Fresh Growth Expected For Costa

This story features COSTA GROUP HOLDINGS LIMITED. For more info SHARE ANALYSIS: CGC

-Additional royalty stream
-Barriers to entry high
-Increased focus on berries
 

By Eva Brocklehurst

Costa Group Holdings ((CGC)) occupies an enviable position in a growing market – fresh, healthy food. As retailers respond to increased demand by investing more in providing fresh food the company's products are central to the table.

The company has four main categories in produce: berries, mushrooms, tomatoes and citrus. Combined, these have grown 11% per annum over the past three years. UBS expects future growth will be supported by rising consumption and new capacity.

International growth should also drive earnings as the company earns royalties on its intellectual property in blueberries in the Americas and Morocco, and the company has are joint ventures in Morocco and China. Costa also operates a marketing and logistics business.

Costa's proforma FY16 profit forecast is $48m, which will be up 24% year on year. UBS forecasts market growth of 3.0% pre annum over the next three years in which Costa's core categories should grow by 9.0%. Beyond FY16, UBS forecasts compound net profit growth of 13%.

The broker initiates coverage with a Buy rating and $2.80 target, envisaging the stock as a medium-term investment. The leading market position in high growth categories is attractive but, as an extra filip, so is the more predictable earnings compared with others in the agricultural sector. Around 75% of the crops are under protection.

Goldman Sachs also initiates on the stock, with a Buy rating and $2.79 target, adding the stock to its conviction list. This view is underpinned by expectations of compound earnings growth of 17% over FY15-18. The broker estimates dividend/free cash flow yields of 4.6%/2.5% and 5.8%/7.5% for FY16 and FY17 respectively. 

The company is considered a beneficiary of the growing Australian demand for berries. Moreover, the asset base is difficult to replicate, given the significant capital expenditure required, and the company has a strong position via its patent protection in five types of blueberries.

UBS does highlight two areas which need to be known. Some leases are not at arms length, in that they are with entities associated with the Costa family. The leases generally have long tenure and some unfavourable provisions for the company.

The other issue is the Driscoll's brand ownership. UBS observes the company sells both raspberries – where Driscoll's owns the IP – and blueberries – Costa's IP – via its joint venture. If the agreement were to cease, the IP created by Costa in Australia under the Driscoll's brand, would be lost to Costa. Still, the broker does not believe these materially disadvantage the company over the longer term.

The company has over 3,000 hectares of farming land, with seven mushroom facilities and 20 hectares of glasshouse across Australia. In Australian berries, Costa has 54% market share based on its own production and this increases to 84% when third party production through marketing via the Driscoll's JV is added. Costa has 42% of the Australian market share in mushrooms and 18% in tomatoes. Goldman forecasts berries to contribute more than 40% of earnings by FY18.

Costa is the largest citrus producer in Australia but its citrus, unlike the other three, is not grown under protection and remains significantly exposed to weather and related risks. Goldman Sachs believes the company has low bargaining power with customers in this area, because of the fragmented nature of the industry.

The company sources 80% of its produce from its farms in South Australia. While production has been declining over the past decade because of rising imports and droughts, the turnaround in Australia's currency should support earnings, Goldman maintains, as around 50% of citrus produce is exported. Main export markets are Asia, the US and New Zealand.

Around 67% of the company's sales come through the four main supermarkets in Australia. In Goldman's view, this is one of the main risks in terms of concentration. Supermarkets enjoy significant bargaining power with suppliers and the increasing competition in this segment could lead to margin pressure for suppliers. Still, Costa probably enjoys a better bargaining position than many because of its significant market share in berries and snacking tomatoes.

The company remains a significant beneficiary of the fact that in Australia, fresh imports account for only 2.0% of sales, as a result of strict quarantine regulations and the perishable nature of the product. Consumer demand for local fresh produce remains high. Costa will service this demand through yield improvements and capacity expansion.

Costa's royalties come from the US and Africa Blue joint ventures, as Costa's blueberry varieties are used in the Americas. This revenue stream is expected to grow as demand in the US grows and further plantings occur in Morocco.

The brokers expect Costa to move beyond current operations in berries, with Driscoll's blackberry varieties currently in the quarantine process. Tomato and mushroom farms are also likely to increase further, particularly in NSW.

The company is a significant marketer of bananas and produces bananas in northern Queensland. Costa considers this a commoditised product and doe not have any significant growth plans. The company also markets and grows avocados but is predominantly a price taker, with no plans to grow this business either.
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

Click to view our Glossary of Financial Terms