Wednesday, May 3, 2017

A current AIM holding: Calavo Growers. (CVGW) by Charles Muth. “Pass the Chips - Calavo Looking Tasty"

Calavo Growers Inc. (CVGW, $66.00): “Looking Ahead: Demand Driven Growth?”
By: Charles Muth, AIM Student at Marquette University

Disclosure: The AIM Equity Fund currently holds this position. This article was written by myself, and it expresses my own opinions. I am not receiving compensation for it and I have no business relationship with any company whose stock is mentioned in this article.

·      Calavo Growers Inc. (NASDAQ: CVGW) markets and distributes avocados and other perishable foods through their Fresh Products (49.5% FY16 Revenue), Calavo Foods (7.4%), and Renaissance Food Group (43.1%) segments. CVGW predominantly operates within the U.S. and customers include food distributors, produce wholesalers, supermarkets, convenience stores, and restaurants.

·      The Fresh Products segment prepares avocados for customer delivery, the Calavo Foods segment purchases, manufactures, and distributes a diverse selection of prepared products (guacamole), and the Renaissance Food Group (“RFG”) sources, markets, and distributes health focused, fresh packaged food products.

·      Increased domestic demand for avocados (guacamole products) at double-digit rates and CVGW’s competitive market position as a leading avocado producer contribute to expected future growth.

·      A growing, diversified, and year-round supply of avocados support market expansion and stability.

·      CVGW’s continued company reinvestment and attitude towards accretive acquisitions highlight management’s growth strategy and indicate strong future performance.

·      The RFG segment is working to build a top-notch operation on quick-turn order fulfillment and just-in-time retailer distribution. This segment had double-digit revenue growth and offset declines in the Fresh business during 1Q17.

Key points:
CVGW has taken advantage of the 4x increase in domestic avocado consumption since 2000. Throughout 2016, over 2.3 billion total pounds (5.2 billion avocados) of this “superfood” were consumed. In addition, 29% of millennials aged 21-34 are willing to pay a premium for more healthy food options and 47% of individuals aged 18-34 have adopted a healthier diet from the prior year. Accordingly, the year-round supply and increased popularity of avocados has spurred innovative recipes and put avocados in the spotlight as a delicious, healthy food trend.
The volume of avocados delivered to company packing facilities directly impacts operating performance. In addition to using Mexican sourcing facilities, CVGW’s strategy focuses on retaining and recruiting growers who comply with their business model. With an increase in expected future demand, CVGW plans to expand and diversify sourcing operations. While solidifying avocado supply by diversifying these sourcing operations, CVGW also limits inclement weather and sourcing facility risk.

Over the last few years, CVGW has placed an emphasis on company reinvestment and expansion. Recently, the Jalisco facility in Mexico was completed. This facility plans to be authorized for U.S. export in the near future and may be a strong sourcing connection. In addition, CVGW has expanded RFG production capacity by 260,000 square feet in Florida and Texas. CVGW maintains interest in future acquisitions, but puts an emphasis on larger companies (>$100M) that are instantly accretive.

Moving forward, major operating concerns include inherent farming risks, international exposure, and the presence of generic brands. First, in addition to being reliant on the market forces (supply and demand) for products, inclement weather and other environment concerns can negatively impact operational performance. Second, the firm sources raw materials from Mexico and are subject to several factors including organized crime, regulations, and taxes. Lastly, large retail stores negatively impact firm performance with significantly lower priced products.

What has the stock done lately?
Since CVGW released 1Q17 results on March 7, 2017, the stock has increased nearly 30% (from $51.20). Despite missing EPS by $0.10, the stock increase is driven by management’s double-digit revenue, margin, and EPS guidance. Looking forward, avocado demand is expected to be strong and the RFG segment will continue to drive earnings. Following this earnings release, company insiders’ increased stock holdings in CVGW throughout March and April, further driving investor confidence.

Past Year Performance:
Throughout the last six-years, Calavo Growers has posted consecutive, all-time high gains in revenues, margins, and earnings per share. CVGW’s stock increased 17.6% (from $56.11 on 04/25/16) in value over the past year. Also, FY16 revenue increased 9% YOY, gross margin increased 26%, and operating income increased 40%. 

Specifically, this gross margin growth highlights increased operational efficiencies coupled with industry expertise in sourcing, production, and management. CVGW is aware of the surrounding operating environment and stays consistent with their strategic objectives, while remaining nimble to adjust with changing market conditions.

1 Year Stock Chart vs. Benchmark from FactSet here

Source: FactSet

My Takeaway
Calavo Growers operates under a competent management structure that has taken advantage of the growing avocado market. In addition to posting all-time high earnings in 2016 and increasing the dividend payout 12.5% to $0.90, CVGW has identified strong future demand in the avocado market. Accordingly, the firm has worked to diversify and expand sourcing operations through company reinvestment and expansion. By taking preemptive action towards locating diversified sourcing locations, CVGW will be ready to meet customer demand and secure increased market share. Also, despite missing 1Q17 earnings, CVGW has maintained investor confidence by effectively disseminating information regarding the missed quarter guidance and updated year outlook. Based off this analysis, I recommend that CVGW be kept in the AIM Small Cap Fund at its current weight and be watched throughout 2017 until additional concrete information is given regarding future market demand of avocado products.

1 Month Stock Chart from FactSet here

Source: FactSet

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