Costa Group puts hand out as drought hurts its bottom line

Costa Group ASX CGC drought capital raising equity guidance entitlement offer
Fresh produce giant Costa Group is seeking to raise $176 million through an entitlement offer to pay down debt as drought conditions and other challenges rage on.

Major fruit and vegetables grower Costa Group (ASX: CGC) has revealed a downgraded profit guidance for 2019, but is hoping a heavily discounted capital raising will entice investors to keep the faith.

The company entered into a voluntary suspension last week ahead of announcing its trading outlook, citing “previously foreshadowed challenges” that have “continued to crystallise”.

However, it has promised a rosier outlook for next year and to help achieve this, it plans to raise $176 million in an entitlement offer, with funds expected to be used to pay down debt.

Downgraded guidance for 2019

In a trading update released on Monday, Costa said earnings before interest, tax, depreciation and amortisation (EBITDA) for the 2019 calendar year is expected to be around $98 million – a steep drop from its last stated guidance, which was anticipated to be in the “lower end” of $140-$153 million.

Its forecast net profit after tax was also downgraded to $28 million.

The company described 2019 as a “challenging and disappointing year, with performance below expectations, due to a combination of cyclical, one-off and structural issues.”

However, Costa chief executive officer Harry Debney said the company is hoping to “return to a more balanced portfolio performance” from the 2020 calendar year – provided its operating regions receive adequate rainfall.

Continued challenges

The biggest problem facing the company is prolonged drought conditions that have created flow-on effects including a deterioration in fruit size and yield, leading to worsening price reductions for some fresh produce.

Costa also cited water security concerns, high water prices and a fruit fly problem (which it said should be resolved prior to the 2020 season) as other challenges currently being tackled.

It said all produce categories, with the exception of tomatoes, will deliver below expectations this year.

Fruit size and yield due to extended extreme dry and hot conditions affected citrus, avocado and blueberry crops, while the company struggled to deal with a problem of raspberries crumbling and therefore could not be sold.

Costa has decided to speed up the closure of its aged higher cost mushroom sites in Tasmania and Queensland, although its Monarto mushroom facility is being commissioned and is expected to achieve full production in the second quarter of 2020. However, this sector is still suffering from low prices.

Meanwhile, the company reported a continued solid trading performance from tomatoes. Although, it noted the lengthy drought conditions have meant an increase in water demand and the need to source alternative water solutions.

“Due to water security concerns, a decision has been taken to pause construction of the 10-hectare GH4 glasshouse expansion project,” Costa stated.

Outlook for 2020

Before taking into account the impact of the equity raising, the company has forecast CY20 EBITDA of about $150 million and for net profit after tax to be roughly in line with 2018, which was $56.6 million.

Costa said its outlook for next year “contemplates a moderate improvement of dry weather and drought conditions in Australia and more normal season and crop cycles in Australia and Morocco”.

“Should the severity of current drought conditions persist or intensify, the company will be required to deal with reduced availability of water in some regions, increased water consumption by crops, high water cost, as well as impacts on yield, fruit size and timing dependent on regional variation in heat and dry conditions, and individual crop responses,” Mr Debney said.

Costa said it is also expecting an improvement in the financial performance of its produce categories and international segment due to “recent and ongoing investment in the business, operational initiatives and, for some categories, more normalised market conditions”.

Entitlement offer

Costa is aiming to raise $176 million in equity at a price of $2.20 per share through a fully underwritten accelerated renounceable pro-rata entitlement offer with retail rights trading.

This share price is at a 36.4% discount to the stock’s last traded price of $3.46 before it went into a trading halt last week and is equivalent to the lower end of its IPO listing price back in 2015.

The company said the raising will strengthen its balance sheet and position to “deliver on current and future growth initiatives”.

Mr Debney also pointed out that this was the first time the company had raised capital since its IPO, despite spending $400 million across six expansion projects.

“Costa has funded this expansion predominantly through cash flow and external debt, as well as some off-balance sheet financing, and while the current financial performance has been impacted by a number of challenges, Costa’s footprint is well invested to deliver strong shareholder returns over the medium to long term,” he said.

Under the entitlement offer, eligible shareholders are invited to subscribe for one new Costa share for every four existing shares held in the company.

According to the company, its non-executive directors have expressed their intention to take up their entitlements.