The Motley Fool

Why I’m holding onto my Costa Group shares

This has been a rough week for shareholders in leading Australian fruit and vegetable producer Costa Group Holdings Limited (ASX: CGC).

The company’s share price fell off a cliff on Thursday after it severely downgraded its FY19 profit guidance. After previously telling investors it expected low double digit growth in underlying NPAT for FY19, the company’s latest guidance signalled that tougher than anticipated trading conditions made that forecast too optimistic, and management now expected underlying profit growth to be largely flat for the financial year.

That news obviously spooked investors, who may have been expecting FY19 to pan out roughly the same way as FY18, when the company reported growth in underlying NPAT of 26.3% to $76.7 million. In response to the announcement, Costa Group’s share price plummeted an astonishing 39% on Thursday, and despite posting a modest gain on Friday, the company’s shares are still down almost 35% for the week to $4.64.

As a shareholder in Costa Group, I’m searching for a silver lining to all this. And the company is trying valiantly to put a bit of a positive spin on the news too. It argued that these conditions are cyclical in nature: that the citrus “off season” started early and that trading in other key produce like tomatoes, berries and avocados will recover, allowing the company to still deliver compound annual growth in the double digits for the two calendar years from 2017 to 2019.

This may be the company extending an olive branch to its shareholders, but there could be some truth to it too. According to a January 11 report on ABC News, a nationwide lemon shortage has caused prices for the citrus fruit to soar over the summer – in some cases almost doubling – as supermarkets are forced to rely on more expensive overseas imports.

And while a hefty profit downgrade is never great news for shareholders, it isn’t entirely unexpected either. Costa Group is pursuing an international growth strategy, expanding its operations in China and Morocco. It also recently acquired the farming operations at Nangiloc Colignan Farm in the Sunraysia district of North West Victoria and is expanding its Australian tomato and mushroom production facilities.

All this obviously comes at an extra cost, especially through increased depreciation and interest charges on capital expenditure.

So the idea has always been that a subdued FY18 would be followed up with a bumper FY19, when the benefits of the additional capital expenditure would be realised through increased output across basically all areas of the business. But this does rely on consumer demand bolstering prices, and it is difficult for investors to have a great deal of faith in this happening, especially after Costa Group had to admit that demand for berries, tomatoes and avocadoes has been “patchy” over summer.

The end result is that Costa Group management is asking for a great deal more trust from its shareholders. And in an environment where investors are increasingly reluctant to take on extra risk that’s a pretty tough ask.

Foolish takeaway:

As an existing shareholder in Costa Group, I’m willing to place my trust in management to still deliver the promised growth in FY19. I originally bought Costa Group shares because I perceived there to be a growing cultural trend in Australia towards healthy eating, promoted in part by the popularity of cooking shows, home cooking kit delivery services like HelloFresh and Marley Spoon AG (ASX:MMM) and the growing hipster movement.

The share prices of other ASX listed “health food” companies like Freedom Foods Group Limited (ASX:FNP) and small cap The Food Revolution Group Limited (ASX:FOD) have also benefited from this trend. Although Freedom Foods, like many other growth stocks with highly inflated multiples, has suffered a significant downturn since volatility returned to global equities markets around September last year.

However, if I was a new investor, particularly one with an aversion to risk, I’d be more inclined to wait until I see real evidence of a profit turnaround before I put my money into Costa Group.

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Motley Fool contributor Rhys Brock owns shares of COSTA GRP FPO and Freedom Foods Group Limited. The Motley Fool Australia owns shares of and has recommended COSTA GRP FPO. The Motley Fool Australia has recommended Freedom Foods Group Limited. 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 Scott Phillips.