Is Costa Group or Lynch the pick of the bunch for investors?

Mourners grabbing a bunch of roses at the supermarket enroute to great aunt Dora’s funeral – or virtual send-off in the case of Victoria – would be oblivious to the complex logistics that enable a bunch of fresh blooms to be available beside the wonky trolleys every day.

We guess the same applies to buying milk or carrots. But flowers pose an added challenge because they are ultra-perishable. They also need to look extra nice on display and often can’t be grown locally.

“Flowers are a unique product category that are highly perishable and have a short vase life, resulting in complex and time sensitive supply chain and high barriers to entry,’’ Lynch Group Holdings (ASX: LGL) chief executive officer Hugh Toll explains.

Lynch has certainly nipped the floral business in the bud, having grown, processed and distributed flowers since 1915.

Recent ASX listing

Private equity group Next Capital took a majority interest in the previously family-owned business in 2015 and the company listed on the ASX on 6 April this year, after a $206 million raising at $3.60 a share.

The shares haven’t done much, but there are some intriguing aspects to the business that suggest the company – one of a few listed floral stocks globally – could come up roses over time.

The first is that Lynch dominates the supermarket and convenience store sector, supplying 88% of blooms procured not just by Coles and Woolworths but IGA, Costco, Aldi, BP servos, Big W and Bunnings.

The company runs four processing centres nationally, with the produce supplied by company-owned and third-party farmers.

Lynch’s wholesaling arm also services 2,000 retail stores and supplies 29% of florists.

Post-pandemic world

The company has emerged from a pandemic “horror show” period that saw consumers rushing the shelves for dunny paper – but not delphiniums.

“Flowers were the last thing on anyone’s mind,” Mr Toll said.

“It certainly made us change some things in the business we never thought we would change, and simplify our range and production methods to make things move faster.”

While the banning of decent-sized funerals and social events didn’t help, the convenience trade is oriented more to consumers self-purchasing flowers to liven up the home.

The convenience blooms typically sell for around $10 for a straight bunch and high teens for a bouquet. Not surprisingly, a Valentine’s Day arrangement can sell for $60 or more, but in the main we’re not talking about emulating the artistry of royal florist Philippa Craddock.

Appealing displays

As well as having a shelf life of only a couple of days, the displays have to enough bunches of fresh-looking specimens to entice buyers – there’s nothing more off-putting than a couple of wilted gerberas a few hours off being the next day’s compost.

Arranging the supermarket displays is not left to the night fill guys more accustomed to piling up baked bean cans: Lynch has its own floral flying squad for that task.

Despite management’s best efforts, wastage runs into the teens. “It’s a necessary part of the business given perishable nature of the product and the fact you need good stock volume when customers come through the door,” Mr Toll pointed out.

Chinese market

The other leg of Lynch’s growth prospects lies with the emerging uptake of stems and buds by China’s emerging middle class. After all, Chairman Mao did once exhort a policy of “letting a hundred flowers gloom and a hundred schools of thought contend.”

(Lo behold anyone who did sprout some free expression, but we digress).

Lynch entered the Chinese market 16 years ago, building two farms from scratch. Of the IPO proceeds, $33 million was earmarked to acquiring two more via the acquisition of premium rose grower VDB Asia.

Mr Toll says the strategy initially was to supply the Australian market, with one advantage being the amenable climate.

“The Chinese operation got started as a way to source product to Australia … we’re starting to supply supermarket chain with a simple range,” Mr Toll said.

“We will develop the business to look more like Australia’s at a retail level, over time.”

Global flower market

Industry stats suggest Australia’s flower market was worth $1.32 billion in 2015 and $1.37 billion in 2019 – a compound annual growth of 0.8%.

With their wide variety of shapes and colours, roses account for at least about one-third of sales.

The sector is expected to expand to $1.46 billion by 2024, or 1.3% growth.

In contrast, the Chinese market is worth much more – $19 billion – but largely has been flat.

While these growth dynamics are nothing to get excited about, Lynch’s dominant position in the convenience sector might be.

According to Mr Toll, the supermarket/convenience channels accounts for only 19% of flower sales here, compared with 55% in the UK.

The company expects the convenience share of the market to grow to 24% by 2024, at the expense of sub scale operators.

Australia’s largest fruit and vegetable supplier

If the supermarkets get the huff with Lynch, there’s no one with the scale to replace that supplier.

Investors have likened Lynch to the country’s biggest fruit and vegetable supplier – Costa Group (ASX: CGC)

Not that the flower grower would appreciate the comparison given Costa’s profit downgrade last week.

The key element is that both companies grow perishable products and they are dominant suppliers to supermarkets in otherwise fragmented sectors.

Both entities have Chinese growing operations and are building a domestic presence there.

“There are some quite strong parallels, but differences in terms of products and how they brand themselves,” Mr Toll says.

The supplier of berries, mushrooms, citrus fruits, glasshouse tomatoes and avocadoes, Costa suffered from a lack of rainfall and other woes including a raspberry disease in calendar year 2019.

The calendar 2020 result swung to a $65 million net profit from a $30 million deficit previously, on revenue of $1.16 billion (up 13%).

So all’s well that ends well? Not quite. At its 27 May AGM, Costa said that June half earnings (1H 2021) would be “marginally ahead” of last year’s result, which would be promising news if investors had not factored in a substantially higher number.

The stock dropped 24% in response.

On broker Citi’s numbers, Costa is trading on an earnings multiple of 20-21 times for the 2021-22 year and a dividend yield of around 4%.

Analyst Ben Gilbert from advisory group Jarden puts Lynch on a multiple of 14-15 times and a yield slightly below 4%.

We hasten to add – probably redundantly – that there are numerous variables including growing conditions and labour supply. With the borders shut, worker availability is especially problematic for Costa and its all-year-round mushroom crops.

With a $440 million market compared with Costa’s $1.3 billion, Lynch arguably is the ‘poor man’s Costa’ for investors, although not quite in the same defensive category.

Nasturtiums aside, you can’t eat flowers when the next pandemic or financial crisis hits.