Company Overview: Costa Group Holdings Limited (ASX: CGC) is a horticulture company and provides fresh produce to major Australian food retailers. It operates across the following three reportable segments- Produce: Operates in five integrated core categories of berries, mushrooms, citrus, tomatoes and avocados; International: Berry farming in foreign lands such as Morocco and China; Costa Farms and Logistics (CF&L): Involves interrelated logistics, wholesale, and marketing activities.

CGC Details

Decent Performance to be Augmented by Strategic Acquisition and Capital Raising: Costa Group Holdings Limited (ASX: CGC) is engaged in growing, packing and marketing fresh produce to major retailers in Australia. The market capitalisation of the company as on 05 July 2021, stood at ~$1.31 billion. During CY20, the Group delivered revenues of $1,164.9 million, reflecting an increase of 11.2% on CY19. EBITDA-SL grew by 47.2% to $144.8 million in CY20, and the statutory NPAT stood at $60.8 million. The management declared total dividends of 9 cents per share for CY20. It ended the period with cash and equivalents of $32.5 million as of 27 December 2020.

The company has reported the citrus season to be tracking to forecast levels and expects Riverland to deliver more favourable yields. The fruit quality has also been better than expected, with an increase in volume of first grade product. It anticipates the export pricing to remain consistent with previous years and has guaranteed labour availability for the season, but with additional quarantine cost.

Dividend Track Record (Source: Analysis by Kalkine Group)

Acquisition of 2PH Farms to Provide Revenue Visibility: The company has entered into a binding conditional agreement with Pressler entities to acquire the assets of 2PH Farms Pty Ltd. 2PH is expected to generate ~$29 million in EBITDA-S in CY21, driven by young citrus orchards, which are still in the growth phase. The acquisition is expected to support increased revenue contribution from the citrus category and also push export supply to key Asian markets. CGC plans to fund the transaction through ~$190 million in equity capital raising and ~$29 million from existing undrawn debt facilities. The transaction is anticipated to be around 10% EPS accretive on a pro forma basis in CY21.

Capital Raising: As per a recent update, the company has announced ~$190 million renounceable entitlement offer to institutional and eligible retail shareholders on the basis of 1 new share for every 6.33 existing company shares. The offer price has been set at $3.00 per new share. It plans to use the proceeds from the capital raising to fund the acquisition of the business and assets of 2PH Farms Pty Ltd and its related entities. The value of the acquisition has been pegged at upfront consideration of ~$200 million in cash. CGC is expected to pay an additional $31 million in July 2023, with regards to the purchase of Conaghans’ property. On 28 June 2021, the company has updated that it has successfully completed the Institutional Entitlement Offer and raised ~$114 million.

CY21 YTD Trading Update: The company expects performance in the first half of CY21 to be marginally ahead of the prior corresponding period, aided by the decent performance from the international segment. It has reported that there will be a mixed performance from the produce segment, with performance in the berry category witnessing favourable pricing with lower volumes. Higher industry supplies of avocados resulted in lower pricing during the period. There has been improvement in tomato yields, matching with demand, and pricing pressure eased towards the end of H1CY21.

Top 10 Shareholders: The top 10 shareholders together form around 23.55% of the total shareholding, while the top 4 constitute the maximum holding. Perpetual Investment Management Limited and Lazard Asset Management Pacific Company are holding a maximum stake in the company at 7.43% and 4.50%, respectively, as also highlighted in the chart below:

Top 10 Shareholders (Source: Analysis by Kalkine Group)

Key Metrics:  The company posted decent performance in CY20 with a gross margin of 65%. The net margin improved to 5.8% in CY20, compared to negative 3.3% in CY19. There has also been a substantial improvement in the ROE of the company to 10.6% during the period. The debt to equity ratio of the company decreased to 0.84x in CY20, from a level of 0.99x in the prior corresponding period. The total debt of the company stood at $494.4 million as of 31 December 2020, comprising of $446 million in long term debt and $48.4 million in short term debt.

Growth Profile and Profitability Metrics (Source: Analysis by Kalkine Group)

Key Risks: The onset of the COVID-19 pandemic has impacted the sector, and there has been an elevation in the risks present in the sector. The company’s operations depend on the ease of availability of labours for seamless functioning, and any challenges regarding their availability might impact the harvesting capability of CGC. The short term labour constraints at Monarto contributed to lower than average production volumes in H1CY21. It is also prone to the impacts of climate risk and foreign currency risk on export earnings. Some of the company-specific risks include – berry yield and pricing, the timing of Tumbarumba (NSW) blueberry harvest, pricing confirmation of 80% of citrus crop, etc., to name a few.

Outlook: CGC expects revenue of ~$627 million in H1CY21, compared to $612.4 million in the prior corresponding period, reflecting an increase of ~2% and driven by decent performance in the international segment. It anticipates NPAT-S at ~$44 million in H1CY21, marginally higher than $43.1 million in H1CY20. As per the company, the citrus season is currently tracking to forecast and fruit quality is ahead of expectations. It expects CY21 EBITDA-S and NPAT-S to be marginally ahead of CY20, prior to the impacts of the acquisition and equity raising.

Valuation Methodology: EV/Sales Multiple Based Relative Valuation (Illustrative)

Source: Analysis by Kalkine Group

*% Premium/(Discount) is based on our assessment of the company’s NTM trading multiple after considering its key growth drivers, economic moat, stock's historical trading multiples versus peer average/median, and investment risks.

Stock Recommendation: On 22 June 2021, the company has appointed Mr Harry Debney as a Non-Executive Director of the Company, effective from 1 July 2021. As per ASX, the stock of CGC is trading below its average 52-weeks’ levels of $2.784-$4.811. The stock of CGC gave a positive return of ~6.75% in the past one year and a negative return of ~1.26% in the past one month. We have valued the stock using an EV/Sales multiple-based illustrative relative valuation and have arrived at a target price of low double-digit upside (in % terms). We believe that the company can trade at a slight discount to its peer average EV/Sales (NTM trading multiple), considering the impact of COVID-19, labour challenges and foreign currency impact. For this purpose, we have taken peers such as Elders Ltd (ASX: ELD), Inghams Group Ltd (ASX: ING), Select Harvests Ltd (ASX: SHV), to name a few, which comes under food products category. Considering the expected upside in valuation and current trading levels, revenue visibility from strategic acquisitions, expected accretion in EPS, and favourable long-term outlook, we recommend a ‘Buy’ rating on the stock at the current market price of $3.215, down by 1.68% (as on 05 July 2021, 11:50 AM (GMT+10), Sydney, Eastern Australia).

CGC Daily Technical Chart, Data Source: REFINITIV

Note 1: The reference data in this report has been partly sourced from REFINITIV

Note 2: Investment decisions should be made depending on the investors’ appetite on upside potential, risks, holding duration, and any previous holdings. Investors can consider exiting from the stock if the Target Price mentioned as per the analysis has been achieved and subject to the factors discussed above alongside support levels provided.

Technical Indicators Defined: -

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Stop-loss: It is a level to protect further losses in case of unfavourable movement in the stock prices.

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