FDP - Fresh Del Monte Produce: Still Strong Trends And Upside Potential

Summary

• Positive change in the product mix, optimization of logistics costs, and the final stage of integration of previous acquisitions continue to support the profitability of the business.
• The company continues to effectively pass on the increased inflation rates to the end consumer.
• The company's shares are trading below a fair level in accordance with my DCF model.

Introduction

Shares of Fresh Del Monte Produce ( FDP ) have risen 9% YTD. Despite macro headwinds, the company is able to keep profit margins at a stable level thanks to improvements in the product mix, logistics optimization, and the final stage of integration with Mann. In addition, business in a stable sector allows the increase in costs due to higher inflation to be passed on to the end consumer, which also supports operating margins. In my personal opinion, investing in the company's shares is an excellent defense against inflation and a bet on the realization of fundamental potential. Thus, in accordance with my assessment, the company continues to trade below fair value and the current price is attractive for opening long positions.

Survey of current trends

Fresh and value-added products: despite the fact that the fresh segment faced slight pressure on sales volumes in the quarter, the increase in the share of products with higher margins contributes to an increase in the gross margin in the segment. Thus, the revenue growth rate was -0.2%, while gross margin improved from 6.9% in Q3 2021 to 9.2% in Q3 2022 . I like the increase in margins amid pressure from macro headwinds.

Banana: revenue continued to recover. Thus, according to the results of the 3rd quarter of 2022, the revenue growth rate was 6.3%, while the gross margin increased from 1% in the 3rd quarter of 2021 to 5.8% in the 3rd quarter of 2022. According to management comments, bananas remain the most accessible and key fruit for the consumer, so the business has the opportunity to successfully pass on the level of increased inflation in the segment to the end consumer, which I take into account in my forecasts.

You can see the details in the charts below.

Gross margin: thanks to a change in the product mix, an increase in the share of the ready to eat category, and an increase in end-user prices, the company was able to increase its gross margin from 4.9% in Q3 2021 to 8.4% in Q3 2022. We have seen continued improvements in core segments such as banana & fresh and value-added products. You can see the details in the chart below.

Cost pressure: despite the continuation of macro headwinds, in accordance with the comments of management, the company expects cost pressure to stabilize. Below you can see the management quote during the earning call .

We don't foresee input costs getting worse from current levels. Having said that, fluctuations in exchange rates are expected to continue to go against us in key selling markets in Europe and Asia. We are partially hedged against movements in the euro and Japanese yen through the end of the year, helping us to mitigate a portion of the impact. I remain confident in our growth path grounded on profitable sales, disciplined expense management, digital transformation and sustainability, all while remaining true to our core mission of high quality fresh and fresh cut fruit and vegetables.

Projections

Based on my personal observations, management comments, and market data, I made my own assumptions about the future cash flows and profitability of the business in order to make a fair valuation of the company.

The main inputs of my model are:

Revenue growth: I do not think that the company will be able to significantly increase sales volumes in the next periods, therefore, in my personal opinion, inflation will continue to be the main driver of revenue, which the company is able to effectively pass on to the end consumer. Thus, I believe that the company's revenue will continue to grow in line with inflation. In my model, I assume 5% revenue growth in Q4 2022 and a modest 4% growth from 2023 to 2026.

Gross profit margin: I assume that the current level of gross margin is sustainable due to the following factors: 1) the final phase of Mann integration will continue to increase economies of scale and reduce transaction costs 2) the company is actively investing in technology solutions to optimize logistics 3) a positive change in the product mix and the growth of the share of ready to eat 4) the company is able to shift the increased costs of labor, logistics, freight, etc. to the end consumer. Thus, in my model, I use a stable gross margin of 7% until 2026.

SGA: based on historical observations and comments from management, I predict a stable level of spending on SGA (% of revenue) of about 4.5% until 2026.

Quarterly projections:

Yearly projections:

Valuation

To value a company, I use the DCF approach. In my personal opinion, building a DCF model is the most optimal way to evaluate a company in consumer staples, because:

1. The company operates in a stable sector and with stable demand.

2. We have a long period of historical observations on the basis of which it is possible to make assumptions about the impact of macro headwinds on the financial condition of the business.

3. The use of DCF allows you to take into account changes in the level of profitability in future periods.

The main inputs in my model are:

WACC: 8%

Terminal growth rate: 3%

Multiples

Based on my forecasts of revenue and net income, I calculated current and target P/E & P/S multiples for the company. You can see the results of my calculations in the chart below.

Drivers

Price actions: the ability to raise prices for key products and the ability to pass on higher inflation to the end consumer could help boost the company's revenue in future periods.

Product mix: changing the product mix and increasing the share of high-margin products (ready to eat) can support operating margins.

Margin: continued integration of Mann, implementation of new technologies to improve efficiency in logistics and distribution, efficient currency hedges, increased economies of scale, and tight control of operating costs can lead to increased profitability.

Risks

Macro: growing geopolitical tensions and tightening monetary policy could lead to a decline in market share and the company's revenue growth.

Margin: rising fuel and logistics prices, rising inflation, and fluctuations in the exchange rate may lead to a decrease in the operating profitability of the business.

Conclusion

I believe that the company is able to maintain a stable level of profitability in the next periods, which is especially important against the backdrop of growing macro and geopolitical uncertainty. The increase in the share of ready to eat in the fresh segment, the final stage of Mann's integration into its own logistics, the introduction of new technological solutions in logistics, and stable demand for the company's products, in my personal opinion, will support the company's gross margin and operating margin in the next periods. In addition, the ability to pass on higher inflation to the end consumer, in my view, will support revenue and margins too. So, according to my DCF model, the fair share price is $40 with an upside potential of 38%.

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