Mission Produce (AVO) has gone public in an offering which was not well-received by the market as pricing took place quite a bit below the preliminary offering range. Furthermore, shares have not really enjoyed a bounce higher from those levels. Based on the 2019 numbers, multiple looks very modest, yet 2020 will become a tough year as I fear that is a cyclical commodity play, despite operating in a structural growth market.
An Avocado Play
Mission Produce claims to be the leader in sourcing, production and distribution of fresh avocados to retailers, wholesalers and foodservice customers. On top of sourcing, production and distribution, the company provides additional value-added services including ripening, customer packing and logistics, among others.
The company has packing facilities in the US, Mexico and Peru, as well as many distribution and ripening centers across the globe. The production assets include 10,000 acres in Peru with additional greenfields allowing for capacity expansion in the years to come.
Since being founded in 1983, the company has focused on growth, innovation and strategic investments, having made a bet on avocados long before it became a very popular food item. Other sourcing regions include notably Mexico and California as the company uses own production and relationships with third-party growers to create complementary growth seasons. This allows for supply across seasons; in fact, throughout the entire year.
So, while the sourcing side of agricultural products is always volatile, the sales side certainly is not, as all the top 10 customers in 2019 have actually been a customer for at least 10 years; that is quite a statement of course. Demand for avocados has been on the rise with the 559 million pounds processed by the company in 2019 actually being three time the volumes in 2009, as revenues rose a factor of 4 times over the same period of time as prices have risen as well.
The US markets for avocados alone represents a $6.5 billion market with consumption having risen to 2.6 billion pounds in 2019 because per capita consumption has been up a great deal. While the volumes keep steadily rising, prices are quite volatile, having ranged between $2 and $3 per pound over the past years, with the US market relying largely on Mexico for import, and to a lesser extent fulfil demand with own production and import from Peru.
Strong growth is in part driven by the status of superfood as well as general increased focus on healthier food. While the US consumption has risen quite sharply to 8 pounds per capita, demand is still very underdeveloped in Europe and notably Asia. The company believes in leadership of this market, focus on innovation and vertical integration to further capitalize on its strength in this attractive market.
IPO And Valuation Thoughts
Mission Produce and underwriters initially aimed to sell 9.4 million shares in a range between $15 and $17 per share, with two-thirds of the shares offered by the company and the remainder by selling shareholders.
Soft demand for the offering meant that pricing was set at just $12 as the total offering size furthermore was cut to 8 million shares, comprised out of 6.25 million shares offered by the company and the remainder by selling shareholders.
The company reports a total share count of 69.4 million shares which translates into a $833 million equity valuation at the offer price. The company reports a net debt load around $132 million ahead of the offering, as this could fall towards $60 million after taking into account the offer proceeds.
The company has a book year which ends in October. For the year 2018, the company generated $860 million in sales on which it only reported $19 million in operating earnings. Sales rose in a very modest fashion to $883 million in 2019 yet operating profits exploded to $106 million. The reason for that is seen in the composition of revenues with pricing up 18% and supply down 13% due to rough weather conditions in Peru and Mexico.
To put this number into perspective, interest expenses on the remaining $60 million in net debt following the IPO runs at just a few million, as 20% tax rates would reveal net earnings potential of $82 million on a pro-forma basis. This translates into earnings potential of $1.20 per share, translating into a multiple of just 10 times at $12 per share.
That sounds too good to be true, and it is. While volume rose more than 8% so far this year (that is for the first three quarters of 2019), these solid volume gains are not seen in the revenue numbers. Sales were up just a percent to $655 million, revealing that real pricing and margin pressure is seen, due to higher supply and lower demand.
Operating profits for the first nine months of the year fell to just $46 million vs. a profit of $75 million in the first three quarters of 2019. If a run rate of $60 million is realistic for this year, with just one quarter to go, I peg net earnings potential at $45 million. This is equivalent to just $0.65 per share, just half the earnings reported last year.
This means that a 10 times multiple for 2019 has risen to a market multiple around 18-19 times.
I see the reason why investors have gotten a bit more cautious and hence pricing has been cut about 25% ahead of the public offering. While a 10 times earnings multiple based on 2019 numbers looks very compelling, combined with the long-term growth of the industry, margins are notoriously volatile as well.
Not only will earnings drop in a big way this year, the recent momentum is soft amidst lower prices and thus profits, the result of a myriad of factors. Slower economic growth and less eating out hurts notably consumption of avocados as other risks include political risk and trade (notably Mexico which is dealing with other social issues as well).
The biggest risk is that of the role which the company plays. Despite its collective dominance in logistics and ripening, the company is earning just pennies on the dollar currently, as it seems that despite the size, it’s subject to the same commodity conditions (low and volatile margins) rather than being a premium product, with higher and stable margins.
While the volumes of such a business are huge, these are not very good long-term value creators as a year or certainly two years of bad pricing, volumes, lost crops, etc. can easily wipe out equity holders. For instance, just check out Fresh Del Monte (FDP), trading currently that the same level as 20 years ago as the fruits business has seen many bankruptcies as well at related companies.
Calavo Growers (CVGW) is one of the best comparisons. It has been around much longer than Mission Produce, and it has moved into other parts of the value chain to create not just another supplier, yet actually produce customized products such as guacamole and other foods. The reason for that is the goal to obtain a higher and more stable margin profile.
Shares of Calavo peaked at $100 in 2018, having ten folded in a period of a decade, as shares had risen from $10 to $100, although shares have now fallen back to $66. For the year 2019, the company reported 10% revenue growth to $1.2 billion and operating earnings of $71 million, making it a bit larger in terms of size, yet being a lower margin business.
The 17 million shares value the company now at $1.16 billion with an enterprise value equivalent to that number. This means that the business is valued at around 1 times sales, equivalent to the valuation at which Mission trades. While Calavo in the long term is a bit more stable with roughly 40% of sales generated from prepared foods, it seems to be hit harder than Mission Produce. The catering foodservice business has been hit very hard, while Mission has more exposure to end-consumers such as grocery retailers.
Amidst all of this, I am compelled to the softer pricing and low multiples based on the 2019 results. This, in combination with long-term demand prospects, looks compelling, yet I fear that this is cyclical commodity play to a big extent. Hence, I have a neutral stance until I learn more about the fourth-quarter numbers before potentially considering a small allocation.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.