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Why the Costa Group Holdings Ltd share price just hit another record high

The Costa Group Holdings Ltd (ASX: CGC) share price has increased almost 30% in the last 6 months and just reached an all time high of $3.61. The company was listed in July 2015 and is primarily involved in the growing, packing and distribution of mushrooms, blueberries, tomatoes and citrus fruits in Australia. The company also has berry farming operations in Morocco and China.

In December 2016 Costa expanded its avocado business when it acquired Avocado Ridge in central Queensland. Macquarie Agricultural Funds Management will purchase the farms, while Costa will operate them through a 20-year lease arrangement. Combined with their avocado farms in South Australia, Costa is intent on creating a “truly vertically integrated fifth pillar” alongside its existing core produce categories.

Costa has a broad geographical presence in Australia, operating farms of various crops in every state. The company is aiming to achieve a 52-week production cycle across its product categories and claims to be the only grower which can supply fresh blueberries and raspberries to the Australian market all year round.

Based on FY2016 statutory net profit of $25.3m, Costa is currently trading on a P/E ratio of ~45. This sounds quite expensive for a business that is expecting 10% NPAT (Net Profit After Tax) growth for FY2017.

However, if we use the annual report’s pro forma profit figure of $49.3m to calculate P/E, then it becomes a much more tolerable 23. The pro forma amount is intended to more accurately represent a company’s performance by taking into account once-off occurrences – in this case being IPO transaction costs of $15.3m as well as the provision of Costa’s new post-IPO banking facility.

Costa’s balance sheet appears in decent shape, with little short-term debt. However, the company reported just $4m in cash and cash equivalents on hand at the end of FY2016. I would prefer to see this amount increase substantially to create more of a safety net in times of stress.

Adverse weather conditions pose a significant risk to agriculture businesses, and is one of the major reasons why I would like to see higher levels of cash maintained.

What I find attractive about Costa though, is its geographic spread to reduce risk in any one crop location, as well as their diverse produce range which minimises risk in a single market and enables year round harvesting. Risk of disease is also reduced through protected cropping environments such as their 10-hectare tomato glasshouse.

What’s next for Costa Group?

The company is planning for continued growth of their farming footprint in Australia and overseas, and has flagged $80m for berry capital projects in Australia over the next four years. Costa is also investing in technology to improve sustainability, including water recycling and reuse. The push into China is seen as a long-term proposition, with a view to establishing a footprint in the wider Asian market.

I believe the “food investing theme” is an interesting one, especially for companies like Costa, Elders Ltd (ASX: ELD) or Graincorp Ltd (ASX: GNC) who are looking to do business in Asia. Whilst Costa is on my watch list, I’m hesitant to buy at record highs when share price performance of agriculture stocks is often quite cyclical.

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Motley Fool contributor Ian Crane 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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