Confidence In Costa Reinvigorated By Berries

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Several brokers suspect they are being conservative regarding the potential of the berry plantations Costa Group is developing in China.

-On track to achieve five-year plan of 240 ha of berry plantings in China
-Logistical advantage with farms in China versus imports
-Breeding program in northern Queensland developing suitable varieties
 

By Eva Brocklehurst

Confidence in Costa Group ((CGC)) has been reinvigorated following visits by brokers to the company's Chinese berry farms and its associate, Driscoll's, for packing, logistics and marketing.

Both Credit Suisse and UBS believe they have probably been too conservative in their estimations regarding the rolling out of the berry plantations in China. Costa Group is on track to achieve its five-year plan of 240 hectares of berry plantings by 2020.

Credit Suisse expects the company will be able to enhance its yields and pricing through genetics and management, estimating that after completing the planting in 2020, the joint venture will carry about $100m of funds employed and it is reasonable to expect a 20% earnings (EBIT) return on assets in China.

China is part of the company's international division, along with Morocco, which represented 17% of 2018 operating earnings (EBITDA). Costa Group has strong relationships with multiple levels of the Chinese government and is a major employer, one of the largest foreign investors in agriculture.

Driscoll's is the minority partner, 30%, and the sole customer. The Chinese market is large, with an addressable population of around 150m but this could also stretch to over 400m for blueberries at the right price. Blueberries are 75% of Costa Group's production in China.

UBS envisages the international business will drive more than 50% of the growth out to FY23, while Macquarie believes international underpins the target for profit growth of over 30% in 2019.

Strange Fruit

China is the world's largest fresh produce market and fruit consumption is high per capita. This is expected to remain favourable as incomes rise and the consumer is more willing to pay a premium. UBS suggests there is strong potential with jumbo berries. Jumbo berries are priced at a 60-80% premium, regardless of the part of the season and demand is overshooting supply.

While Costa Group is competing against imports, it has a logistical advantage in that it takes two days to market from harvests, versus Chile and Peru (the bulk of berry imports to China) which take 30-35 days.

Therefore, fixed cost leverage may be greater then fully appreciated. UBS agrees 2019 guidance is achievable as the citrus crop is on track, international business is growing and Morocco should have a more “normal” year. Brokers note availability of appropriate labour in China is of more concern than cost inflation.

Credit Suisse remains little more cautious about the Moroccan business, as April is the key month for that industry and the market expects a strong rebound from the weak season in 2018. Meanwhile, Australian conditions have stabilised and berry and tomato prices have improved through February and March.

Wilsons notes, beyond the initial five years, management remains reasonably bullish on the outlook. This entails growing the more suitable varieties for tropical environments, where blueberries are not traditionally cultivated. Costa Group has a breeding program in northern Queensland, developing varieties for southern Morocco, southern China and central Mexico. These varieties will support royalty income from Driscoll's third-party growers.

Wilsons, not one of the eight stockbrokers monitored daily on the FNArena database, has a Hold rating and $4.95 target. The broker asserts the challenges in terms of production are well understood, given the climate in Yunnan, China, is similar to that of Far North Queensland.

There are three major growing regions outside of Yunnan, supplemented by imports from Peru and Chile. Production from Yunnan targets the window of opportunity in March-May, after Chile and before peak Chinese domestic supply.

FNArena's database shows four Buy ratings for Costa Group, one Hold (Morgans) and one Sell (Ord Minnett). The consensus target is $5.89, suggesting 10.0% upside to the last share price.

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