Has the Costa Group share price bottomed out?

The Costa Group Holdings Ltd (ASX: CGC) share price has dropped 2.03% lower on Tuesday morning to $5.31 at the time of writing.

One of Australia’s largest suppliers of fresh produce, Costa Group started 2019 on the back foot after presenting the market with a negative trading update and guidance on the 10th of January. Citing subdued demand and reduced profit margins, shares in the company plunged nearly 34%, closing at a 52-week low of $4.50.

Smashed avo’s

The company which supplies produce to giants Coles Group Ltd (ASX: COL) and Woolworths Group Ltd (ASX: WOW) makes 80% of its profits from the sale of fruits and vegetables. Major contributors to the company’s revenue growth include citrus, avocadoes, berries and tomatoes. In the update, Costa Croup cited a lower profit and earnings guidance due to subdued demand and incorrect retail pricing across several fresh produce categories. The categories most affected included tomatoes, mushrooms, bananas, avocados and berries. In addition, a shorter than usual citrus season contributed to lower guidance. The company had previously forecasted double-figure growth, however, issued a warning to investors that underlying profits may remain flat if current trading conditions continued.

Sweet pickings

There are a number of positives on the horizon for Costa Group, as 2019 shapes to be a make or break year for the company. Most fresh produce categories have recovered and pricing for certain products are being optimised. Raspberries and blueberries, which were selling below the optimal cost of $3.00, now have shelf prices of $4.50. In addition, tomato oversupply is correcting itself due to a hot summer in South Australia. Citrus contributes greatly to revenue and the company estimates that it will beat its citrus harvest guidance for mid-April.Costa Group has also declared its intentions to further invest in new technology and grow its export market with a China investor tour scheduled for April.

Currently, the company trades at a price-to-earnings multiple of 20 times forward earnings, in comparison to 43 times in 2018, indicating that the reaction to January’s update may be overstretched.

Foolish takeaway

In my opinion, Costa Group looks to have great potential for long-term earnings growth. Demand for fresh produce looks to increase as the population transitions to healthier food options and as Australia grows into its role as the ‘food bowl’ of Asia. However, caution should always be given to the cyclical nature of the fresh produce sector, especially with the challenges posed by changing environmental conditions.

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Motley Fool contributor Nikhil Gangaram has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of and has recommended COSTA GRP FPO. The Motley Fool Australia owns shares of COLESGROUP DEF SET. 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.

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