2023-09-12 05:21:36 ET
Summary
- Calavo reappointed a former CEO to restart a multi-year turnaround process, signaling a focus on improving the avocado business.
- Q3/F23 showed improved gross margins in the avocado business, but sustainability remains uncertain.
- Investors appear to have already factored in a return to historic profitability in their valuations of Calavo shares. I believe more caution is warranted.
A few months ago, I downgraded Calavo Growers, Inc. ( CVGW ) to a hold after a string of disappointing earnings reports. Simply put, I initially thought the business was an attractive turnaround story, but the turnaround had been more challenging than I expected.
Shortly after my article, the company fired its CEO and rehired a former CEO to restart the turnaround. With a full quarter under the former CEO, let's take a look at Calavo's operations to see if the company is worth another look.
New CEO Is The Old CEO
As mentioned above, shortly after a disappointing Q1/F23 earnings report , Calavo announced the departure of its CEO, Brian Kocher, and the reappointment of Lee E. Cole as President and Chief Executive Officer.
Mr. Cole was Calavo's President and Chief Executive Officer from 1999 until his retirement on January 31, 2020. He also served as a Director of Calavo for 39 years, with 28 as Chairman of the Board.
Mr. Cole was responsible for taking Calavo public and helped make Calavo one of the largest avocado companies in the world. He has extensive knowledge of the avocado business and his reappointment could be a sign that Calavo is serious about improving the flagging avocado business.
While investors cheered the reappointment of Mr. Cole, a key question remains outstanding, does Mr. Cole have a plan to turn around Calavo's fortunes?
Cuts Dividend To Conserve Capital
In addition to changing the CEO, Calavo also cut its quarterly dividend by 65% to $0.10/quarter. The cut was understandable, as profitability had declined significantly and the company needed to conserve capital until operations turned around.
Q3/F23 Was A Beat On Margins
Recently, Calavo reported its first full quarter under the new/old CEO. For Q3/F23, Calavo reported revenues of $260 million (-24.0% YoY), missing consensus estimates by $24 million. However, revenues are partly a function of avocado prices, which can be volatile. What is more important to monitor is gross margins and adj. net income (Figure 1).
Figure 1 - CVGW Q3/F23 financials (Company reports)
Gross profit for the third quarter was $25.0 million (9.6% of net sales), compared to $18.5 million (5.4% of net sales) for the same period last year. Adjusted net income was $7.2 million, or $0.41 per diluted share, a beat vs. consensus of $0.33 and $0.16 per diluted share for the prior-year quarter.
Importantly, for Q3/F23, Calavo recorded gross profit of $21.4 million in the grown segment (i.e., the avocado business), or a gross margin of 14.8%, compared to gross profit of $11.8 million or a gross margin of 5.7% in the prior year Q3 (Figure 2).
Figure 2 - CVGW segment gross profit (Company reports)
Q3's 14.8% gross margin is the highest quarterly gross margin in the avocado business in years and is reminiscent of the peak profitability of the avocado business that was last seen in 2019 (Figures 3 and 4).
Figure 3 - CVGW quarterly gross profits (Author created with company reports) Figure 4 - CVGW 2019 fresh gross margin was 14.0% (Company reports)
Management attributed the improvement in avocado margins to "enhanced focus on operational execution and customer service". Margins improved despite avocado sales prices being down 38% YoY as the industry benefited from increased volumes from Mexico and lower imports from Peru.
Model Update
Granted, this was only a quarterly result, but it is definitely a step in the right direction for Calavo. So far in 2023, Calavo's operation is running at gross profits of $54.5 million on net revenues of $730.8 million or 7.5% gross margin, compared to $53.5 million in gross profits on $947.5 million in revenues or 5.6% gross margin.
YTD SG&A grew 8.0% YoY to $52.3 million and is running at 7.2% of net revenues. However, embedded in those numbers are $5.2 million in restructuring costs and $12.8 million in depreciation and amortization compared to $4.5 million and $12.5 million respectively in 2022. Excluding restructuring costs, cash SG&A is currently running at a $46 million annual run rate.
Using these figures as inputs into my model for Calavo, I am now expecting the company to return to full-year profitability in fiscal 2023, recording full year revenues of $953 million, 8.5% gross margin, and $0.44 in diluted EPS (Figure 5).
Figure 5 - CVGW financial model (Author created)
More importantly, I am raising my 2024 gross margin and EPS estimates to 9.5% and $1.17 respectively. For 2025, I am expecting an EPS of $1.46.
For comparison, consensus estimates are calling for $0.69 in 2023 EPS, $1.65 in 2024 EPS, and $2.40 in 2025 EPS (Figure 6).
Figure 6 - Consensus EPS estimates (Seeking Alpha)
While Wall Street analysts and myself agree that Calavo's operations are on the mend, I believe consensus estimates may be too optimistic, as $1.65 in 2024 EPS implies a gross margin of ~10.6%, which was last achieved in 2019. $2.40 in 2025 EPS will require a gross margin of >12.0%, which Calavo has never achieved in the past.
The key impediment to Calavo's profitability is the Prepared food segment, which has been disappointing despite repeated restructuring efforts. Past management had guided to a 10-12% gross margin for the Prepared segment, but actual results have never approached those levels (see Figure 3 above). Until we see signs of improvement in Prepared margins, I am not ready to give Calavo the benefit of the doubt.
Operating Improvement Built Into Valuations
Looking at Calavo's valuation, the shares remain expensive on 2023 estimates, trading at 40.7x Fwd P/E compared to the sector median of 18.2x (Figure 7).
Figure 7 - CVGW valuation (Seeking Alpha)
On consensus 2024 earnings of $1.65, Calavo is trading at 17.0x, which is more in line to the sector valuation. This means investors have already built in a return to historic peak gross margins of ~10.6% in their valuation for the shares.
Risks
The key downside risk to Calavo remains execution. Although the rebound in Q3 margins is encouraging, it is unclear whether the margin improvement is sustainable or a flash in the pan.
On the upside, if avocado prices increase while margins hold steady, then gross profit dollars could come in higher than I am modeling, which would be a boon to earnings.
Conclusion
In summary, the turnaround saga at Calavo continues after the company reappointed a former CEO as its current CEO. Although avocado margins rebounded in the latest Q3 earnings report, it is unclear whether this is sustainable. I believe caution remains warranted until Calavo can string together a few good quarters. I maintain my hold recommendation on the shares.
For further details see:
Calavo Growers: Restarting Turnaround From Scratch