Citrus Squeezes Costa’s Earnings, but We Expect Earnings Recovery as Weather Normalises

We maintain our AUD 3.10 fair value estimate for shares in no-moat Costa CGC following the release of calendar 2022 earnings. Underlying EBITDA of AUD 215 million was 2% lower than the prior corresponding period, or pcp, and our prior forecast of AUD 220 million. Despite the first full year of earnings from citrus acquisition 2PH, wet weather in Australia weighed on citrus quality. Input costs were also elevated across the board in labor, freight, energy, packaging, and fertilizer. While we anticipate a proportion of elevated costs can be passed through to higher pricing, we lower our calendar 2023 EBITDA forecast by 4% to AUD 264 million. We expect earnings to gradually improve over the next two years as weather normalizes, elevated input costs moderate, and growth projects come online.

Costa declared a final dividend of AUD 5 cents per share (40% franked), bringing full-year dividends to AUD 9 cents per share—level with the pcp despite EPS more than halving. The firm expects to maintain the franking level of about 40% for the foreseeable future, given the increasing international earnings contribution. We forecast Costa paying out dividends at around 60% of EPS as earnings recover.

Sales lifted in covered crops (glasshouse tomatoes, berries, and mushrooms), and avocado pricing improved as the year progressed. However, underlying EBITDA in the domestic produce segment was 7% lower than the pcp, mainly due to the impact of poor weather on the citrus crops and elevated input costs. While yield was strong, cold and wet weather meant lower citrus quality. Less citrus volume was destined to the more profitable export market, with export quality volumes down about 20%. Combined with elevated input costs (freight, labor, and pest and disease spraying), citrus was an earnings headwind of about AUD 40 million. But we maintain citrus quality headwinds are short term and continue to expect citrus quality to improve as weather normalizes.