Australia | Jun 24 2021
This story features COSTA GROUP HOLDINGS LIMITED. For more info SHARE ANALYSIS: CGC
The expansion of citrus orchards continues apace for Costa Group, with the latest acquisition adding scale and significant export opportunities
-Potential for greater export supply to Asian markets
-Costa consistently achieves a price premium for exported citrus
-Net profit growth expected to be marginal in 2021
By Eva Brocklehurst
Citrus is blossoming for Costa Group ((CGC)), with the purchase of a high-quality strategic asset set to substantially increase revenue per tonne and earnings margins.
The acquisition of Queensland-based 2PH Farms for $200m will take the company's total area under citrus to 4500 hectares, up 60%, adding 30,000t of citrus production. Furthermore, this will increase to 60,000t by FY24 as trees mature, and the earlier season at 2PH Farms will increase Costa Group's supply duration to nine months from seven.
This is a strategically sound acquisition, Citi asserts, estimating the transaction to be 4% accretive in FY21 from a contribution of five months. 2PH generates revenue per tonne that is nearly double that of Costa and achieves 39% operating earnings margins.
All sales are derived from mandarins of which 50% are proprietary cultivars. As a result, Credit Suisse believes the company has bought a good strategic asset and includes the acquisition in modelling.
The acquisition will provide greater export supply to Asian markets and also enables the company to obtain exclusive rights to proprietary varieties and a larger production scale as well as geographical diversity.
Macquarie also highlights the ability of 2PH to sell into a global market and attract premium pricing for its niche citrus products. The implied acquisition multiple of 6.6x FY21 operating earnings is undemanding, the broker asserts, and while more expensive than prior acquisitions, is understandable given the superior margins and offshore earnings 2PH offers.
Goldman Sachs believes citrus could be the next "big thing" for the company offshore as it has already implemented an export strategy that will be complemented by the transaction. In evidence is the highly profitable berry operations that have been established in Morocco and China. The broker envisages upside from establishing operations and licensing the citrus rights in the northern hemisphere.
Credit Suisse agrees Australian citrus is well-positioned for export, given the southern hemisphere timing and premium quality relative to South Africa, which is Australia's competitor for citrus to China. The proximity to Asia also provides an advantage in terms of freshness.The broker points out Chile gained citrus access to China in December 2019 and made its first shipments in 2020.
Peru is another country Credit Suisse believes should be watched for citrus expansion, and its season is a little earlier than Australia's. Peru's citrus exports were up 25% in 2020 and most of its Asian exports went to Japan.
Costa is not allowing for much in the way of cost synergies but Credit Suisse points out there may be revenue opportunities as the company has a strong distribution network in Japan and 2PH in China.
Goldman Sachs highlights perpetual access to plant breeder rights and a long-term platform to establish offshore production and/or license these rights. Costa is acquiring royalty-free rights to commercialise plant breeder rights and trademarked Amarette and Phoenix mandarin varieties.
There are also future varieties being developed by 2PH breeding program in Australia, China, India and Africa. Moreover, should Pressler entities decide to sell, Costa will have rights to purchase and own the breeding program in the future.
Goldman Sachs likes Costa Group for its ability to enhance profitability and returns through the company-owned shoulder season harvests and third-party peak season relationships in order to provide a year-round supply.
Costa has consistently achieved a price premium for exported citrus and the broker expects this should continue. Goldman Sachs, not one of the seven monitored daily on the database, has a Buy rating and $4.20 target.
Costa has announced a fully underwritten renounceable entitlement offer to raise $190m at $3.00 a share. Macquarie suspects the market will be surprised by the size of the equity raising, being almost 100% of the consideration for the 2PH purchase.
Nevertheless, the broker suggests this highlights a conservative approach and provides some capacity for further growth initiatives such as Conaghans. Costa will pay $31m in July 2023 to purchase a property where a new citrus crop will be planted.
The broker's view is supported by the balance sheet which has pro forma net debt/earnings of 1.4x as of June 30,2021, below the company's target range. Macquarie raises FY21 estimates for earnings per share by 22% to reflect the accretion from the acquisition and also to reflect guidance for the base business.
The base citrus business is tracking along with the broker's expectations while avocados are well below as lower prices persist and there are early signs that the Arana blueberry yield in Far North Queensland will not meet the overall yield target. Mushroom production is expected to progressively improve over the second half and truss tomato pricing is returning to more normal levels.
The company has also indicated that net profit growth will be marginal and, given the 2PH acquisition is late in the citrus season, the dilution from the capital raising could be overwhelming, Credit Suisse warns, resulting in a decline in earnings per share of -20% in FY21. The broker upgrades estimates for 2022 by 5% after including the acquisition.
Citi continues to envisage risks around domestic produce into the second half, namely for citrus and the 80% of the crop that is yet to be harvested. Costa has signalled that this is a more normal pricing year for the 20% that has been harvested. Berry pricing for the main season in NSW is also a risk, Citi points out, as wholesale pricing for raspberries and blueberries appears softer.
Jarden believes the outlook is mixed, although earnings and returns on investment should improve into 2022 as one-offs are cycled, the Monarto venture ramps up and there is some normalising of the supply/demand dynamics.
Hence the broker forecasts a 54% lift in 2022 earnings per share, in part driven by 2PH but primarily by these other factors. Assuming a successful integration of the acquisition, Jarden remains positive about the stock and retains an Overweight rating.
The broker, also not one of the seven stockbrokers monitored daily on the database, has a $3.90 target and expects the key catalysts will be signs of improved execution, pricing and export markets in late 2021.
Wilsons considers the "relatively full" purchase price is justified by the unique nature of the asset and the strong margins. Nevertheless, after considering the earnings profile for the whole produce segment, the broker is "marginally underwhelmed" by a lack of growth.
Wilsons, not one of the seven, retains a Market Weight rating and $3.60 target. The database has one Buy (Credit Suisse) and three Hold ratings. The consensus target is $4.02, signalling 18.3% upside to the last share price.
See also, Citrus Crop Critical To Costa Group in 2021 on June 1, 2021.
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