The Costa Group IPO
The group which is one of Australia's largest wholesalers of fruit and vegetables was started as a family business in the 1930s and is now going public. When the offer has been completed, the group will have a market capitalisation of up to $ 839.4 million and the Costa family will still own 10.5% consolidating their position as one of the richest families in Australia. They are expected to list in late July on the ASX under the code CGC. In terms of the offer, between 64.8 million and 78.2 million new shares will be issued at an indicative price range of $ 2.20 to $ 2.70 and the final book building which should finish on 22 July 2015 will determine the final price. This means that the group is hoping to raise between $ 541 million and $ 637.4 million.
Historical + Forecast Performance (Source - Company Reports)
What are they hoping to do with this additional capital? They are hoping to use some of it to pay off their debt of $ 132 million but this still leaves them with a lot of cash. Neil Chatfield, the chairman of the group, said in a letter to potential investors that the purpose of the offer is to raise capital for the group to provide access to capital markets which should provide the financial flexibility to repay the existing debt and pursue new growth opportunities. Part of this growth will be the expansion of the blueberry farm in Morocco which is a joint venture with Moroccan firm Agrogailes and UK firm Total Berry. They have also signed a deal with US firm Driscoll’s to build a berry farm in Yunan Province, China. The climate in that area is supposed to be similar to berry growing regions operated by Costa on the east coast of Australia. They are expecting this farm to take care of projected growing demand in Asia and more particularly from the rapidly growing Chinese middle class.
They also plan to invest in research and development, ‘product innovation’, and growing their export markets. To achieve this objective, they are turning away from old-fashioned agricultural processes towards future technology, they don't want to be known as an agricultural company but to be regarded as a technology company first and foremost. By this they mean the kind of technology which will permit them to satisfy demand for pricey seasonal products like berries. They are also looking to maximise production and quality even where growing conditions are difficult. They are also developing special systems of their own to cater to logistics and wholesaling.
The company has developed proactive risk management techniques through the diversification of categories and geographies and uses protective cropping environments with the help of technology. It is currently undertaking a major expansion program in producing berries to cover seasonal and geographical production gaps as well as to cater to the growing consumer demand for berries. Investment is being made in a new 10 hectare tomato glasshouse in Guyra, New South Wales, to provide greater flexibility in relation to selecting and growing tomato varieties that make for unique offerings to the market. They are working on products which are good quality and produce high margins but where there are seasonal gaps in production. By their own estimate, for instance, they already produce 50% of the blueberries and 65% of the raspberries in Australia. A lot of produce is grown in glasshouses but unlike anything that you are likely to have seen, these are state-of-the-art glasshouses covering 20 ha with more than 650,000 individual tomato plants.
Mushroom Growing (Source - Company Reports)
They have also developed innovative irrigation and hydroponic methods such as irrigation technology which allows them to minimise the quantity of water needed to grow notoriously thirsty citrus plants. They are expanding on these methods regularly such as acquisition of the the rights to an unspecified ‘licensed technology from Monterey Mushrooms Inc which increases the Vitamin D content of mushrooms. Monterey Mushrooms, Inc. has been partnering with the United States Department of Agriculture to reproduce what happens in nature when mushrooms are exposed to light. Through their research methods, they have found that mushrooms respond to light just as people do by converting the sun’s rays into Vitamin D. Mushrooms have a natural level of vitamin D, and when exposed to sunlight they synthesize vitamin D. Whether you eat them raw or cooked, all of the vitamin D comes through to provide recommended daily intake. This is particularly relevant because a serving of ordinary mushrooms only provides between 5% and 25% of the vitamin D that you require.
The pros of investing
The group has some of the characteristics of being a strong business such as a dominant market position as Australia’s largest horticultural company.
This dominant position has been attained by being the largest supplier of fresh fruit and vegetable to the major retailers in Australia.. The group is also the most dominant supplier of raspberries, blueberries and tomatoes and citrus in the country, a marketshare of better than 70% in berries. In this makes it difficult for competitors to establish a competitive position, because major customers have limited options alternative options to obtain these products at volumes that will suffice for the requirements. The substantial investment in the distribution chain ensures the freshness and quality of its products.
The cons of investing
Canny investors may find a cause for complaint because of the manner in which the business assets have been distributed. New shareholders will participate in the business including the growing operations, logistics and manufacturing but the majority of the land ownership will continue to invest in the hands of the Costa family. The family will have to be paid rent on commercial terms on the land which would work out to a yearly payout of around $ 20 million annually to the family. Another possible cause for dissatisfaction may be that the newly floated group will commence with a debt burden of around $ 142 million which is fairly substantial for a company with a forecast net profit of $ 47 million and limited amounts of free cash flow.
On balance, we believe that the cons outweigh the pros and would not recommend an investment in the IPO. Later, if there is more encouraging news or a pullback in price, you could consider an investment at that stage.
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