Costa Group ((CGC)) is extending its production season and continues to expand geographically. The company acquired three avocado businesses in the first half, broadening its geographical reach to include northern NSW and adding Queensland acreage.
This extends the production season to February to December versus February to August previously. Total capital investment is $110m and management intends to more than double farm production over the next five years.
Macquarie believes the company is a step closer to achieve its ultimate goal of a 52-week production window and this will be positive for prices and margins.
The first half result shows significant progress with profitability, driven by citrus and avocados, Ord Minnett notes, while growth options are in berries, avocados, mushrooms and the expansion internationally.
Ord Minnett increases earnings estimates by 16% for FY19 and suggests this could be revised upward as further additions to the business unfold. The broker upgrades to Accumulate from Hold and forecasts 32% net profit growth in FY18, on the back of citrus, avocados and M&A.
Citrus performed strongly in the first half but is likely to sustain a lighter crop in FY19, yet the company expects positive export pricing should reduce the negative effect that comes from citrus being in an "off" year. Positive price momentum should be sustained as there is strong demand from export markets. The company exported 75% of its citrus product in the first half.
Expansion of mushroom capacity is expected to ramp up from November 2019. The time frame has been pushed out to allow for new compost preparation technology and a retrofit of the existing site.
As well as what is visibly available to deliver growth, the company is diversifying production and the main risk, in Ord Minnett’s view, is pricing. Nevertheless, management envisages supply will tighten for the majority of its products and this means the risks may be to the upside.
UBS also upgrades its rating, to Buy from Neutral. The broker increases produce earnings estimates by 8-13%, to reflect not only the strong first half result but the avocado acquisitions. UBS also flags upside to Chinese pricing as costs are lowered. This will be partly offset by higher net interest.
UBS expects supply from competitors, particularly in berries and tomatoes, will put pressure on realised prices but this will be mitigated by a move towards year-round supply in berries and a mix shift towards higher priced tomatoes.
If the Chinese expansion proves successful and further plantings are announced, UBS suggests international business could move to over 35% of group operating earnings (EBITDA). The broker envisages more than 10% upside to medium-term earnings for avocados, amid further M&A opportunities in a fragmented market.
The stock screens attractively versus its high-growth peers and UBS suggests market growth should accelerate over the next 3-5 years, supported by the focus on healthy eating and retailers providing more "fresh" offerings.
The broker expects the market to grow at around 3% per annum over the next three years and the company’s core categories to grow at around 9% per annum, driven by berries and snacking products.
FNArena’s database shows three Buy ratings. The consensus target is $7.54, suggesting 7.0% upside to the last share price. This compares with $6.74 ahead of the results.