Costa Group Holdings Ltd (ASX: CGC) is Australia's leading horticulture group, with fully integrated operations in growing, packaging and marketing across five key product categories (avocados, berries, citrus, mushrooms and tomatoes).
Although its shares were trading at $8.79 in August last year, two disastrous earnings updates sent Costa Group investors into a world of hurt. Now, after a tumultuous 12 months, the Costa Group share price may be set to rebound.
What went wrong for Costa?
In January 2019, the market was unimpressed by the company's trading update – reporting flat NPAT-SL (net profit after tax, prior to movements in the value of biological assets, lease liability, and some depreciation components) growth compared to its forecasted double-digit growth. This was caused by an 'off-season' in citrus production, as well as unexpected costs from its African Blue acquisition. Despite management's best efforts to explain the 'cyclical' and not 'structural' nature of these problems, the Costa share price fell more than 30% in a single day. Nevertheless, management remained optimistic about its ability to deliver a double-digit CAGR (compound annual growth rate) over the 2017–2019 period.
Investors hoping for a quick turnaround were thoroughly disappointed. A "deteriorating operating environment" was the driver of another earnings downgrade at the company AGM on 28 May. This included summer temperatures affecting mushroom demand and pricing, delayed fruit maturity in Morocco, and a fruit fly causing 17,000 tonnes of citrus to be quarantined. Unsurprisingly, the revised NPAT-SL forecast dropped from 30% growth to a rate between 0%–16%. Costa's shares fell a further 30% on the announcement, bringing it to a 2-year low of just $3.56.
Is Costa Group a buy?
While there is no doubt that these issues present a material impact, I believe that the market has vastly overstated the effect that they will have on future earnings.
Costa's vertically integrated business commands higher margins through supply and logistics chain efficiencies. Despite a terrible year all round, its gross margin of 15.92% still outpaces the industry average of 12.06%. Costa's patented farming technologies such as automated irrigation also provide a diversified source of income through licensing and royalty fees.
Furthermore, Costa's main growth driver will be an expanding international market for Australian fruits and vegetables. Over the last year, 73% of packaged citrus products have been sold to overseas countries such as Japan, the United States, New Zealand, and China. The falling Australian dollar may also provide a favourable tailwind as Australian exports become more attractive in overseas markets.
Some investors agree, with the stock rebounding 12% in just the last 3 weeks.
Foolish takeaway
As recent events have shown, it's clear Costa operates in a medium–high risk business. However, with an abundance of growth opportunities and a 2.8% fully franked dividend, I'd consider Costa's current share price to be an attractive investment as part of a diversified portfolio.
