Summary
- Calavo Growers is a leading distributor of avocados and other fresh fruits and vegetables in the U.S.
- The company is in the midst of a corporate turnaround, with a new CEO and a restructuring plan.
- Early results have been mixed, with modest improvements in gross margins, but the lack of cost containment is hurting results.
- I think there is still value in the shares of Calavo if it can get close to historical gross margin levels. Execution will be key in unlocking shareholder value.
One of my worst calls in 2022 was being bullish Calavo Growers, Inc. ( CVGW ) after its Q2/2022 results showed improvement in the business fundamentals, suggesting a turnaround was taking hold. Unfortunately, the company reported Q3 and Q4 results that were not well received by investors, and the stock price suffered gap downs on both quarterly reports (Figure 1).
For me, personally, I had identified $45 as a key resistance level the stock needed to overcome, so I did not get involved with CVGW while it was under $45. However, it is still important to reassess my investment thesis to see what I got wrong and determine whether the stock is still a buy.
Brief Company Overview
First, a brief company overview for those not familiar with the Calavo story. Calavo Growers is a leader in packaging and distributing avocados and other fresh fruits to grocery stores and restaurants. The grown segment, which includes the avocados, tomatoes and papayas business, account for 59% of revenues and 69% of gross profits (Figure 2) The prepared segment includes fresh-cut fruits and vegetables and was formerly called Renaissance Food Group.
2022 In Review
When I initially launched coverage on Calavo, the company saw a rebound in gross margins to 6.5% in Q2/22, from a low of 2.8% in Q3/21. This turnaround in gross margins led to a jump in profitability, with the company reporting adjusted net income of $5.8 million and adjusted EPS of $0.33 (Figure 3).
Unfortunately, Q3/2022 results turned lower, with gross margin of only 5.4% on total revenues of $342 million. Adjusted net income also declined QoQ to $2.9 million or $0.16 per share. Management blamed a sharp increase in fruit input costs for the poor earnings result but noted that avocado prices had declined significantly in August, and they expected margins to normalize in Q4/2022.
For the fourth quarter , gross margins did improve to 8.4% as management had guided. However, revenues declined 11% YoY to $244 million. Adjusted net income fell sharply QoQ to $0.6 million or $0.03 per share, primarily on income tax provisions. The decline in topline revenues was mostly due to a decline in avocado prices, which fell 20% YoY.
Figure 4 summarizes the financial results for Calavo in fiscal 2022.
Gives And Takes On 2020 Results
Taking a step back, Calavo's operating results were actually not as bad as the stock price reaction suggested. Over the course of fiscal year 2022, we can see that gross margins gradually improved, especially for the prepared foods segment, which had been the cause of much angst in fiscal 2021. Gross margins for the prepared segment improved from -3.5% in Q3/21 to 9.4% in Q4/22 while topline revenues stayed stable.
Within the grown segment, revenues are going to be volatile as it depends on actual selling prices for avocados. However, gross margins were stable, indicating that Calavo was able to target something close to the $3-4 historical per case profitability.
Operating income for fiscal 2022 came in at $6 million, a sharp turnaround from an operating loss of $10 million in fiscal 2021, although it fell far short of my estimate for $27 million.
The two biggest deltas to my estimate were the miss on gross margins (I had expected gross margins to recover to 7.5% for the year versus 6.2% actual) and operating expenses, which came in at $68 million vs. my estimate of $59 million.
In my article, I had warned that:
Additionally, surging inflation can hurt Calavo's cost containment strategy, particularly in fuel and labor costs that are a large part of Calavo's operating expenses.
Unfortunately, my warning turned out to be accurate, as my estimate was based on a modest 4% YoY increase from 2021 SG&A levels, but actual SG&A grew 15.9% YoY.
2023 Guidance Offers Some Hope
Looking forward, management's guidance for 2023 offers some hope for the investors (Figure 5). Calavo expects gross profit in the grown segment to be relatively stable as the company guides to avocado gross profit of $3-4/case, while gross margin in the prepared segment is expected to improve to a 10-12% run-rate exiting 2023.
However, the company did not mention SG&A, which in my opinion is the critical component of the turnaround story. Without any guidance on costs, it is hard for analysts to measure and assess the company's progress.
Could Fresh Guacamole Drive Growth?
On the Q4 earnings call, management also announced that Calavo had partnered with General Mills ( GIS ) to be the exclusive U.S. manufacturer of Old El Paso brand fresh guacamole and salsas. Old El Paso is the number one Mexican brand in the U.S. and about a third of all U.S. households purchase Old El Paso products on a regular basis. So this partnership with General Mills could be very significant in the coming years in driving revenues and profitability in the company's prepared foods segment.
The company expects gross margins in the guacamole division to be 25% in 2023, more than double the company's gross margins overall. So any growth in guacamole could be very beneficial to the company's overall profitability.
Updating Model And Valuation
Updating my model to reflect the 2022 operating trends and management guidance for 2023, I now expect a more gradual recovery in the company's gross margins over the next few years. I also expect SG&A to be a concern, with 2023 non-depreciation SG&A growing 12.4% YoY compared to 2022's $49 million figure (Figure 6). I also lowered my 2025 terminal gross margin estimate to 9.0%.
The net result is a DCF valuation of ~$40/share (Figure 7).
However, the two biggest variables in my forecast are the gross margin recovery story and the SG&A cost containment story. If Calavo can rein in costs to historical levels of 4% of revenues, and gross margins can return to historical levels of 10%, then there is upside in the shares to $60.
Calavo's current stock price of $32 seems to imply investors believe gross margins will peak out at 8.5% vs. 6.2% in fiscal 2022 and a 10Yr average gross margin of 9.1% (Figure 9).
Risks To Calavo
As with any turnaround story, the biggest risk is in management's execution. So far, the results have been mixed for Calavo, as the company showed a good rebound in Q2/2022, but mixed results in Q3 and Q4.
Furthermore, it seems odd that Calavo's gross margin in the grown segment has languished in the 6-8% range in the past 6 quarters versus historical margins of over 10%. While I am hopeful that 2021 and 2022 results were due to one-time disruptions like COVID and labor shortages (management highlighted that avocado prices went from $35 per case to $70 per case back to $30 per case over the course of the year), there is certainly a risk that the avocado market has become more competitive and Calavo's historical 10%+ gross margins are no longer achievable.
Conclusion
In summary, the turnaround story at Calavo is ongoing. Although Q3 and Q4 fiscal 2022 results were disappointing, they were still improvements vs. 2021. I think there is still good value in Calavo shares, provided the company can continue to demonstrate margin improvement and cost containment. However, I think the timeline to unlock value may require patience, as investors digest the coming quarterly results.
For further details see:
Calavo Growers: More Patience Required