Background
FDP is arguably the worldwide leader in fresh produce. The company’s vertically integrated operations include company owned farms (primarily in Central and South America, Africa, and the Philippines), port facilities, a fleet of refrigerated vessels and trucks, and distribution centers.
FDP’s two primary products, accounting for a combined 61% of 2011 sales, are bananas and gold pineapples. Management claims to be the #1 marketer of fresh pineapples worldwide and the #3 marketer of bananas worldwide. Other products in the company’s basket include melons, tomatoes, grapes, apples, pears, peaches, plums, nectarines, cherries, citrus, avocados, blueberries, and kiwi, along with prepared food products such as juices, beverages, and snacks.
Bananas – the slippery peel
The problem with bananas is that they are low margin. There is little barrier to entry to growing bananas as they have a short growing cycle, limited capital investment is needed, and they can be grown year round in tropical locations. Competition can easily enter the market when supply is tight, and exit when there is a glut. Other fruits require more capital investment and time to grow – creating a competitive advantage for large, committed producers. Pineapples, for instance, have an 18 month growing cycle, require re-cultivation after one to two harvests, and require higher levels of capital investment as well as greater agricultural expertise.
Now the lower margins on bananas are not an outright negative for FDP – everybody has known about this anomaly for a long time. And there are benefits to growing bananas. The product diversification and high volume of bananas (Wal-Mart sells more bananas annually than any other single item) creates a great revenue stream for the company. The problem comes when bananas become a larger portion of sales.
As the chart above shows, banana sales have climbed from 35.6% of sales in 2007 to 46.1% in 2011. Although there has been some reshuffle in the company’s other divisions (i.e. an Argentine grain operation was sold), bananas gain has been a loss to Other Fresh Produce and Prepared Foods. Other Fresh Produce dropped from 48% of sales in 2007 to 44.1% last year. Prepared Foods dropped from 12.8% in 2007 to 9.9% last year. This is a big deal when we look at the average gross margins on all three divisions from 2007-2011: Bananas 5.6%; Other Fresh Produce 11.7%; Prepared Foods 13.9%.
Book Value, Margins, and ROE
The drop in margins has created a direct assault on one of the biggest value propositions of FDP: it trades at 0.75x book value. The assets on the balance sheet (at historic cost less depreciation) are worth more than the stock. However, as the company’s melon business (part of “Other Fresh Produce”) drops from 7.5% of sales in 2007 to 3.4% last year, management has to start “rationalizing” its melon assets. I love that word “rationalizing.” Basically a nice way of saying these assets aren’t worth what we bought them for, so we’re going to write them off – poof! In that case, your book value is going to drop.
If we view FDP as an asset play – basically valuing it as a liquidation – this would be very concerning. Book value might not be representative of what the assets are really worth, and our whole investment thesis would be out the window. However, FDP is a going concern – people are going to continue to eat fresh fruit (hopefully they start eating more!). So, more important than the asset values on the balance sheet is the earnings power of the company.
The shift toward bananas has resulted in lower margins overall. The gross profit margin has dropped from 10.8% in 2007 (admittedly a peak year for margins) to 8.9% today. This has weighed on shares in recent quarters/years. But, the news isn’t all bad.
Over the past 10 years, the gross margin on bananas has averaged 5.1%. Other fresh produce has averaged 11.9% (I’m knocking out the “outlier” margins in 2002 and 2003 of 24.5% and 17.8%). Prepared foods have averaged 14.5%. If we assume last year’s sales levels can be maintained (46% Bananas, 44% Other Fresh Produce, and 10% Prepared Food), we get a weighted average normalized gross margin of 9.0% (basically right in line with last year’s 8.9%). SG&A along with interest and taxes have historically dropped gross margins by 5.5% to get to a normalized net margin of 3.5% (management initiated a wide reaching restructuring program in the 4Q11 to try and further improve net margins).
If management can maintain asset turnover at its 10y average of 1.55x, and leverage stays at today’s 1.5x (arguably low, see below), we get a normalized ROE of 8.1%. Jump leverage up to its historic average of 1.8x, and we get a normalized ROE of 9.8%. (ROE = Return on Equity = Asset Turnover [sales/assets] x Net Margin [net income/sales] x Leverage [assets/equity])
At 0.75x book value, for every $1 we invest, we earn $0.108 in normalized income [$0.081 / 0.75]. That’s a 10.8% return on our investment. At these types of valuations, as long as management can maintain sales, turnover, and margins, we are buying a 10%+ return investment. If they can actually grow revenues and/or improve fundamental metrics, we stand to see significant gain. Of course, the opposite is also true, but that’s where the balance sheet comes in.
The Balance Sheet
FDP has the strongest balance sheet in the industry. Debt to Capital is a very manageable 11%. Compare that to Dole (67%) and Chiquita (42%). Management also maintains a very healthy 2.4x current ratio and a 1.1x quick ratio as of most recent year end. In other words, no one on the industry is better positioned to handle stress, opportunity, or turmoil than FDP.
FDP: Banana Republic?
Finally, I would be remiss if I didn’t talk about management. Management is both a concern and a potential asset for FDP. There is some concern that CEO Mohammad Abu-Ghazaleh, whose family controls 34% of outstanding shares, and his Chief Operating Officer Hani El-Naffy, run FDP as their own Banana Republic. If you go out and Google FDP, you’ll likely find reference to a 1996 lawsuit over the purchase of the company by the Abu-Ghazaleh family from the Mexican government and whether a bribe was paid to hasten the process / lower the price – the lawsuit was ultimately dismissed.
On one hand, management is invested right beside us as shareholders. On the other hand, they are less than forthcoming on the details. This year’s annual letter was a whole ½ page – not exactly “long” on the details. On one hand I like that management thumbs its nose at Wall Street and focuses on running the business (you can almost hear management’s disdain for the analyst questions on the quarterly conference call). On the other hand, some outline of long-term strategy (I have no interest in quarter to quarter EPS targets) and where management sees the business going would be helpful.
Although management is less than forthcoming on details, they are major shareholders, have been committed to this for decades, espouse a focus on long-term value creation, continue to seek out new markets (leveraging management’s history in the Middle East) and new products (there was a reference on the 4Q call to a new pineapple variety in the next 2-3 years), and have recently reinstituted a dividend, which is now yielding 1.8%.
Conclusion
Although I personally don’t care for the taste of bananas, I continue to like Fresh Del Monte Produce. At current price to book and normalized return on equity levels, FDP is attractive. At this valuation, FDP stands to provide a healthy return even without growth and/or ROE expansion. If industry dynamics should improve, I feel we are getting a free call option on the improvement. With the backing of a solid balance sheet, it continues to be a part of my portfolio – an investment that I’ve increased on recent weakness. A warning for those looking for a quick buck however –most everything I just said could have applied as far back as 2008. Fairly warned be thee, says I.
Full Disclosure: Long Fresh Del Monte Produce (FDP)
Harvest Investor © 2012. All rights reserved. The content and ideas contained in this blog represents only the opinions of the author. The content in no way constitutes investment advices, and should never be relied on in making an investment decision, ever. No content shall be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The author may hold positions in the securities and companies mentioned on this site. Any position disclosed on this site may be modified or reversed without notice to you. The content herein is intended solely for the entertainment of the reader, and the author.
Bananas – the slippery peel
The problem with bananas is that they are low margin. There is little barrier to entry to growing bananas as they have a short growing cycle, limited capital investment is needed, and they can be grown year round in tropical locations. Competition can easily enter the market when supply is tight, and exit when there is a glut. Other fruits require more capital investment and time to grow – creating a competitive advantage for large, committed producers. Pineapples, for instance, have an 18 month growing cycle, require re-cultivation after one to two harvests, and require higher levels of capital investment as well as greater agricultural expertise.
Now the lower margins on bananas are not an outright negative for FDP – everybody has known about this anomaly for a long time. And there are benefits to growing bananas. The product diversification and high volume of bananas (Wal-Mart sells more bananas annually than any other single item) creates a great revenue stream for the company. The problem comes when bananas become a larger portion of sales.
As the chart above shows, banana sales have climbed from 35.6% of sales in 2007 to 46.1% in 2011. Although there has been some reshuffle in the company’s other divisions (i.e. an Argentine grain operation was sold), bananas gain has been a loss to Other Fresh Produce and Prepared Foods. Other Fresh Produce dropped from 48% of sales in 2007 to 44.1% last year. Prepared Foods dropped from 12.8% in 2007 to 9.9% last year. This is a big deal when we look at the average gross margins on all three divisions from 2007-2011: Bananas 5.6%; Other Fresh Produce 11.7%; Prepared Foods 13.9%.
Book Value, Margins, and ROE
The drop in margins has created a direct assault on one of the biggest value propositions of FDP: it trades at 0.75x book value. The assets on the balance sheet (at historic cost less depreciation) are worth more than the stock. However, as the company’s melon business (part of “Other Fresh Produce”) drops from 7.5% of sales in 2007 to 3.4% last year, management has to start “rationalizing” its melon assets. I love that word “rationalizing.” Basically a nice way of saying these assets aren’t worth what we bought them for, so we’re going to write them off – poof! In that case, your book value is going to drop.
If we view FDP as an asset play – basically valuing it as a liquidation – this would be very concerning. Book value might not be representative of what the assets are really worth, and our whole investment thesis would be out the window. However, FDP is a going concern – people are going to continue to eat fresh fruit (hopefully they start eating more!). So, more important than the asset values on the balance sheet is the earnings power of the company.
The shift toward bananas has resulted in lower margins overall. The gross profit margin has dropped from 10.8% in 2007 (admittedly a peak year for margins) to 8.9% today. This has weighed on shares in recent quarters/years. But, the news isn’t all bad.
Over the past 10 years, the gross margin on bananas has averaged 5.1%. Other fresh produce has averaged 11.9% (I’m knocking out the “outlier” margins in 2002 and 2003 of 24.5% and 17.8%). Prepared foods have averaged 14.5%. If we assume last year’s sales levels can be maintained (46% Bananas, 44% Other Fresh Produce, and 10% Prepared Food), we get a weighted average normalized gross margin of 9.0% (basically right in line with last year’s 8.9%). SG&A along with interest and taxes have historically dropped gross margins by 5.5% to get to a normalized net margin of 3.5% (management initiated a wide reaching restructuring program in the 4Q11 to try and further improve net margins).
If management can maintain asset turnover at its 10y average of 1.55x, and leverage stays at today’s 1.5x (arguably low, see below), we get a normalized ROE of 8.1%. Jump leverage up to its historic average of 1.8x, and we get a normalized ROE of 9.8%. (ROE = Return on Equity = Asset Turnover [sales/assets] x Net Margin [net income/sales] x Leverage [assets/equity])
At 0.75x book value, for every $1 we invest, we earn $0.108 in normalized income [$0.081 / 0.75]. That’s a 10.8% return on our investment. At these types of valuations, as long as management can maintain sales, turnover, and margins, we are buying a 10%+ return investment. If they can actually grow revenues and/or improve fundamental metrics, we stand to see significant gain. Of course, the opposite is also true, but that’s where the balance sheet comes in.
The Balance Sheet
FDP has the strongest balance sheet in the industry. Debt to Capital is a very manageable 11%. Compare that to Dole (67%) and Chiquita (42%). Management also maintains a very healthy 2.4x current ratio and a 1.1x quick ratio as of most recent year end. In other words, no one on the industry is better positioned to handle stress, opportunity, or turmoil than FDP.
FDP: Banana Republic?
Finally, I would be remiss if I didn’t talk about management. Management is both a concern and a potential asset for FDP. There is some concern that CEO Mohammad Abu-Ghazaleh, whose family controls 34% of outstanding shares, and his Chief Operating Officer Hani El-Naffy, run FDP as their own Banana Republic. If you go out and Google FDP, you’ll likely find reference to a 1996 lawsuit over the purchase of the company by the Abu-Ghazaleh family from the Mexican government and whether a bribe was paid to hasten the process / lower the price – the lawsuit was ultimately dismissed.
On one hand, management is invested right beside us as shareholders. On the other hand, they are less than forthcoming on the details. This year’s annual letter was a whole ½ page – not exactly “long” on the details. On one hand I like that management thumbs its nose at Wall Street and focuses on running the business (you can almost hear management’s disdain for the analyst questions on the quarterly conference call). On the other hand, some outline of long-term strategy (I have no interest in quarter to quarter EPS targets) and where management sees the business going would be helpful.
Although management is less than forthcoming on details, they are major shareholders, have been committed to this for decades, espouse a focus on long-term value creation, continue to seek out new markets (leveraging management’s history in the Middle East) and new products (there was a reference on the 4Q call to a new pineapple variety in the next 2-3 years), and have recently reinstituted a dividend, which is now yielding 1.8%.
Conclusion
Although I personally don’t care for the taste of bananas, I continue to like Fresh Del Monte Produce. At current price to book and normalized return on equity levels, FDP is attractive. At this valuation, FDP stands to provide a healthy return even without growth and/or ROE expansion. If industry dynamics should improve, I feel we are getting a free call option on the improvement. With the backing of a solid balance sheet, it continues to be a part of my portfolio – an investment that I’ve increased on recent weakness. A warning for those looking for a quick buck however –most everything I just said could have applied as far back as 2008. Fairly warned be thee, says I.
Full Disclosure: Long Fresh Del Monte Produce (FDP)
Harvest Investor © 2012. All rights reserved. The content and ideas contained in this blog represents only the opinions of the author. The content in no way constitutes investment advices, and should never be relied on in making an investment decision, ever. No content shall be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The author may hold positions in the securities and companies mentioned on this site. Any position disclosed on this site may be modified or reversed without notice to you. The content herein is intended solely for the entertainment of the reader, and the author.
2 comments:
Another great post.
Thank you for sharing your ideas with us.
I bought Dole about 1 1/2 years ago but bailed when it fell last year. I bought it on flimsy advice and didn't do any homework.
This looks better.
Do you have any other investing blogs that you follow that you think are of the same quality that you provide?
Thank you for the kind words. I follow a whole slew of other blogs, but when I really think about it, a couple of the best are:
Geoff Gannon: he now writes for gurufocus.com, so a lot of his ideas are behind the paywall. I am not a subscriber, so I have no comment on the value of "premium" membership, but his free articles contain a lot of good information and really make you think through investment ideas. http://www.gurufocus.com/news.php?author=Geoff%20Gannon
Value Investors Club: not really a blog, but if you're looking for new investment leads, sign up for guest access and you can see ideas on a 45 day delay. You can also access the historical archive of ideas to cross reference and get background on stocks you may be interested in. http://www.valueinvestorsclub.com/value2/
Post a Comment