Description
This is a very long write-up, but the investment case can be summarized in one sentence. CQB is an underfollowed post-bankruptcy equity trading at less than 5X my estimate of next year's earnings.
1)Description and History:
Chiquita Brands International markets, produces and distributes fresh fruits and vegetables. The company operates in two primary lines of business: bananas and other fresh fruit. Chiquita possesses significant market share in bananas with #1 market share in Europe (20%), #2 in North America (27%) and #5 in Asia (10%). The Company’s fresh fruit business comprised 10% of 2002 sales (excluding sold assets). The Company recently sold its canning business to Seneca Foods for $209 million (or 7.0x EBITDA) and recently purchased a German distributor for the assumption of debt (Atlanta AG). Chiquita stock is trading at $16.00 / share or 7.5x my estimated 2003 earnings and 4.9x my estimated 2004 earnings. CQB currently is covered by only one analyst (From BB&T) who has earnings estimates of $1.91 in 2003 and $2.68 in 2004. Year to date, the company has generated approximately $1.70 per share in earnings (excluding one-time items).
2)Why the Company filed for bankruptcy
Banana supply increased dramatically in the early 1990’s as a result of a) an anticipation of growth from newly independent eastern European countries and b) increased production from former European colonized nations as a result of European quotas targeted at increasing these countries market share. Due to the Russian financial crisis, increased demand in eastern Europe did not materialize and due to the European quotas, South American bananas that could no longer enter the European markets, flooded North America. As a result, annual US banana prices declined by over 25% from 1997-1999. As a result of these factors coupled by significant balance sheet leverage, Chiquita filed for bankruptcy in 2001.
3)What has changed since bankruptcy filing
Chiquita received a favorable ruling on the European banana quota in 2002, which allowed the Company to significantly increase the volume of bananas it sold into Europe. The significant curtailment of the quotas forced many “marginal” producers that had entered the market in the late 90’s to exit and forced African countries that no longer had support from European Quotas, to reduce production. This has had the effect of stabilizing the banana industry. Chiquita emerged from bankruptcy in the first quarter of 2002 with a debt level that was reduced by over $600 million.
Upon emergence from bankruptcy, Cyrus Freidheim, a former Vice-Chairman of Booz-Allen, became CEO and James Riley, the former CFO of Republic Engineered Steel, became CFO. The new management team has been focused on cost cutting and debt reduction. In addition, insiders have purchased approximately 70,000 CQB shares in the last few months. Since emergence, management has been able to reduce operating costs by over $40 million and reduce net debt by over $300 million.
Emergenc TEV Current TEV Variance
# of Shares Outstanding 39.9 39.9 0.0
Share Price $14.00 15.80 ($1.80)
Total Equity Value $558.6 $630.4 ($71.8)
Total Net Debt 600.0 300.0 (300.0)
Other Owned Securities 0.0 (15.0) (15.0)
Total Enterprise Value $1,158.6 $915.4 (386.8)
2002 EBITDA 149.0 130.0 (19.0)
Implied 2002 EBITDA Multiple 7.8x 7.0x (0.8x)
Debt/ EBITDA 4.0x 2.2x (1.8x)
4)Why the company has performed well since emergence
Cost Cutting Opportunities - Chiquita has the opportunity to significantly cut costs through consolidated purchasing, decreased advertising expenditures, reducing overhead costs and the sale of the Armuelles plantation (annualized savings of $18mm). The Company has identified specific cost savings that it expects to realize in the 2003-2005 timeframe. The total of these savings (net of implementation and industry cost offsets) amount to $70 million by 2005 (or $1.75 of earnings per share). In the Company’s most recent quarterly earnings report, the company indicated that it expects to beat its gross cost reduction target of $40 million in 2003. In 2004, the savings program, net of implementation costs, will add $0.63 per share of earnings.
Market Share Gains - Chiquita has recently been awarded significant contracts in North America that will increase Chiquita market share and decrease reliance on sales into the volatile North American spot market. As a result of these market share gains, spot market sales for the third quarter will be 26% of banana sales, down from 40% in the same period last year. These share gains are important, as they will lessen the impact North American banana market conditions will have on Chiquita’s future earnings. Sample wins include added volume at Wal-Mart (will add 1% in North American market share) and Winn-Dixie.
Brand differentiation in Europe - The North American market for bananas is commodity in nature as grocery stores choose to sell a single brand of banana. If one is interested in purchasing bananas in North America, one goes to the produce aisle of the local grocery store and buys whatever they have. In contrast, European grocery stores sell a variety of banana brands, allowing for brand and quality differentiation. In Europe, Chiquita bananas sell at a 10%+ price premium over competitor brands. As a result of the perceived superior quality of Chiquita produce, an independent appraisal of the Chiquita brand completed as Chiquita emerged from bankruptcy valued it at $400 million.
Currency Hedges and European Banana Pricing - Chiquita has a policy of hedging European pricing exposure on a rolling 6-quarter basis. As a result, Chiquita has a hedge on Euro pricing through the end of 2004. As the year progresses and entering into next year, Chiquita will begin to benefit from the hedge as it increases from current levels of 1.05/dollar to 1.13 - 1.17 / dollar. Although year over year the Euro has appreciated significantly relative to the dollar, Chiquita has not benefited significantly from this improvement as European customers have demanded pricing decreases as a result of the weak dollar. Management has indicated that European pricing has flattened which I believe is a result of the stabilization of the Euro relative to the dollar. With stable pricing and increased hedge levels, Chiquita should generate significant realized price improvements over the next 18 months. I expect earnings and EBITDA growth to slow markedly in 2005 as I assume that Chiquita gives back over 50% of 2004 currency and pricing gains in 2005.
Acquisition of Atlanta AG - This purchase will add $11 million in EBITDA in 2003 and it is expected that over 2 years, the EBITDA will grow to $22 million (estimated sales are $1.1 billion). Atlanta is the #1 customer for Chiquita products in Germany but also sells a significant amount of competitor products. My projections do not assume incremental penetration of Chiquita products at Atlanta (which could add $3 - 8 mm in EBITDA). Chiquita’s recent non-recurring charges have resulted from the restructuring of this business. I believe that this business will allow for incremental volume expansion into Europe for bananas and other fresh fruit products and am excited by the prospects for growth in this business through cost cutting. Assuming 1-2% net margins, Atlanta can add as much as $0.28 - $0.55 a share in earnings (although we are much more conservative in our estimates).
5)Fresh cut fruit Initiative may provide significant growth potential
Management estimates the market for fresh cut fruit to be in excess of $1 billon and believes that the Chiquita brand will provide an inroad into this potential lucrative market. Competitors include Fresh Del Monte and Performance Food Group. The company has invested in this business and should be in the market with fresh cut product by the end of this year. I believe that there is significant potential in this market for Chiquita but have only assumed $5 million of EBITDA in 2005 (based on 10-20% EBITDA margins on sales of $25-50 million). Sell-side equity research analysts such as Leonard Teitelbaum of Merrill Lynch believe that this market will be huge as fast food chains such as McDonald will continue to broaden their healthy menu options. Teitelbaum has a buy rating on Fresh Del Monte primarily due to their introduction of a fresh cut fruit business.
6)Potential for dividend or share repurchase
On the Company’s most recent quarterly conference call, management indicated that it has $65 million of excess cash on its balance sheet as a result of operations and asset sales. I believe that management will return this additional capital to shareholders by initiating a dividend or announcing a significant share buyback program ($65 million is over 10% of the current equity value). Management indicated that it would provide an update on the use of this cash and its strategic plan during the fourth quarter.
7)I believe Chiquita will generate in excess of $3.00 per share of EPS in 2004
As a result of the aforementioned, I believe that CQB will generate in excess of $3.00 per share in earnings in 2003. As shown in the EBITDA and Net Income bridge below, the growth is based on cost cutting initiatives identified by management and pricing increases as a result of the Euro offset by various one-time items, again as identified by management. A detailed discussion of the company’s cost cutting plan can be found on chiquita’s website at www.chiquita.com
2003 2004 2005
Base EBITDA 149.9 161.6 21.01
Costa Rica Flooding 5.0 0.0 0.0
Armuelles 9.0 9.0 0.0
Price Increase
Logistics Savings
License Cost
Currency
Costa Rica - Excess Fresh Fr (16.0) 5.0 0.0
Paper (4.0) 0.0 0.0
Fuel (Ship Bunker) (4.5) 2.3 0.0
Processed Vegetable Sale (17.0) 0.0 0.0
Strategic Sourcing 10.5 5.0 2.5
Sale of Other Assets (13.0) 0.0 0.0
Atlanta Purchase 11.0 5.0 6.0
Overhead Reductions 10.5 7.5 0.0
Volume Increase 3.8 (0.3) 1.6
Operational Restructuring
Advertising 0.0
Fresh Fruit
North American Pricing 4.5
Volume Increase 0.0
Other Asset sales 0.0
Fresh Cut Fruit 0.0 0.0 5.0
Other/Currency 11.9 15.1 (8.0)
Estimated EBITDA 161.6 210.1 217.02
Depreciation and Amortizatior 38.3 38.3 38.3
Interest Expense 29.9 29.4 28.0
Taxes 8.9 13.7 15.1
NET INCOME 84.4 128.7 135.9
Earnings Per Share $2.12 $3.23 $3.41
Based on these estimates, Chiquita is trading at very attractive levels. Dole, Chiquita’s largest competitor, was recently taken private (in a leveraged buyout) by its CEO at a significant valuation premium relative to Chiquita.
2003 2004 2005
EBITDA 161.6 210.1 217.2
Implied EBITDA Multiple 5.3x 3.6x 3.0x
EPS $2.12 $3.23 $3.41
P/E 7.5x 4.9x 4.6x
Free Cash Flow 33.7 96.9 109.1
Cash Flow Yield - Equity 5.3% 15.4% 17.3%
Cash Flow Yield - Enterprise 4.3% 13.0% 17.0%
Dole EBITDA Multiple 7.5x
Dole P/E 11.8x
8) Risks
European Quotas - Revenues and profitability are largely dependent on Europe. Any material change in the tariff system in Europe may reduce Chiquita market share and profitability.
Commodity pricing - Banana prices have historically fluctuated due to supply and demand imbalances. Any material increase in supply could decrease banana pricing.
Weather - Weather affects the cost of production and supply of fresh fruit. Any material variance in weather may impact Chiquita performance
Plantation Ownership - Chiquita owns plantations that grow 50% of the fresh fruit that it sells while its rivals contract a larger percentage of production from third-party producers. Increased ownership of plantations provide less flexibility when pricing is depressed (ie. Fresh Del Monte grows only 20% of its sales).
Foreign currencies - More than half of total sales are in foreign currencies. An inability to effectively hedge foreign currencies will materially impact financial performance.
Fuel and Paper costs - Chiquita has significant fuel and paper costs which are dependent on commodity markets. Any material movement in such markets would have an effect on financial performance. It is expected that Fuel and Paper costs will increase by an aggregate of $10mm in 2003 due to increases in bunker fuel prices for ships and increased linerboard cost for boxes.
Political risk - Many of the Company’s plantations are located in South American countries with unstable governments.
Tax attributes - The Company currently operates with an approx. 10% tax rate. Earnings are taxed based on where the growing risk resides. As a result, Chiquita is able to transfer profits to foreign countries with much lower tax rates. Any change in tax rules would have a detrimental effect on earnings and cash flows.
Catalyst
1) '04 EPS of $3+. 2) Potential for share repurchase as early as Q4. 3) Greater investment community coverage/recognition.