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Why the Costa Group share price is set to crash

All eyes will be on the Costa Group Holdings Ltd (ASX: CGC) share price when it returns to the board today or tomorrow following its profit warning and deeply-discounted capital raise.

The Costa share price will likely tumble but the key thing for investors to be watching for is whether it can hold at or above the $2.20 level, which where Australia’s largest fruit and vegetable grower is pricing its new share sale.

The stock last traded at $3.46 before it went into voluntary suspension last week. This takes CGC share price loss to around 44% over the past year when S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index is up 15%.

While many agriculture-exposed stocks are doing it tough due to adverse weather, Costa is suffering more than most. The Australian Agricultural Company Ltd (ASX: AAC) share price tumbled 21%, the Graincorp Ltd (ASX: GNC) share price crashed 8% while the Nufarm Limited (ASX: NUF) share price gained around 13%.

Capital raising details

Coming back to Costa, at least the company can be assured that it will get circa $176 million through an accelerated renounceable 1-for-4 entitlement offer, which is fully underwritten by UBS.

Proceeds from the raise will be used to “strengthen” its balance sheet – meaning it will probably be used to pay down debt to appease nervous lenders as the group deals with the ongoing impact of the drought.

Management also downgraded its 2019 calendar year earnings forecast yet again. It now expects adjusted net profit of $28 million and earnings before interest, tax, depreciation and amortisation (EBITDA) of $98 million.

Extremely dry and hot conditions have impacted on the size of fruit and yield in avocados, blueberries and the late season citrus crop.

Is the worst over?

But is a slim silver lining. First off, if the market saying that profit downgrades come in trees (oops, I mean ‘threes’) is right, this could be the last of the bad earnings news in this cycle.

Management is at least trying to give that impression as it’s tipping 2020 earnings to double from its dismal 2019 forecast. Costa said that “a moderate improvement of dry weather and drought conditions in Australia and more normal season and crop cycles in Australia and Morocco” could see its adjusted EBITDA jump to $150 million and net profit to $50 million plus.

No one is saying the drought is breaking but there’s anecdotal evidence that some parts of the country are getting improved rainfall and that things aren’t getting worse (although that isn’t surprising as we are already at the bottom).

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Motley Fool contributor Brendon Lau owns shares of Nufarm Limited. Connect with him on Twitter @brenlau.

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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