Description

LMNR

Limoneira has been written up on VIC pre COVID and has largely been a loser since 2019 as its valuable land and water assets (worth more than the entire EV) have largely yielded terrible returns being utilized for growing lemons.  The management team at Limoneira leaves a lot to be desired.  So why decide to jump in now?  I believe the arrival of Peter Nolan to the board alongside long term holder Global Alpha means that proper capital allocation and a strategy reboot is finally afoot and shareholders will finally see great returns from the company’s asset base.  Peter Nolan ran PE firm Leonard Green for 17 years as co-president with Jon Sokoloff and John Dankahl, growing the firm from $100M in assets to $40B when he left in 2014.  He now manages his family office comprising about ~$600M of his personal assets.  He has taken an activist role at LMNR and has joined the board.  I believe with his leadership, the company will finally realize the potential of its valuable asset base.

What is Limoneira?

Limoneira is an agribusiness with the vast majority of its assets situated in California along with smaller parcels sprinkled in Arizona, Chile, and Argentina (The Argentina orchards are non operated and immaterial to the company’s value).  This is snapshot of its assets:

Despite possessing what is an impressive asset base IMO, farming lemons on its acreage has yielded no economic return since the COVID pandemic.  Lemon prices have been depressed for years amid oversupply from US and overseas farmers.  Prices have firmed recently as the situation has finally reached the point where farmers are ripping out lemon trees including Limoneira following its unproductive Arizona acreage.  

Since Peter Nolan came aboard 6 months ago the company has moved to explore strategic alternatives for all its assets vs. haphazardly selling whatever assets they could under the company’s previous strategy to pivot to an asset lighter model.  

When I spoke to mgmt a year ago I was perplexed by their decision to invest $25M in a packing house for their Chilean operations and that of third party growers.  They made heroic assumptions of ROIC for the packing house in a country where they had zero competitive advantage vs. locals. Furthermore the Chilean assets had yielded little to no profit for them for years.  Fast forward to its most recent presentations and we see they have abandoned the proposed $25M investment and, more importantly, shifted towards farming much more profitable avocados on some of their acreage vs. lemons.  

The Avocado Market

I believe the avocado is poised for structurally higher prices going forward as a result of the US cracking down on imported avocados grown illegally in Mexico.  LMNR’s CEO comments illustrate recent developments and their importance.

“Many of you have recently seen the media attention regarding avocados coming from Mexico and how the U.S. ambassador, Ken Salazar, told producers in Michoacán, Mexico, the country's largest avocado producing state, that the United States will not import fruit grown on the illegal plantations that contribute to deforestation. To put this into perspective, approximately 1/3 of avocados grown in Mexico come from this state and represent approximately 800 illegal orchards. This is the first time these orchards have been identified by authorities. The U.S, Mexican and Michoacán agencies are now working on protocols to thwart future export efforts of the illegally farmed produce.”

Over the past 4 years Mexico has supplied 88% of US avocado consumption with one third coming from areas that are farming illegally.  I believe prices will inflect higher going forward.  Indeed Mission Produce, on their latest call, indicated it was starting to see much stronger avocado pricing and its stock rallied 10% the following day on a stronger long term outlook.

The US is expected to consume about 3bn pounds of avocados this year. US production is expected to be only 225mm pounds.  Mexican production will have to fill in for the remainder.  Demand has been growing nicely:

Globally demand per capita is much lower than the US but is growing quickly:

China’s 2023 consumption has tripled off a low base and is now 40% higher than 2019.  European consumption is growing in the low double digits according to Mission Produce.  I believe demand has ample room to grow in the US as well at low single digit rates.  The supply side is set to contract not only due to clampdown on illegal Mexican farming but also due to water scarcity issues developing in Mexico.  

Avocados are water intensive and require a lot of water that Mexico gets through its water Compact agreement with the US. The agreement states:

The agreement is set to be renegotiated this year and, given the increased effects of drought and population growth in both countries since, it's highly unlikely Mexico can negotiate a higher allocation.  Water scarcity is becoming a much bigger issue for Mexico:

https://www.bloomberg.com/opinion/articles/2024-03-06/mexico-should-be-spending-billions-on-water-not-oil?embedded-checkout=true

The above article highlights water challenges Mexico is facing.  This is significant for LMNR as it controls a huge amount of water rights in California where avocados can be grown year round as well.  LMNR expects the partial pivot to increased avocado farming to yield $15M in additional EBITDA vs. lemons in 3 years.  This is part of their plan to boost EBITDA by an incremental $30M over the next 4 years from a $10M base with lemon cartons pricing at $20.  I believe these numbers are conservative as lemon prices at $20 are still unprofitable for a large percentage of farmers.  As such, we are buying at a high multiple of very depressed lemon earnings.

Real Estate Assets

LMNR owns 3,000 acres in Santa Paula and has a program with local developers to sell lots for residential development.  It has worked with officials in Ventura County for years to allow the agricultural acreage to be rezoned for residential purposes.  It is actively seeking to increase the amount of acreage they can convert into residential.  The company’s currently approved plans for lot sales and some commercial development of land it was not using for farming is expected to bring in $131M in cash over the next 8 years with the majority coming in 2025 and beyond.  I estimate the present value of this cash flow at $70M.  I believe there is a lot of upside in the future from this “land bank”. The potential is incredible when one considers they are getting close to $1M per acre for the lots currently being developed.  Furthermore they have a 200 acre lemon plantation in the city of Ventura which has ocean views they are seeking to convert to residential.  The price per acre here, if successful, could be more than $2M per acre.  The land has water rights which could be a carrot as the city of Ventura can get most of that water in exchange for the rezoning.  This is a potential option that could yield a large payoff over time.

The company also owns vineyards in Paso Robles that it has been marketing for sale as residential vineyard estate sites.  They have marketed these assets along with a small position in Chile/Argentina and are expecting at least $50M in proceeds.  As such the total real estate value is approximately $130M today.

Arizona Water Rights 

The company owns 1,100 acres in Arizona that it has been using for what has been unprofitable lemon production.  The water rights attached to this acreage are Colorado River Level 3 water rights.  These water rights are extraordinarily valuable to residential developers in Arizona.  The company is in the process of negotiating payments for its water rights going forward. It has partnered with hedge fund Water Capital (go figure what’s in a name) to maximize the value of these rights.  The company expects to have an agreement to follow its entire acreage and give up all its water rights by 2026.  Potential pricing on these water rights has been increasing dramatically.  

This projection was made at the June ‘23 analyst day by CEO Harold Edwards.  Since then water pricing has improved based on various data points and they might be able to negotiate an annuity stream for those water rights that is as much as 25% higher per year.  I calculate the present value of an $7.5M annuity using a 6% rate at ~$85M.  I believe the water rights in Arizona will be monetized at a higher number than $7.5M a year but am using $85M as the value at this point.

California Water Rights/Operating Business 

The company’s CA water rights are perhaps worth more than twice its EV but selling them without liquidating the business is not possible so I prefer to value them as a going concern for future farming needs.  Lemon pricing has been stuck below $20 a carton over the past 5 years making the lemon operations break even at best.  This has finally led to a reduction in lemon acreage around the world with LMNR finally seeing better pricing.  They are expecting to generate $10M in EBITDA from their own farming operations this year and approximately $3M from their new asset light, packing and brokerage business where they make an average of $2.50 per carton for their services.  Avocado production is expected to add $4M in EBITDA this year.

I believe we have seen trough pricing as lemon demand has remained steady, growing very modestly while supply is finally falling.  As such we might see lemon pricing return to historical averages of about $25 a carton or perhaps higher given labor costs have been rising for the past 5 years.  At $25 a carton, LMNR can earn $25M from its lemon acreage.  In addition, its pivot to more avocado acres is expected to provide an incremental $15M in EBITDA.  In 2025 and beyond I believe the company can earn $40M a year from its operating businesses without any further monetization of additional land or water rights. 

Their recent investor presentation above lays out the incremental EBITDA they expect going forward.  At $20 a carton for their own lemons they generate about $10M in EBITDA.  As lemon pricing improves, each $1 increase per carton translates into ~$4M in additional EBITDA.  I believe over the next few years the company will see the benefits of more normalized pricing of about $25 as the $20 current price is still unprofitable for many lemon farmers and therefore unsustainable.

Sum of the Parts 

VIneyard/South American Assets - $50M

AZ Water Rights - $85M

CA Residential Development - $80M

Operating Business - 10x $35M normalized EBITDA or $350M (I believe will be much higher and above $50M in 2 years)

Total Value = $515M

Current Debt $40M

Implied Equity Value of $525M in 2 years.  Based on 17.5M shares outstanding I see ~$30 in equity value

Conclusion 

In my view the shares offer a greater than 50% return over the next two years.  Importantly the numbers in the sum of the parts are understating the optionality in their business as it relates to additional residential real estate development and monetization of water rights which over time could yield much greater value.  With a top notch capital allocator in Peter Nolan now leading the way, the company is poised to finally realize the value of its assets.  At $19 I believe the shares offer a superb preservation of capital proposition alongside very compelling returns which could turn out to be multiples of its EV if it is able to monetize more assets favorably.

Catalyst

The company is currently in the process of exploring strategic alternatives and language on the last call from CEO indicates they are receiving a lot of interest and the pricing for some of their assets is potentially generating a lot of internal excitement