Buying Costa Group shares before their FY results

Costa Group Holdings (ASX:CGC) shares has found some good buyer support in the last couple of weeks. Despite this, it is still well-off the recent highs. With their full year results due later this month, are we still positive enough to be a buyer at current levels?

About Costa Group (ASX:CGC)

Costa Group is a leading horticultural company in Australia. It has three divisions: Produce, International, and Costa Farms and Logistics. The main earnings driver of the business is the Produce division. This division comprises five core categories: berries, mushrooms, glasshouse tomatoes, citrus and avocadoes. This is where the Company grows, packs and markets these products.

Key Earnings Drivers for Costa Group

i. Strong consumption trends in the berries category. In particular, increases in the average weight consumed per buyer across all sub-categories of fresh berries. That is, blueberries, strawberries, blackberries, and raspberries. In context, both the consumption growth rate and average weight consumed per buyer lag the US market. There is therefore potential for the both these measures to improve given that the consumption trends in the Australian market are still at an earlier stage in comparison to the US market.

ii. High levels of domestic demand in avocados, with the industry targeting per-capita consumption to increase from 3.5kg to more than 5kg.

iii. The doubling of mushroom capacity, which is expected to be one of the main contributors to earnings growth over the FY19-FY21 period.

iv. The expansion of the higher-margin international businesses. These comprise five blueberry farms in Morocco (African Blue) and two berry farms in China. The Company still expects “significant earnings growth for the full year” from the International division. This is reflective of increased plantations and increased ownership in African Blue (from 49% to 90% in November 2017).

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v. Ability to finance acquisitions off-balance sheet, ensuring that future acquisitions are value-accretive. CGC continues to seek out Merger & Acquisition opportunities in citrus, in particular high-quality citrus plantings.

vi. While there have been some market concerns over pricing trends across the Produce categories, on balance, the outlook for prices remain positive. Overall, CGC consider that supply is tightening for the majority of its products. This means that there is upside risk to pricing in FY19 in the context of current expectations.

Fundamental View of Costa Group

We consider that the current 1-year forward P/E multiple of ~28x appears undemanding when considered in context to consensus EPS growth estimates of ~15% and ~17% for FY19 and FY20, respectively. We note that there is also potential for upgrades to these EPS estimates from the growth opportunities currently underway. To this end, many market valuations have yet to fully incorporate the value of the current growth projects. In particular, the further Avocado acquisitions announced at the interim results release.

The next catalyst for the share price is the full year results announcement (due 24 August), with NPAT-S growth guidance of 25% (upgraded at the interim results announcement from “at least 20%”) still likely to be conservative. The significance here is that while the FY18 result is retrospective, a beat on its own guidance underpins the fact that the Company has so far executed its growth plans well. And accordingly, it provides a high degree of confidence that the management will to continue to deliver.

Charting View of Costa Group

We can see that the sharp rally in late May/early June was unsustainable, and CGC needed to consolidate. It did so by falling back towards the last area of support near $7.50. Recent price action shows that there is buying support at these levels. This means that CGC is likely to head higher from here. The fully year results can make all of this analysis meaningless of course. However we note that CGC fell away earlier this year, in the months leading into the half year results. It then found support in the couple of weeks prior, and then rallied strongly on a good result. Is history repeating?

Daily chart of Costa Group (ASX:CGC)
Daily chart of Costa Group (ASX:CGC)


Current share prices available here.

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Michael Gable is managing director of Fairmont Equities.

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