Thread by @DownunderValue

Costa Group Holdings $CGC $CGC.AX is Australia’s largest grower, packer and marketer of fresh fruit and vegetables. If you like your berries, mushrooms, tomatoes, avocados and citrus, maybe you’ll like the taste of Costa Group.

Let’s take a deep dive. 👇

1. Investment thesis:
✅Stalwart.
✅Market leading position in multiple growing consumer staples lines.
✅International expansion.
✅Generating decent operating free cash flow.
✅Trading at 52 week lows.
🚩CAPEX requirements
🚩Margins & growth rates.

2. Costa’s has grown over the years by modernising fruit and veg growing – bringing new varieties, 52-week availability to supermarkets, economies of scale, and locations near to major urban centres.

3. Costa's aim to be a diversified sustainable commercial agriculture firm.

While this approach is capital intensive, this is also creates barriers to entry and potentially market power.

4. The crops Costa focuses on tend to be higher margin: tomatoes in greenhouses, vertical farmed mushrooms, year-round berries, avocados for millennial renters, etc.

5. The main segment for Costas is Australian produce supply – typically been +75% of revenue with around 10% EBITDA margins. This has been growing slowly, and can be quite volatile.

6. An example of volatility in a key market is the price of avocados have plummeted due to oversupply – finally perhaps some of those millennials may be able to afford avocado on toast and a home mortgage?
bloomberg.com/news/articles/…

7. Farms and logistics provides supply chain support to third parties. While it’s ~12% of revenues, it has thin EBITDA margins of ~10% and has not been slow growing if you remove the acquisitions.

8. International has been a major growth area.

While it’s only ~25% of revenue, it has contributed 60-70% of EBITDA over the past 12 months due to it’s high margins. It is a fast growing segment across both their Africa and China berry footprints.

9. Using their patented jumbo berries and IP in efficient growing, they have been able to get footholds into the larger Africa/European and Chinese market. However, while they don’t have the duopoly supermarkets to deal with, they also don’t have strong retail channels.

10. The recent 2PH acquisition is also interesting. While it’s low-margin high-volume citrus, they are buying a range of trademarked varieties in established yet young (growing) orchards.

11. 2PH is also a massive shift from domestic to export focused production. Margins are higher, EBITDA is accretive instantly, and could become a platform for other exports. But at $190m (or 7xEBITDA), it will require decent growth.

12. Costa sells mostly into a concentrated market of Woolies $WOW Coles $COL and Metcash $MTS – so they don’t have a lot of pricing power.
afr.com/companies/reta…

13. Labour shortages for fruit / veggie producers is a major risk. This is driving up costs, and literally harvests are being left to rot. They can’t pass on a lot of these costs.
abc.net.au/news/rural/202…

14. Weather and disease risks are always present – the outlook for FY22 already sees an avocado glut exacerbated by poor berry volumes. It’s a fine line to get strong volumes and prices.

15. CAPEX remains very high. In 2018-20, they depreciated ~$210m and invested in ~$300m CAPEX (+$90m net growth CAPEX), contrasted with a total ~$290m of cash flow from operations.

16. Future plans are to continue growth CAPEX in the face of high maintenance CAPEX. Resultantly, there has been increasing debt (+800m/3yrs) and shareholder dilution ($175m or 27% / 3yrs, 100% / 7yrs).

17. Despite the share price catering 40% past six months, it’s still trading at PE=22. While it’s not so bad on EV/EBITDA=10, the massive CAPEX requirements makes this immaterial. Even factoring in accretive 2PH earnings, the PE=20.5.

18. Where’s the growth going to come from?

Personally, I don’t see any real catalyst beyond the organic growth of international sales – which I also think is the riskiest as it is an area that is farthest from their circle of competence.

19. h/t @berthon_jones who also has been highlighting some of the terrible momentum and valuations

https://twitter.com/berthon_jones/status/1449864888856170505

20. Overall, the 52-week lows have been piquing my interest, but the underlying numbers just do not stack up.

Share price probably needs to drop from ~$3 to ~$2 before I’d look at this again. Or, there needs to be a significant catalyst for growth.

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A deep dive per week is my commitment to FinTwit.

Questions and feedback always welcome. DYOR.

Disclaimer, I have no position in $CGC.