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Is the Costa Group share price good value?

2019 has been a tough year for Australian fruit and vegetable producer Costa Group Holdings Limited (ASX: CGC).

What happened

In January, the Costa Group share price plummeted almost 40% in a day, after Costa Group announced an earnings downgrade in light of weaker than expected demand for berries, tomatoes and avocadoes in December.

More recently, on 30 May, the share price slid a further 30% lower when Costa Group announced a further earnings downgrade. Costa Group had previously signalled it expected an increase in NPAT-SL (net profit after tax, prior to movements in the value of biological assets, lease liability, and some depreciation components) of 30% over the prior calendar year.

However, Costa has had to contend with a number of recent negative developments. Weakening demand for mushrooms, high waste in the raspberry category, and the detection of a female fruit fly in one of its citrus crops has combined to put downward pressure on Costa’s annual earnings expectations.

Rather than the 30% increase in NPAT-SL, Costa Group announced that it now expected NPAT-SL for the 2019 calendar year to fall somewhere in the range of $57 million to $66 million, which would only represent an uplift of between 1% and 17% over 2018 NPAT-SL of $56.6 million.

This second earnings downgrade in the space of only a few months was too much bad news for many Costa Group shareholders, many of whom may have picked up shares in the company expecting it to be a solid growth stock.

So are things actually as bad as they seem?

On the one hand, Costa Group has shown that it can withstand tough market conditions and still post modest profit growth (that is assuming its 2019 NPAT-SL ends up somewhere within its most recently announced guidance range). And at least a few of this year’s misfortunes seem a little outside of Costa management’s control.

The discovery of the fruit fly, for instance, means that about 17,000 tonnes of Costa’s citrus crop may need to be packed by a third party rather than at Costa’s own facilities. But this would have been a difficult event to have predicted, and charitable investors might forgive Costa for it.  But the real issue for shareholders is that this is just another problem in a half year dotted with them. The company has had to struggle through the drawn-out bottom end of the citrus season cycle and weaker than expected demand for berries, avocadoes and tomatoes. And then there is the apparent negative impact that unseasonably warm weather has on mushroom demand. It’s getting to the point where shareholders want to hear some good news, rather than more excuses.

But there is some good news. There’s plenty, in fact. Since the company listed in 2015, it has grown in size from 4 farms to 7, and increased the total size of its plantings by 1,000 hectares to 3,000 hectares. It is expanding its international presence in Morocco and China. The company invests in technology, and is currently attempting to genetically develop a new range of blueberries capable of growing at lower latitudes. This is to further bolster its ability to supply year-round crop production.

Foolish takeaway

These recent earnings downgrades have demonstrated that Costa Group is a significantly more risky investment than many investors previously understood it to be – and makes it a difficult share to recommend.

But if you believe management at Costa, this is all just cyclical. And if they’re right, and Costa can generate an earnings surprise in one of its upcoming results, expect to see its share price surge as many of its fair-weather investors come rushing back.

But if not, whatever shareholders still remain might start finally running out of patience.

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Motley Fool contributor Rhys Brock owns shares of COSTA GRP FPO. The Motley Fool Australia owns shares of and has recommended COSTA GRP FPO. 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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