Costa’s International segment operates farms in Morocco and China, and earns royalty income from licensing its blueberry genetics

Business Strategy & Outlook

Costa’s strong earnings growth to continue over the near term as expansionary investment in farms both domestically and in the firm’s China and Morocco businesses begins to bear fruit. However, Costa’s customer base is highly concentrated, and its products highly commoditized, and the company has carved an economic moat required to sustainably derive economic profits. Despite the potential for short-term fluctuations, which are inherent in an industry exposed to changes in weather and climate, the Australian fruit and vegetable industry has enjoyed a consistent trajectory, growing its value at an average of 3.4% per year over the past decade. Similar industry growth over the next decade is expected, underpinned by population growth, inflationary price increases, and some per capita increases in fruit and vegetable consumption.

It is expected expect Costa can outpace industry growth and capture market share, at least in the near term. Costa is growing its Australian market share to around 20% over the next five years, from 15% currently. However, this comes at a cost. With current projects such as the Monarto facility expansion increasing its footprint in mushrooms and ongoing berry expansion, Costa’s growth activities are capital intensive. The firm’s capital expenditure has expanded from around 5% of sales in 2016 to 11% in 2021, and the remaining is in the high single digits in the near term as the firm continues to ramp up growth with new projects. Costa’s International segment operates farms in Morocco and China, and earns royalty income from licensing its blueberry genetics. The Morocco operation is principally an export business, supplying blueberries to the U.K. and continental Europe, while China berry farming sales remain predominantly local. A significant growth is expected in the international segment over the short term as Costa continues to ramp up its international facilities. While labor costs are lower in these regions, without the biosecurity regulations of Australia, international farming is more exposed to import competition.

Financial Strengths

Costa’s balance sheet is in good shape. Net debt/EBITDA lifted to 1.8 in calendar 2021 as elevated capital expenditure, including the AUD 237 million 2PH Farms acquisition, was partially offset by the AUD 185 million equity raise. Costa’s AUD 176 million equity raising in calendar 2019 has placed the firm in a much more conservative position–suitable for a firm needing to ride out short-term fluctuations, which are inherent in an industry exposed to changes in weather and climate. Costa’s fiscal 2019 net debt/EBITDA would have ballooned to over 3.6 without the raising. This is much higher than the firm’s target range of 1.5-2.0, and would breach the estimate of the firm’s covenants, it is expected to be in the vicinity of 3.5. Costa’s balance sheet is well placed to underpin a dividend payout ratio of around 60% of underlying earnings per share. Conservative management of the balance sheet is also prudent considering the capital requirements ahead of the firm. With current projects such as the Monarto facility expansion increasing its footprint in mushrooms, investment in the Guyra tomato glasshouse, continued berry expansion, and ongoing international expenditure, Costa’s growth activities are capital intensive. The firm’s growth capital expenditure has expanded from around AUD 30 million in 2016 to AUD 128 million in 2021. While growth expenditure dipped to AUD 50 million in calendar 2020 as the firm tightened growth expenditure amid COVID-19 uncertainty, this expanded to more elevated levels around AUD 80 million in calendar 2021, not including acquisitions. A near-term growth capital expenditure of above AUD 60 million as the firm continues to ramp up expansionary projects.

Bulls Say

Costa’s strong market share in key categories mitigates its high customer concentration risk
International berry expansion to China is running according to Costa’s original five-year plan, and appears set for significant growth.
Costa is well positioned to capitalize on high growth in emergent product categories, such as blackberries.

Company Description

Costa Group is the largest fresh produce company in Australia, with an estimated market share of over 15%, principally supplying fresh fruit and vegetables to the major Australian supermarkets. While supplemented by third-party growers, the firm’s products are predominantly sourced from around 5,000 planted hectares of farmland, 30 hectares of tomato glasshouse facilities, and mushroom-growing facilities across Australia. Costa also operates berry farms in Morocco and China as part of its international business.

(Source: Morningstar)

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