Saturday, December 23, 2006

Going Bananas- Chiquita Brands

CQB is a global diversified brand with over $4 billion in sales in over 70 countries. Some 44% of sales are bananas, 31% are “Fresh Select” fresh fruit and vegetables other than bananas, and 24% are “Fresh Cut,” packaged salads. The Fresh Express acquisition, completed in June of 2005, diversifies the company’s business and accelerates revenue growth in higher margin value−added products. Importantly, it balances the mix of sales between Europe and North America, which should reduce the company’s susceptibility to risks unique to Europe, such as the recent changes to the European Union (“EU”) banana import regime. The company operates a joint venture through which Chiquita operates in the Far East market selling approximately 10% of bananas imported into Japan.

About 85% of its North American sales are through long term contracts of at least one year. Such contracts stabilize demand and pricing over the year and reduce the company’s exposure to volatile spot market prices and supply and demand imbalances. About 30% of the bananas sourced by CQB are produced by its own subsidiaries and the remainder is grown by independent growers, many of whom are contracted for multi-year periods. The company purchases over 150 types of fruit and produce from independent growers. CQB also owns or charters about 70% of its shipping capacity.

Interestingly, the company is a champion of environmental performance with CQB’s entire Latin American banana farm operations certified under the Rainforest Alliance, an annual certification which CQB has achieved since 2000. About 83% of its independent growers comply.

The European Union (EU) has imposed a new restrictive importation regime for bananas which commenced in January of this year. It eliminates the quota that previously applied to the import of Latin American bananas. In addition, it gives a tariff preference to certain African, Caribbean and Pacific (“ACP”) sources, which in many cases are former EU colonies, while it imposes a higher tariff on bananas imported from Latin America and other non−ACP sources. Increased tariffs could cost up to $110 million per annum. To some degree, this is offset by a $40 million elimination of licensing quota costs. Nevertheless, there are sovereign complainants that this regime is a WTO (World Trade Organization, successor to GATT) violation. Importantly, the Chiquita brand allows it to sell at premium pricing, and the company has enjoyed leading market share across the EU.

Chiquita is a significant brand. US consumer surveys have shown that Chiquita is one of the top brands in the food industry. In Europe, where the company devotes the majority of its Chiquita brand advertising, the brand is even stronger.

Pricing of bananas has improved with a 5% price increase in the EU, and 4% in the US. However, there have been significant supply issues which have reduced the volume of bananas available. Consequently, the price improvements look unsustainable as the supply situation resolves itself with the new crop. Profitability is also impacted by the higher costs of bunker fuel.

Chiquita is transforming itself from a pure commodity seller of bananas to a value-added food company wtih products that carry higher gross profits, have some patent protection, and carry strong brand loyalty. It seems strange to talk about product innovation in a produce company, yet this company has brought Chiquita minis, small bananas designed for kids, Chiquita to go, which are singly packaged banans distributed through convenience stores, amd Chiquita Apple slices, single serving non-browning apple slices.

Consumer trends away from unhealthy sugar-packed snacks to healthier products seems well entrenched. No less an authority than the FDA suggest 13 servings of fruit or veggies daily. Bananas rank fourth in human consumption globally, behind suchstaples of rice, wheat, and corn. The average American eats 28 lbs of bananas per year, making it the number one fruit in America...yes, ahead of apples!

Fresh Express, which is the number 1 salad maker in the world was never implicated in the recent tainted spinach E. coli outbreak. Fresh Express has 48% of the packaged salad market.

Chiquita's recent results have been plagued by a series of non-recurring charges which include the spinach recall, the imnpact of the EU, and the ongoing impact of the 2005 hurricane season which forced incremental costs into 2006. Complete with a writedown of goodwill, 2006 will be viewed as an "annus horribilis." The worst should be over as December 2006 draws to a close.

The company has significant financial leverage...long term debt is about 35% of assets. Operating margins were negative 7 in the most recent quarter versus last year's plus 5%. Returns on capital last year were around 7.5% versus red ink this year.

The stock is down about 21% YTD but has shown some slight recovery in the last month or so.Insiders own about 1.5% of the stock and have another 3% with options.

On a TTM basis, the company has generated about $67 million in free cash flow, well down from last year's $180 million, but nevertheless respectable in this punk year.

The company has underperformed virtually everything in the food processing industry over the last year. Contrast CQB with Hain Celestial (HAIN) for example. Hain is up about 50% for the year and sells on an EV/Sales of 1.64 times. CQB sells at merely 0.35 times revenues. Hain earns close to a 9% operating margin, my guess, long term, CQB will be closer to 7% on a normalized basis.

The market has generally been kind to the food processing industry this year, as sector rotation into non-cyclicals has predominated "thinking" about next year's prospects. In my view, many of these names are priced for perfection and I believe could disappoint. Not so with CQB in my view.

Despite the levered balance sheet, in my view the stock appears attractive at current levels.

Disclaimer: Neither I, my family, nor clients have a current position in Chiquita Brands.


At 2:23 PM, Blogger Leadsteer said...

On the plus side, the stock is trading below book per share (on 12/27) with $2.41 of cash per share.
On the minus side, the forward PE of 22 is a high price and this is hardy a value stock. Moreover, the ROA of 1% sucks and the earnings are inconsistent.
I pass.

At 5:17 PM, Blogger Rick said...

As they say, that's what makes a market. Estimates for 2006 range from a loss of 42 cents to a loss of $1.88. Estimates for 2007 range from $0.40 to $0.90. There are two estimates for 2008,$1.40 and $1.62. One thing for certain, all of these point estimates are wrong! Not sure where you are getting your ROA estimate. On a TTM basis, the ROA is worse! 0.8%. Next year's high estimate suggests a ROA of 1.4%. Putting it in context, the average ROA of its last three full years was 3.4% This will drop after the annus horribilis of 2006!

No question that the earnings are super-cyclical and the history is troubled. However, diversification beyond bananas should tend to smooth earnings to some degree.

Thanks for posting!


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