Avocado is a brunch staple, so why is grower Costa getting smashed?

Key figures: Interim chief executive Harry Debney, chair Neil Chatfield.

The bull case: Even as consumers start rethinking their spending habits with the rising cost of living, non-discretionary goods like food and fresh produce will stay in demand. Roughly 70 per cent of Costa’s produce sales are made via its four largest customers – supermarket chains Woolworths, Coles, Aldi, and Metcash (IGA).

“Costa is the largest player in a highly fragmented Australian fresh produce market with an estimated share of more than 15 per cent, and has a significant share in some product categories, notably blueberries and raspberries at over 60 per cent,” wrote Morningstar analyst Angus Hewitt.

Investment and advisory firm Jarden, which has an ‘overweight’ rating on the company, described Costa as “one of the global leaders in produce”.

The company looks well-positioned for the short term through its international business (berry farms in Morocco and China), and Morningstar’s Hewitt expects Costa to retain its edge as the market leader.

”We expect Costa can outpace industry growth and capture market share, at least in the near term,” he wrote in a note to clients. “We forecast Costa growing its Australian market share to around 20 per cent over the next five years, from 15 per cent currently.“

More recently, news that former major investor, US private equity firm Paine Schwartz, has snatched a 14 per cent stake with plans to increase this seems to have invigorated investor interest, leading to an 11 per cent bounce in the company’s share price last Wednesday.

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“Despite its [Costa Group] troubles and issues, it is really showing deep value,” said Tribeca Investment Partners lead portfolio manager Jun Bei Liu. “There’s a lot of value in Costa … it’s really one for the strategic, longer-term investors.”

The bear case: Most players across the food supply chain are facing more challenging conditions created by climate change-fuelled extreme weather events.

This year’s La Niña bruised Costa’s orange crop along with its share price, which caused Morningstar to lower its fair value estimate of Costa’s shares by 9 per cent to $3.10 – though this is still almost 20 per cent above where the stock is trading at the moment.

“The biggest risk in fresh produce is fluctuations in weather and climate. Weather conditions are variable by nature,” wrote Hewitt, who also noted Costa faces risks around its intensive resource use as energy costs and water prices rise.

Jarden slashed its price target for Costa shares from $3.15 to $2.20 after the company’s recent poor trading update. UBS has the same 12-month price target of $2.20, down from $2.80, effectively predicting a more than 20 per cent decline in market value over the next year.

“While a large part of the downgrade relates to quality and pricing issues across citrus, issues around pack-out rates, spraying and labour were also prevalent, with management currently reviewing practices for future years,” Jarden’s analysts wrote. “Recent abnormal weather events, COVID, labour shortages and freight volatility have all contributed to material earnings uncertainty.”

Costa’s avocado business hasn’t been profitable for some time, due to a national oversupply of the green fruit. And the sudden resignation of Sean Hallahan, who was until recently the company’s chief executive, has injected uncertainty about the company’s management.

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More broadly, while Costa is the biggest national player in the fresh produce market, it may struggle to maintain a competitive advantage, the sceptics say.

“In our view, only products with very strong brand equity can earn excess returns in this competitive environment,” Hewitt wrote.

“There is little differentiation between Costa’s products and competing products on a retail level.”

• Advice given in this article is general in nature and is not intended to influence readers’ decisions about investing or financial products. Investors should always seek their own professional advice that takes into account their own personal circumstances before making any financial decisions.