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Is Costa Group Holdings Ltd a raging buy?

Costa Group Holdings Ltd (ASX: CGC) is the largest fresh fruit and vegetable supplier to the major supermarkets in Australia. It is the market leader across each of its major product categories of berries, tomatoes, mushrooms and citrus fruit.

Industry

Agriculture businesses have many risks to contend with including disease, bad weather and volatile pricing. However, thanks to its diversification Costa is better protected than most in the industry given any adverse events are unlikely to impact all of its products at once.

The Australian fruit and vegetable market is a reasonably attractive segment, growing at 3.5% between 2008 and 2014. This exceeds the population growth over the same period and I expect this trend to continue as increasingly health conscious consumers change their dietary habits. Indeed, Costa recorded average revenue growth of 18.9% across its four key products for the first half of 2016.

The company has identified berries as having large growth potential and in February this year announced $80 million of capital projects for the division over the next four years. Costa is also looking to sell its berries overseas and launched a Chinese production company with partner Driscoll earlier in the year, complementing its existing African blueberry operation.

Competitive advantage

As the outright market leader across its four product categories, Costa benefits from superior economies of scale and geographic reach to its competitors. Multiple growing locations reduces disease and weather risks and enables the company to supply all year round.

Thanks in part to its size, Costa has the resources to develop superior crop varieties which it is now looking to export into China and Africa. Also the company farms, packs and markets its key products ensuring high consistency and quality. This vertically integrated business model combined with its market share, puts it in a strong position when bargaining with retailers.

Valuation

For the first half of 2016, Costa announced revenue growth of 12.7% to $403.8 million and pro forma NPAT of $20.2 million. It also confirmed that it was on track to $47.6 million pro forma net profit after tax (NPAT) for the full year.

Management is targeting a pay-out ratio of between 50% and 70% of NPAT which translates to a dividend yield of between 2.6% and 3.6% based on current guidance. With $113.0 million of net debt at 31 December 2016 and a market capitalisation of $918.4 million, Costa trades on an enterprise value-to-earnings ratio (EV/E) of just under 22.

This is a lot for an agriculture stock which are typically high risk and capital intensive businesses. However, Costa has a strong vertically integrated business model and enjoys numerous competitive advantages as market leader and so the current share price appears to be justified.

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Motley Fool contributor Matt Brazier 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.