US: Chiquita sell-off is bananas

Chiquita (CQB) reported Q4 2008 results last week which missed analyst expectations due primarily to lower salad sales (more on that), foreign exchange headwinds, and an $8m expense from flooding in Panama and Costa Rica. CQB also took a $375m goodwill impairment charge which made the GAAP number look much worse, however the write-off has no effect on covenant compliance or borrowing capacity.

In response to this weaker than anticipated quarter, the stock had the steepest sell-off in its history, falling -56% in the past two days! This is not a highly levered homebuilder or RV manufacturer, these guys grow bananas, leading me to believe this sell-off is way overdone. Keep in mind that CQB has a solid balance and even paid down $2.7m in debt during Q4 2008. Furthermore, they have no significant debt maturities until 2014 so there should be no concern over liquidity.

What the heck happened?
Sales for bananas were strong at +9%, but the salad part of the “Salad and Healthy Snacks” segment was weak as CQB canceled certain foodservice contracts with customers that were unwilling to accept price increases. Foodservice salad volume was down -25% in the Q, according to last year’s 10-k the foodservice business makes up 30% of Salad & Healthy Snack sales. Retail value-added salads volume declined -4% in the Q. All in all, sales were roughly flat on a yr/yr basis as banana strength and growth from healthy snacks offset the weakness in salads.

Guidance was actually fairly positive in my opinion as management said they expect improved FY 2009 results vs. 2008. If CQB is able to execute I think they will be one of the few companies to show earnings growth in 2009. Given the results and guidance for FY 2009, the market’s reaction seems wildly inappropriate.

CQB is now trading at a compelling valuation relative to peer Fresh Del Monte (FDP) and is generating a FCF yield of +20%. If banana prices and volumes stay relatively constant with where they are now, I think CQB could make $1.17 (vs. $1.12 in FY 2008) in EPS in 2009. Assume a 10X P/E and CQB is an $11 stock. At $11 the stock is trading at 9.4x P/E and 6.3x EV/EBITDA. This estimate does not include any favorable impact from the removal of EU tariffs so that potentially offers even further upside, more detail below. With the stock currently trading at tangible book value (real assets, by the way, such as farms, land, etc.) the downside risk is muted.

* Attractive business, significant growth potential

CQB uses their strong brand recognition to dominate the markets in which they compete with a #1 banana market share in Europe, #2 banana market share domestically, and a #1 packaged salad market share domestically. In addition, CQB is well positioned to benefit from the growth in health consciousness and the new FDA pyramid which recommends 13 daily servings of fruits and vegetables. CQB is leveraging their strong brand by introducing new products that should accelerate the company’s growth rate and achieve higher margins. CQB enjoys competitive advantages such as scale, brand recognition, and supply chain efficiencies.

* Stable demand and “fruit arbitrage”

CQB sells staple products that have steady demand which is attractive during rough economic times such as these. The products are low in absolute cost so any pressure on consumer spending should not have a huge impact. CQB has recently been able to offset cost increases by meaningfully raising banana prices in the US for the first time in 15 years. In addition, CQB has shown the ability to add surcharges (related to Katrina expenses last year) when necessary without damaging demand.

Anecdotal evidence, bananas increased from $.49 per lb to $.59 per lb at my local grocery store (shout out to Harris Teeter) over the past year. This still represents a huge discount to other fruits (apples $1.89lb) and I expect that demand is relatively inelastic at these price levels due to this “fruit arbitrage”. On the call management noted that banana supply/demand remains favorable for banana prices with stable demand and tight supply.

* EU tariff appears to be on the cusp of being overturned

Over the past few years CQB had been pressured by the EU tariff regime change that took effect at the beginning of 2006 which called for the removal of the existing quotas for Latin American producers while simultaneously increasing tariffs for these producers. The law was intended to provide benefits for EU interests in Africa, Caribbean, and Pacific (ACP) regions but appeared to many as a violation of free trade. The tariff per 40lb box increased 135% which effectively added $2.20 in incremental tariff cost to each box imported from Latin America. An analyst that I spoke with estimates the tariff cost CQB $1.00 EPS in 2007.

The legal landscape appears to be shifting in favor of CQB and other Latin American producers. In December 2007 the WTO ruled in favor of Ecuador that the EU was breaking international trade rules by giving preferential treatment to bananas imported from Europe’s former colonies. In May 2008 the WTO ruled in favor of the US complaint against the EU tariffs. These rulings are a big step towards reversing the tariffs. Given that a removal of the tariffs would add roughly $1.00 to EPS and my FY 2009 estimate is at $1.17, a favorable ruling should revalue CQB significantly higher. I think it is likely that the US and Ecuador prevail in overturning the tariff based on the prior WTO rulings and a pretty open/shut case.

At the current stock price of $5.60, CQB is trading at tangible book value and offers an attractive risk-reward profile. The weakness seen in Q4 was self-induced due to exiting their contracts. End demand remains stable and finding companies with earnings growth in this economy is rare.

* Risks
o Natural disaster disrupts operations.
o EU tariffs are not overturned. At this price I don’t think there is any expectation of the removal of tariffs baked into the valuation.
o Banana prices fall back to 2006 levels. This seems unlikely as the reason for depressed bananas prices in 2006 was the removal of the EU quotas which resulted in the market being flooded. Since then these unsophisticated importers have gone out of business leading to a more rational marketplace.


Source: seekingalpha.com

Publication date: 2/25/2009