Costa Group Holdings (ASX: CGC) is Australia’s leading grower, packer, and marketer of fresh fruits and vegetables. They hold a market-dominating position in an essential sector.
The company offers high-quality mushrooms, raspberries, strawberries, blackberries, tomatoes, citrus, avocados, bananas, grapes, and other fruits to a range of domestic supermarket chains and independent grocers. It also provides chilled logistics warehousing and services, as well as wholesale and marketing services. The company also exports its produce to Asia, Europe, and North America. Most of the produce is grown on traditional farmland, but Costa is also known for its glasshouse grown tomatoes and mushroom growing facilities.
In addition, the company engages in licensing blueberry varieties in Australia, the Americas, China, Africa, and internationally, and berry farming activities in Morocco and China. As of June 23, 2021, it had approximately 5,000 planted hectares of farmland, 30 hectares of glasshouse facilities, and 3 mushroom growing facilities in Australia.
Costa Group is extremely diversified, and this gives the firm stability. Costa’s produce business operates in three core categories: Produce, Costa Farms and Logistics, International.
Produce: The Produce segment operates in five core categories: berries, mushrooms, glasshouse grown tomatoes, citrus and avocados. These operations are vertically integrated into farming, packing and marketing, with the primary domestic sales channel being the major Australian food retailers.
Costa Farms and Logistics: The CF&L segment incorporates interrelated logistics, wholesale avocado marketing and banana farming and marketing operations within Australia. These categories share common infrastructures, such as warehousing and ripening facilities, and are predominantly trading and services focused.
International: The International segment comprises royalty income from licensing Costa’s blueberry varieties in Australia, the Americas and Africa, and international berry farming operations in Morocco and China.
Costa’s business model is built on optimising its portfolio of integrated farming, packing, and marketing activities. After what the company has experienced, with multi-year harsh agricultural conditions, Costa is now striving to broaden its assets further to mitigate agricultural and market risks. We have seen many approaches by the firm to de-risk its business through diversification of categories and geographies. For instance, the company is innovating growing in protected cropping environments using market-leading technology. Currently, Costa’s income mainly comes from its products for the domestic market, representing 77% of the group’s total revenue. The international business segment is only 11%. However, this might change rather rapidly as Costa is embarking on a quest for diversification which involves acquisitions to extend its footprint and develop further its export market.
Since the last decade, Costa has been continuously undertaking strategic transformations focused on expanding its scale and vertical integration within its portfolio and reinvesting in the business to refresh its core assets and fund growth. This strategy has paid off as this led Costa’s share price to appreciate almost threefold from its debut at $2.25 per share to its all-time high at $8.55 per share in June 2018. However, the rally ended abruptly and last peaked in mid-2018 due to deteriorating growing conditions and supply issues at that time. We believe it is a lesson learned for the company, and we have seen that Costa has addressed the issue since then.
We first recommended Costa Group back in August 2021 at a share price of $3.28 a share. CGC shares have traded sideways since then; it tells us that all the issues that were originally the cause for the downturn have been priced into the stock price. Therefore, CGC is now primed to go back up. The question is when the markets will once again favour it. But with their issues now rectified, there is quite a bit of an upside for Costa Group.
It’s been more of the same since our earlier coverage, which is why we are positive about the outlook of Costa Group. Half Year results were good as Costa achieved their forecasts, and their international performance was stellar. We saw +25% revenue growth on pcp, with positive pricing, yield and demand maintained over the entire China season and favourable earlier fruit timing and stronger pricing in Morocco.
Through operations in China and Morocco, the International segment continues to make an ever-increasing contribution to the overall performance and has delivered record results. This has not only occurred because of increased berry plantings but is also an endorsement of Costa’s world-leading blueberry genetics, which continue to be well received by consumers across Asia and Europe and are attracting a price premium.
China: Higher volumes from increased plantings and lower imports of South American fruit, especially earlier in the year, supported strong pricing and demand over the season. Production volumes were +1,093 tonnes versus pcp. The overall China yield finished in line with expectations, with jumbo (Arana) blueberry variety volumes higher than budgeted toward the end of the season. The premium varieties, including Arana, have gained further market recognition and continue to attract a significant price premium. This supports the company’s continuing development of its China farming footprint across multiple locations in Yunnan Province.
Morocco: Early season plantings in Agadir (south) and earlier saw higher volumes across the northern farms. This, together with strong pricing over the season, contributed to a positive result. Total production volume increased by 1,4563 tonnes versus pcp, with performance also benefiting from the delayed timing (three weeks) of the main Spanish blueberry season. There will be an accelerated focus on scheduled replanting at the northern farms in CY22, involving replacing legacy varieties with new premium Costa varieties.
Emerging regions (genetics licensing): Africa’s third-party grower tonnage increased by 148 tonnes versus pcp. There was a positive early start to Zimbabwe and South Africa licensed third-party grower season. Planted hectares in these regions continue increasing year on year and building on 52-week supply volumes. A new long term exclusive agreement with Driscoll’s was signed in late CY20 for the licensing of Costa blueberry genetics in the Americas, highlighting the growing importance of the international licensing program, including expanding geographical reach across Africa, China and the Americas. This is in recognition of Costa’s superior blueberry genetics and consumer demand for premium quality fresh produce.
Domestic performance was mixed with generally favourable pricing across the four berry varieties, avocado impacted by sustained higher industry volumes, and New Year’s Day ’21 Colignan (Sunraysia) hail storm progressively impacted over the half on table grape yield and reduced citrus yield.
Mushroom: Short term labour constraints at the Monarto (SA) facility contributed to inconsistent volumes from this site over the half. Overall, demand conditions were strong, particularly going into the cooler months, as reflected in favourable retail and wholesale pricing. However, due to inconsistent production volumes, the full benefit could not be realised. The mushroom retail sales mix over the period at circa 80%+ was in line with budget, with pre-pack products continuing to drive this segment. Sourcing and retention of labour continue to be a key priority. Monarto harvest worker numbers have increased over recent weeks, contributing to higher harvested volumes.
Berry: Over half the Corindi raspberry crop returned to normal after the late CY19/early CY20 drought impact. Blueberry pricing was impacted by some quality issues, but there was generally favourable pricing across the four main berry varieties, which was ultimately in line with expectations. Although there was a stronger than usual finish to the Tasmanian season, overall volumes were down due to climatic conditions versus the prior period and shortage of labour during peak harvest periods. The early Far North Queensland (FNQ) Arana volumes attracted a +23% price premium on average compared to other FNQ blueberry products. However, the overall yield was lower than forecast (circa 155 tonnes vs 237 tonnes), including the impact from pest pressures. The weather impacted the Western Australian crop, resulting in a 64-tonne shortfall against forecast. There has been a relatively slow start to the main Corindi (NSW) season due to poor weather, with the most crop to be completed over the second half.
Avocado: As noted earlier, sustained higher avocado volumes contributed to significantly lower pricing and category performance in the first half. COVID-19 also contributed to the food service sector contraction. Total trays produced were circa +92,000 (+15.2%) versus pcp. Industry volumes are up circa 50% versus pcp, and the third party marketed trays were +11.4% versus pcp. Western Australian (WA) avocado crop volumes are strong, further contributing to the higher avocado supply and lower prices, with estimated WA production of circa 9 million trays over the season. Export activity has been a positive year to date (circa 86,000 as at end-August), with volumes already exceeding CY20 export volumes but coming off a low base (CY20 total exported trays 37,000).
Tomato: Increased field tomato and truss supply impacted short term pricing across all varieties, particularly truss and, to a lesser extent snacking and cocktail. This resulted in a negative pricing impact in the range of 30% – 60%. Volumes were down due to poorer growing conditions, caused mainly by lower-than-normal light over the summer months and shortfall in sourcing quality truss from external growers. This resulted in a circa 4% reduction in yield (own and third-party) versus pcp. On a positive note, retail and wholesale pricing improved over May and June, heading into the second half, with forecasted yield improvements and anticipation of reduced reliance on external grower volumes in the future once the new glasshouse fully comes online.
Citrus: The impact of the previously advised New Year’s Day ’21 hailstorm damage to our Colignan (Vic) table grape crop progressively increased, resulting in significantly lower production volumes from this farm and a subsequent earnings impact with citrus yields also impacted. The early citrus harvest through May and June delivered tonnage ahead of forecast due primarily to the early timing of the mandarin harvest. The Riverland (SA) yield has been tracking close to forecast, with fruit quality above expectations and the percentage of first-grade fruit being packed ahead of the same time versus pcp. Fruit fly restrictions in the Riverland have impacted performance, adding additional cost. Restrictions will remain for the remainder of the season, which involves cold treatment for most of Costa’s export markets. This is being well managed, and the expected cost over the season is between $6m to $8m. The 2PH season progresses positively, with favourable pricing in all export markets, especially China. Product is attracting a price premium in Guangzhou and Shanghai wholesale markets above that of competing citrus brands.
Costa Farms and Logistics
Although sales volume was ultimately lower than budget over the half for the farms segment, servicing revenue was strong, especially for grapes, tomatoes and third-party avocado ripening resulting in a marginal increase in revenue versus pcp.
In the Logistics segment, Eastern Creek DC performed ahead of budget due to strong volume for third party customers. There was reduced revenue overall versus pcp due to the completion of retailer ripening contract and banana handling services. During the half, the acquisition of Select Fresh Group (SFG) was completed. SFG is a leading Western Australian based wholesale distribution business, supplying fresh produce to foodservice channels, and independent retail channels (Metcash, IGA stores) for resale to the public. The acquisition is a key part of Costa’s strategy to develop and expand our footprint in the fresh foodservice sector.
Insiders Continue Buying Shares
We noted in our earlier report that insiders were stacking up their holdings as Costa Group were on the right trajectory as a firm. It’s deeply reassuring that the Directors have complete confidence in the company’s outlook. There is growth ahead for Costa, and CGC shares are undervalued at current prices.
Tim Goldsmith, Sean Hallahan, and Neil Chatfield have recently bought shares and topped up their holdings. These trades have been on-market buys and are all around the current share price that CGC shares trade at.
Now that we have established that Costa’s business is stable. Let us take a look at how well positioned they are for growth and how their outlook is. During the recent period, Costa completed a few acquisitions. These acquisitions cover Citrus, Tomato, Avocado in Australia. Additionally, Costa has also pushed acquisitions internationally to boost their exposure further.
2PH Acquisition in Central Queensland
- Offers greater export supply to key Asian markets – 2PH has an established brand presence in Asia. Enhances Costa’s ability to capitalise on market access drivers, including quality and proximity to Asia.
- Increased citrus category revenue contribution – total citrus group revenue contribution increases from approximately 30% to approximately 35% post-transaction.
- Exclusive rights to selected proprietary varieties – access to a proven 30-year proprietary breeding program. Proprietary mandarins include AC41114PBR (AmoretteTM ) and 66-75PBR (PhoenixTM).
- Extended variety and early season timing – 2PH season commences in mid-March, the earliest citrus season in Australia. Future opportunity to achieve a 52-week supply into key Asian markets.
- Tree maturity – 50% of plantings under 5 years old, 63% have yet to reach maturity (8 years).
- Consideration – total final capital cost of $220m. Partially funded by a successful capital raise of 190m completed end July. The initial cost was above what was previously announced due to timing on working capital at settlement and to earlier completion than expected.
- CY21 –sale agreement includes economic and cash flow benefit of CY21 season to Costa. However, the majority of earnings accounted for as a balance sheet rather than CY21 P&L. Proforma CY21 EBITDA-S contribution would have been $29m if 2PH assets had been owned for full-year CY21.
Season update – forecast volume is circa 30,000 tonnes. The season is largely performing as expected. Main Murcott season is progressing as planned, export pricing in line with expectations and no disruptions in access to the Chinese market to date.
US market access – As of August ’21, the United States has given market access to the export of citrus grown in Central Queensland, further opening up potential markets for our 2PH volumes.
KW Orchards Acquisition in Sunraysia
- Expands Sunraysia (Vic) footprint – circa 600 hectares of land, with current citrus plantings of 312 hectares, 45 hectares of wine grapes. At maturity, it is forecast annual citrus production will be 30,000 tonnes per annum.
- Attractive varietal mix – suited to the export market and will play an important role in our capacity to take further advantage of strong citrus export demand. Tree maturity profile has a majority of plantings less than 4 years old and circa one-quarter of plantings 10+ years.
Cufari Acquisition also in Sunraysia
- Location and plantings – Colignan (Sunraysia Vic) 45 hectares of planted citrus across two main blocks. They are producing circa 1,500 tonnes per annum.
- Tree maturity – Circa 90% of trees aged between 1 to 5 years. Also, 5 hectares of mature avocado plantings. Well established orchard, including river access and irrigation.
New 10-hectare glasshouse 4 (GH4) and 2.5-hectare nursery project at Guyra, NSW proceeding to schedule. As previously noted, additional costs of $7.5m on increasing water capacity and $2.5m restarting costs for recommencement of construction after pausing due to water security concerns in late 2019.
Full commissioning of glasshouse and nursery will be completed on schedule by the end of August ’21. Nursery builds were completed at the end of July. Planting has commenced across five hectares, the first initial production before the start of CY22, with volumes ramping up in 1HCY22.
As announced at CY20 full year, Board approval was received for the commercialisation program to plant 40 hectares of protected, trellised high-density substrate avocado trees across several regions aligned to existing avocado plantings.
Benefits include production costs significantly less than standard orchard plantings, faster tree maturity, higher yield, better fruit quality, and greater water use efficiency versus conventional plantings. Export opportunities continue to be developed and pursued to expand offerings beyond domestic markets.
The first harvested crop is expected from CY23/24, and the forecast harvest from 40 hectares at full maturity is circa 300,000 trays compared to 115,000 trays from a conventional in soil avocado, unprotected crop.
Morocco: A further 14 hectares will be planted at Agadir (southern farms) in November ’21, taking total plantings in this region to circa 102 hectares. The progressive replanting program of northern farms is scheduled to commence 2HCY21, with the planting of Costa VIP purpose-bred, superior genetics blueberry varieties. This will result in a reduced yield impact in CY22 of circa -430 tonnes.
China: The Baoshan CY21 development of 50 hectares (all blueberries) has been completed with a protective tunnel and plastic installation. The new dam is now operational with main drainage and road system works also completed. Packing facility and training room construction are also nearing completion, with the site on schedule to deliver the first crop in CY22.
Work on the Baoshan CY22 development of 100 hectares has commenced. Groundworks and fencing have been completed, and work has commenced on installing protective tunnels. Irrigation and substrate materials have been ordered, and plant supply is also confirmed for CY22 planting.
The full-year forecast is confirmed in line with the 2PH capital raise disclosure. CY21 EBITDA-S and NPAT-S are marginally ahead of CY20, excluding any contribution from 2PH. Significant domestic activity continues to occur over the second half, with positive momentum driving the remainder of the citrus season and the main berry season expected to deliver healthy growth versus pcp.
Citrus yields and quality align with expectations across Costa’s growing regions. Demand from North Asia export markets (Japan, China and Korea) is strong going into the second half. Some COVID-19 supply chain issues contribute to a likely challenging demand situation for the remainder of the season into South East Asian markets.
There has been positive berry pricing due to fluctuating blueberry industry volumes due to poor weather causing delays to Corindi (NSW) crop timing, including Arana. However, the overall berry crop is expected to meet expectations.
The expectation is continuing favourable mushroom demand and pricing, presenting a positive opportunity once volume consistency improves. Short term labour supply challenges have been addressed at the Monarto mushroom facility.
New glasshouse planting continues to proceed as scheduled with no expected delay. Light issues that have affected growing conditions will improve over the second half as we move into the spring/summer months with improving volumes.
The high Western Australian avocado season volumes previously flagged will contribute to continued depressed pricing over the second half.
Given the acquisition strategy and outlook, we expect Costa to keep increasing its revenues and EBITDA consistently for the next few years. As transport costs and supply chain issues ease by the end of 2022, we will see a slight expansion of EBITDA margins and then reverting to its mean.
As far as Costa’s balance sheet goes, there is no reason to be concerned. The firm has enough short-term assets to cover short-term liabilities. Current and Quick ratios, both short-term liquidity measures to meet unforeseen circumstances, are healthy and come in at 1.52x and 1.03x, respectively. Costa’s total assets outpace its total liabilities by over 1.8x – another sign of strength.
To best estimate the long-term value of Costa Group, we have adopted a detailed Discounted Cash Flow Valuation. We believe the DCF offers the best possible cases to value Costa Group as it is a mature firm with a steady source of revenues and earnings.
We begin the process by estimating the firm’s revenues, earnings, and cashflows. Following this, we estimate the enterprise value of the firm.
For the valuation, we have assumed a 7% discount rate and a 1% perpetual growth rate for Costa Group, which is in line with the long-term (perpetual) inflation. Since the forecasts here are in the future, they first need to be brought back to today’s terms by calculating their respective Present Value.
We finally arrive at an Enterprise Value and Equity Value for Costa group and finally an implied share price of $3.95 a share – which represents an upside of 37% considering today’s share price of $2.88 a share.
Coming to the all-important dividends, Costa’s dividend policy is fairly straightforward. The most recent interim dividend distribution came in at $0.04 a share, fully franked. This represented a 16% increase. We expect more of the same – that is, dividends to have a 50% payout ratio compared to its EPS.
Our earlier report can be viewed by clicking here.
Costa Group is an extremely diversified company that has sorted out the headwinds of 2021. We now see a company that is a lot more streamlined in its operations and one that has clearly laid out growth plans by aggressively expanding in overseas markets. This limits Costa’s exposure to the hardships of dealing with the erratic domestic weather here in Australia. With a clearly laid out plan that we have gone through in detail and the fact that directors have been buying shares at levels that the stock is currently trading at, our opinion on Costa’s outlook is reassured. We find Costa also to be undervalued, especially compared to its peers in the industry. We thus recommend investors to “Buy” Costa Group.