Growth is returning to the fore for Costa Group as the weather gods smile favourably on a range of horticultural produce.

-2021 to benefit from non-recurrence of one-off costs
-Morocco, China expected to drive growth in 2021
-Initiatives expected to keep yield and fruit quality ahead of historical levels
 

Water availability and poor cropping conditions are now behind Costa Group ((CGC)), and the business appears primed for a strong second half in 2020. International earnings have recovered while gearing has improved as well.

The market has rewarded the better outlook, Macquarie observes, although several external variables continue to have an impact. These include pandemic-related costs and the lingering impacts of drought in terms of fruit size and yields.

Still, 2021 should benefit from the non-recurrence of $34m in one-off costs, and the broker acknowledges seasonal conditions in Australia have improved substantially. Costa Group has water security across all sites in 2020 and has doubled its capacity for water at Corindi where dams are now 93% full.

Goldman Sachs considers the citrus division is still somewhat weak and the second half is likely to show a smaller contribution compared with the second half of 2019. Quality has been below original expectations as a result of hail damage in late 2019. The broker also points out securing seasonal labour remains a challenge because of the problems related to international and state border closures.

Going forward the citrus crop is likely to be much better and Morgans suggests this could mean prior 2020 guidance can be achieved, although guidance was not reinstated. The broker expects 2021 will be a much stronger year for the company, with the usual caveats that devastating bushfires are not repeated and the weather outlook remains favourable.

Additionally, Morgans points out 2021 is an "on-year" for the citrus crop and demand/pricing has been strong, while there will be a full 12 months of capacity expansion at Monarto (mushrooms). Macquarie flags strong consumer demand and good yield & quality in mushrooms.

Further plantings are being made in Morocco (berries) and the avocado footprint is maturing. Costa Group will now be the largest grower and marketer of avocados in Australia and is on track to reach 2m trays of its own production over the next four years.

Growth Expenditure

Growth capital expenditure has fallen this year and is expected to reduce further in 2021. Morgans envisages scope for operating leverage to return in 2021 and understands the operating earnings return hurdles of 20% are unchanged.

The balance sheet has improved after the capital raising in 2019 and Citi observes an adequate return on the capital expenditure and a fading expenditure profile over the next three years. Wilsons assesses further expenditure on growth would also present upside to existing forecasts, noting the balance sheet is now in a position to accommodate such plans.

Growth is returning to the fore for Costa Group, Credit Suisse agrees, as the weather becomes more benign. The second half will largely be underpinned by the rest of the citrus harvest, mushrooms and Australia's main berry season, as well as tomatoes.

Most of the remaining production is undercover and mostly protected from weather risk. Rain has helped and water infrastructure has been completed. Moreover, output pricing is firm.

The stock should re-rate as earnings momentum improves over the next year, although Citi expects a partial reversal in margins in 2021, highlighting it is not practical to assume perfect weather continues. UBS highlights increasing consumption of food at home has meant stronger demand for grocery items and this underpins an improved earnings outlook.

International

Driving growth in 2021 are Morocco and China in terms of expansion of berry acreage, as well as the Australian berry premiumisation and increased output of mushrooms.

International was the highlight for Macquarie in the first half. There was a more normal season in Morocco, which exhibited earnings growth potential, and revenue increased 130% in China as acreage expanded.

Citi anticipates the company's initiatives should keep yield and fruit quality ahead of historical levels and forecasts long-term margins of 35% in the international segment. There was no update on the plans for additional acreage in China or Morocco but the broker expects Costa Group will grow sales faster in China which is a higher margin region.

Goldman Sachs, not one of the seven stockbrokers monitored daily on the FNArena database, has a Neutral rating and $3.45 target, believing growth is largely factored into the current share price, while Wilsons, also not one of the seven, has an Overweight rating and $3.67 target.

The database has four Buy ratings and one Hold (Macquarie). The consensus target is $3.63, suggesting 6.6% upside to the last share price.

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