m and NPAT before SGARA and material items increased +26.4% to $76.7m.
  2. CGC delivered strong cashflow with free cash flow up +42% to $128.7m and a strong cash conversion ratio of 85% (up from 79% in FY17).
  3. Net leverage increased to 1.2x EBITDA-S (from 0.7x in pcp), primarily due to payment for African Blue acquisition, however management noted that balance sheet and debt facilities remained comfortably positioned.
  4. CGC declared a final dividend of 8.5cps, taking the full year dividend payout to 13.5cps, a growth of +22.7% over pcp.
• FY19 outlook. CGC expects to deliver significant scale in mushrooms and avocados in FY19 and expects to generate low double digit NPAT-S growth in FY19. Management noted, “forecast growth in the coming year is consistent with our target of generating a strong return on capital and average annual low double-digit earnings growth over a three to five year horizon. Through execution of the Company’s domestic and international growth platforms, Costa’s earnings profile has become dramatically skewed to the January-June half year reporting period. This trend will become further pronounced with on-going expansions, amplified by additional farming cost investment required over July-December. As a consequence of this earnings profile shift, each subsequent July-December half year will contribute less in earnings than previous years, due to additional farming cost investment.”
• Produce segment (~79% of revenue).
  1. The segment delivered revenue growth of +7.3% at $843.3m and total transacted sales were up +14.8% to $1,180.3m.
  2. The mushroom category delivered incremental production gains, but overall performance capacity was constrained but management confirmed that it is focusing on the retail segment ahead of new volume when the Monarto, South Australia farm expansion comes on stream as mushroom industry demand remains positive with growth of +6.3% per annum.
  3. Blueberry production during FY18 was impacted by lower yields, led by pest pressure in FNQ and berry sizing issues arising from adverse weather conditions. Further, pricing was down -7.5% due to additional industry volumes. Raspberry production faced challenges from a concentrated summer peak, however the pricing was in line with management’s expectations (down -6.3%).
  4. Citrus revenue was up +31%, with 75% of the produce being imported, leading to an increase in export sales from $70m to $99m in FY18.
  5. The truss and field tomato segment revenues were down by -12.2% and -12.6% respectively, led by lower pricing however the snacking segment grew +4.8% equating to +13.9% volume growth despite a reduction in price by -8.1%.
  6. Avocados contributed to the strongest sales growth with pricing up +16.7% (due to low industry volumes from the Central QLD, West Australia and New Zealand), partially offset by a -13.5% decrease in volumes due to Central QLD volumes impacted by a combination of reduced fruit set and a hail event at the Kumbia farm. Avocado category performance included for the first time a full 12 months operating result for the farms acquired in Central QLD and Atherton (FNQ).

FY18 Results Summary…

Figure 3: CGC FY18 Results Overview 

Source: Company, BTIG

• Produce segment (~79% of revenue).
  1. The segment delivered revenue growth of +7.3% at $843.3m and total transacted sales were up +14.8% to $1,180.3m.
  2. The mushroom category delivered incremental production gains, but overall performance capacity was constrained but management confirmed that it is focusing on the retail segment ahead of new volume when the Monarto, South Australia farm expansion comes on stream as mushroom industry demand remains positive with growth of +6.3% per annum.
  3. Blueberry production during FY18 was impacted by lower yields, led by pest pressure in FNQ and berry sizing issues arising from adverse weather conditions. Further, pricing was down -7.5% due to additional industry volumes. Raspberry production faced challenges from a concentrated summer peak, however the pricing was in line with management’s expectations (down -6.3%).
  4. Citrus revenue was up +31%, with 75% of the produce being imported, leading to an increase in export sales from $70m to $99m in FY18.
  5. The truss and field tomato segment revenues were down by -12.2% and -12.6% respectively, led by lower pricing however the snacking segment grew +4.8% equating to +13.9% volume growth despite a reduction in price by -8.1%.
  6. Avocados contributed to the strongest sales growth with pricing up +16.7% (due to low industry volumes from the Central QLD, West Australia and New Zealand), partially offset by a -13.5% decrease in volumes due to Central QLD volumes impacted by a combination of reduced fruit set and a hail event at the Kumbia farm. Avocado category performance included for the first time a full 12 months operating result for the farms acquired in Central QLD and Atherton (FNQ).
• Costa Farms & Logistics segment (~14% of revenue). Revenue was in line with FY17 revenue (up +0.4%) but EBITDA before SGARA rose +32.6% with EBITDA margins up 80bps due to additional services income offsetting lower earnings from wholesale operations due to lower banana pricing, and reduced availability of avocados and mushrooms.
• International segment (~7% of revenue). The key points to the segment results include:
  1. Transaction sales were up +84.4%, revenue up +525.2%, and EBITDA excl SGARA up +81.7% on pcp.
  2. The cold northern hemisphere spring and early summer period impacted both the China and Morocco harvests with Morocco being affected significantly.
  3. The Morocco harvest was delayed by up to eight weeks with overall yield being circa -10% below expectations, and a higher proportion of lower grade product (~60% of product sold was first grade vs 76% in pcp).
  4. The yield in China was in line with expectations, primarily due to harvest of additional 20 hectares of blueberries from the new Manlai farm, however pricing was below expectations, primarily due to late harvest timing. Raspberry yield performance was strong however pricing was disappointing due to low consumer uptake.
  5. Licensing income stream grew across Driscoll’s America’s plantings and Morocco with growth in Driscoll’s US licensing agreements attributed to fruit production royalty component, due to stable year on year plant sales.

Figure 4: CGC Financial Summary

Source: Company, BTIG, Bloomberg

COMPANY DESCRIPTION

Costa Group Holdings Ltd (CGC) grows and markets fruit and vegetables and supplies them to supermarket chains and independent grocers globally. CGC has leading market positions in five core categories of Berries (Blueberries, strawberries and raspberries), Mushrooms, Citrus, Tomato and Avocado via the recent acquisition.