Description

Chiquita Brands International is one of the largest marketers and distributers of bananas and other fresh produce in the world. I believe that the Company's business is about to benefit from a number of powerful tailwinds, including increased profitability from its salad business restructuring, strength of the euro relative to the US dollar, lower production costs for bananas and declining interest expenses. As described in detail below, I believe that Chiquita has potential to achieve 2009 EPS of $2.40 (vs. consensus of $2.15) and 2010 EPS of nearly $4.00 (vs. consensus of $2.23). Based today's closing price $17.02, CQB is trading at approximately 4.3x 2010 EPS and 3.8x 2010 EV/EBITDA.

Business Description:

Chiquita operates three separate business segments, including bananas ($1.95bln of 2009E sales), salads and healthy snacks ($1.0bln) and other produce ($250mm). Despite being just 60% of total sales, the banana division generated nearly all of the Company's EBIT in 2007 and 2008. This pattern will end in 2009, as the salads business has undergone a restructuring, and will produce at least 6% EBIT margins in 2009 (company guidance).

For those readers who are not familiar with the banana industry, coffee1029 does a very good job of illustrating the industry dynamics in a July 29, 2008 write-up for Fresh Del Monte.

Earnings Potential:

Bananas Segment:

Banana industry fundamentals remain very strong, and Chiquita has positioned itself to be an outsized beneficiary. CQB has disproportionately large exposure to the European market, with 62% of its banana segment sales coming from that region. The European banana market remains tight, and pricing should continue to show year-over-year inflation of low-single digits. More importantly, CQB is a massive beneficiary of the strength of the euro. Chiquita has historically bought put options to hedge out the downside, but maintains exposure to euro appreciation. Based on the Company's September investor presentation, CQB is 35% covered at $1.39 for 2010 and could purchase additional puts at even more favorable rates since the euro spot is currently at $1.47. Despite sourcing a great deal of their inventory from South America, Chiquita uses US dollars, and thus has not been hurt on cost side by a weak dollar. CQB management believes that for every $0.01 move in the euro, it equates to a $4.5mm change in EBIT. In my base-case, I assume that the euro averages $1.43 in 2010. However, the current spot is $1.47 and many economists believe the dollar will continue to weaken. If the euro were to average a rate of $1.47 in 2010, it would benefit CQB EBIT by $31.5mm, or approximately +$0.60 of EPS upside.

Another tailwind for the banana segment is that it will anniversary $25mm of incremental costs due to flooding (mostly experienced in 1H 2009, see the recent September 2009 investor presentation). With approximately three weeks left, the 2009 storm season has been more moderate than 2008, and management has a good idea of what next year's crop supply looks like. Assuming the storm season ends without major disruptions to key sourcing countries, management expects to get that $25mm back next year and return to a more normalized cost environment. This should not be interpreted as a one-time benefit. The $25mm of increased costs in 2009 were above and beyond a normal year's spend on floods. This would equate to incremental earnings per share of $0.50

The North American banana market largely operates based upon annual price contracts. Chiquita's expirations typically roll throughout the year, and therefore it has good pricing visibility through September 2010. Management was on the road marketing recently, and indicated to investors that they anticipate North American price inflation similar to that experienced in 2009 (approximately +3%).  However, for my earnings bridges shown below, I assume that North American banana EBIT is flat year-over-year in 2010 (ex-flood cost savings).

Salads and Healthy Snacks:

Since Chiquita bought Fresh Express in 2005, it has dramatically underperformed the Company's initial expectations. Some of this was out of Chiquita's control (e-coli impact), but a lot of the issues were related to an overaggressive and unsuccessful product expansion plan (Fruit in a Bottle, etc). After several years of managerial errors, I believe that Chiquita has finally taken the appropriate steps to permanently turn the salad business around. This is a segment that will generate over $1.0bln in sales this year, and was thought to be a 10% EBIT margin business at the time of acquisition.

Why will this business finally work? The restructuring has eliminated 500 low-or-unprofitable SKUs (cutting a lot of food service business out) and will focus on its remaining 250 SKUs. Additionally, they have closed 2 facilities and will relocate more production to a northeast facility. Another important step relates to contract renegotiations, as fuel surcharges were only included in 50% of Chiquita's old contracts. The salad business produced an EBIT margin of 7.3% in 1H 2009 and management has guided to a full year 2009 EBIT margin of "at least 6.0%." For my earnings bridge, I assume the bottom end of this guidance in 2009. Additionally, my 2010 base case only contemplates 50bps of EBIT margin improvement, or 6.5%. I believe this is conservative and that the Company can easily get to 7.5% or higher next year just by moderating its robust marketing spend. 

Earnings Bridges: 

The annual earnings bridge assumes that Chiquita will use free cash flow to pay down debt. This is a continuation of the current strategy, and will provide a $12mm tailwind to 2010.

Valuation:

At today's closing price of $17.02, Chiquita was trading at 7.1x my expected 2009 EPS and a ridiculous 4.3x my 2010 EPS. On an EBITDA basis it is currently trading at 3.8x my 2010 estimate. Not only are these valuations extremely cheap on an absolute basis, but they represent massive discounts to Fresh Del Monte on 2010 P/E (53%) and EV/EBITDA (42%). I am not advocating an outright short position of Fresh Del Monte, but I would argue that Chiquita deserves at least an equivalent multiple, and more appropriately, a premium. Relative to Fresh Del Monte, Chiquita's multiple has recently been penalized for its higher financial leverage as well as its failing salad business. Both of these issues have been resolved and each will continue to improve in 2010. I would expect investors to reward CQB with multiple expansion. Using a 10x multiple on my 2010 EPS, my price target is $40.

It is important to note that my analysis does not give any benefit to potential decreases in the European tariff for bananas or cost savings through additional African sourcing (which will ramp up in 2010 and 2011). Though the timing is unclear for a change in the tariff regime, most in the industry expect a gradual step down in the rate over 7-8 years. Through discussions with management, the impact could be around $11mm of annual cost savings. The company will likely pass some of these savings on, but if they are able to retain $8mm, this would add an additional $0.15 each year as the tariff steps down.

Catalyst

- Q3 earnings results and implied guidance for the remainder of FY2009

- Upward analyst revisions for 2010

- Multiple re-rating as investors begin to realize earnings potential of the salad business.