Down 45% in a year: Are Select Harvests Limited shares a bargain?

Select Harvests Limited (ASX: SHV) is a commodity producer at the core of its operations. Unlike BHP Billiton Ltd (ASX: BHP) and Rio Tinto Limited (ASX: RIO), which produce ‘hard commodities’ like iron ore and copper, Select Harvests operates in the niche market of almond harvesting. With the share price coming under heavy pressure after hitting an all-time high in July last year, now appears to be a good time to take another look at this ‘soft commodity’ producer.

About Select Harvests

Select Harvests presents an interesting investment blend as commodity producer and consumer staple. The company is a fully integrated almond business comprising orchards, processing plants, trading functions and consumer/consumption products.

In a nutshell (pun intended), Select Harvests grows almonds, packages them and sells them to the public for consumption. It is also involved in exporting almonds to other countries, piggybacking the growing trend of Australian agricultural exports and benefitting from increased global demand for food. In this regard, it acts as a food producer akin to A2 Milk Company Ltd (ASX: A2M), Bega Cheese Ltd (ASX: BGA) and Bellamy’s Australia Ltd (ASX: BAL). This provides it with solid fundamentals going forward.

The concern, however, is that almonds are considered a commodity. This means Select Harvests has no power over pricing and thus is at the mercy of market forces. Like most commodity producers, market fundamentals of supply and demand dictate the final price paid for its almonds. Accordingly, the recent downturn in almond prices (which the company believes is a natural reaction to record prices) has sent its share price in a tailspin. I believe this makes it a good time to look at buying the company.

Financial performance

Select Harvests reported strong operating results to the first half of 2016 with net profit after tax (NPAT) jumping 41% on prior corresponding period to $23.9 million. Underlying NPAT was up 8% to $21.1 million and the group generated strong cash flows of $80.8 million in the first half, demonstrating exceptional operational resilience in a dwindling commodity market. Net debt sat at a comfortable $52.6 million (as at 31 December 2015), equating to a gearing ratio of 17.8% on equity.

In the first half, management declared an interim dividend of 21 cents per share, up 40% on the prior corresponding period. Assuming the same final divided as 2015, this means Select Harvests currently trades on a whopping trailing yield of 13.3% (unfranked), providing a robust income stream which should be maintainable through free cash flows.

Market outlook

Following the solid set of results, Select Harvests’ share price slumped almost 21% and currently trades near 52-week lows. Its share price has fallen over 70% since July last year, largely on the back of a decrease to almond prices off their record highs.

Whilst traders believe the pullback in almond prices is a result of increased supply from the U.S., management indicates that U.S. production has only increased an approximate 1.8%. This means the decline in almond prices is likely a result of the market returning to equilibrium.

Therefore, whilst I’m not hopeful of a sharp rebound in almond prices in the short term, I’d expect prices to trend higher over the long-term, making Select Harvests a good pick to play on the thematic of global food demand.

Foolish takeaway

With Australia set to become the global food bowl through an increase to global population and lack of global agricultural resources to support demand, Select Harvests appears insulated from dwindling commodity prices and thus should benefit from growing volumes.

Select Harvests possesses excess capacity to increase supply of almonds (the  company plans to increase capacity to 20,000 MT per annum by 2022/23 from 13,700 MT this year) and has a natural geographic advantage by being based in Australia, thus close to large consumers India and China.

Accordingly, Select Harvests should benefit for years to come from the global food boom, despite the current oversupply, making today’s share price an attractive entry point for the long-term investor.

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Motley Fool contributor Rachit Dudhwala has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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