A different kind of protein

People that know me know that I love a burger. If it doesn’t work out for me as an investor it has been suggested − that with my list of 74 burger joints sampled throughout Melbourne − I may have to fall back on a career as a burger blogger. 

My burger odyssey began enthusiastically about 5 years ago but recently it has tailed off as I am experimenting with flexitarianism. Last month this led me to venture with an industry colleague to an establishment selling the Beyond Burger. Unfortunately, that day they had sold out. For those not familiar, the Beyond Burger, from Beyond Meats is described as “the world’s first plant-based burger that looks, cooks and ‘satisfies’ like beef without gluten, soy or GMOs”. Earlier this month Beyond Meats listed on Wall Street and closed up 163%, making it the best IPO of the past two decades and giving it a valuation of approximately US$3,900 million. This puts the company on about 40x its 2018 sales.

The other prominent plant-based burger is from Impossible Foods who in January this year released the Impossible Burger 2.0. For what it’s worth, the reviews from the United States (it’s not available in Australia) are that it is superior to the Beyond Burger, partly because of the heme content. Recent reports suggest Impossible Foods has had to increase hours at its California plant due to demand-driven product shortages.

Whether it be my recent Beyond Burger experience, the stellar IPO performance of Beyond Meats or the increasing cohort within my social circle turning to vegetarianism or veganism, it is obvious this is a powerful trend that I am wholly supportive of, yet still far from fully adopting. My veg-curiosity leads me to always ask my friends, who have fully embraced this trend, “How do you get your protein bro?”. “Well, nuts” is the bleedingly obvious response.

So, although we can’t invest in Beyond Burger on 40x sales we can invest in Select Harvest (ASX:SHV), an Australian listed almond producer that offers similar exposure to the protein substitute thematic. Select Harvest trades on a reasonable − and what we believe is a potentially misstated − multiple of ~18x FY19 consensus earnings, (~16x FY20). I’ll explain further below.

Production

Select Harvest has a portfolio of approximately 19k acres of orchards (both leased and owned) at different stages of maturity that provide a pathway to production growth, as shown in the first graph below. In April 2019 management stated that the first 25% of production for the 2019 season had been harvested at 10% above industry yields and the remainder at least at industry yields. Given the previous projection of 16,923 tonnes at theoretical industry yields the update suggested a 2019 crop level between 2.5-10% above this level so between 17.3-18.6 kilotonnes (kt). Some of this may be seasonal, but commentary like “new technology and improved horticultural practices” suggests an element of structural increase which should translate to upside for production projections in FY20 onwards i.e. 1.3 tonnes per acre at maturity versus 1.2 assumed.

Source: SHV FY18 Results presentation

At the time of the April update the market was predominantly only pricing in the announced upside i.e. ~17.5kt in FY19 so potential existed for further upgrades if the remainder of the crop tracked the first 25% processed. This proved to be the case in early May when with 48% of the crop processed, SHV’s yield continued to show all varieties and regions producing yields at least 10% above industry benchmark volumes (18.6kt).

Price

I’ve written in the past that the almond market displays similar hallmarks to the oil market, with periods of supply-driven booms and busts based on a globally quoted almond price. In fact, about 80% of production is derived from California which has gone through almost decade-long planting cycles. The most recent of which appears to have peaked in 2015 after the drought scare caused a significant price spike. The projected 2019 Californian production growth seems startling, at 9% but global demand is currently growing to approximately 10% and 2018 production was only slightly above 2017. It is expected this growth will not supress prices. We have already seen SHV in FY19 upgrade received prices from A$8.20-8.50/kg to A$8.40-8.70/kg, and a weakening A$/strengthening US$ only acts to strengthen the translated price.

Source: Bell Potter, data from USDA

Furthermore, with a seven-year orchard maturity timeframe if the cycle is repeated, we could be entering a prolonged period of sustained price increases, beyond the harvesting period in 2022.

Sales

It appears in previous years that due to the timing of financial year and the horticultural cycle the entirety of a season’s crop often wasn’t sold by 30 June, meaning previous reporting periods included a percent of sales from the prior season and elevated inventory levels.

Source: Chester Asset Management

Hence it makes sense for SHV to switch to a September year end as per the slide below.

Source: SHV February 2019 presentation

This by no means guarantees that all production is sold in a given year but commentary throughout recent announcements and the increased China trade, displacing US exports, provides support for our assumption that sales will match approximately 100% of production in FY19. Chinese tariffs on US production (currently at 50%!) have been a boon for Australian production and hence also price. SHV is one of the few stocks in our universe actually benefiting from the trade war, although the recent share price action would have you think otherwise!

Source: SHV February 2019 presentation

In the current period for the Almond Division, 18.7kt of production at A$8.55/kg = A$160m, plus Management services gets us to revenue of A$164m.

Source: Chester Asset Management

Costs

Management further notes that given the ongoing focus on yields, cost of production per kilogram has decreased, except for water.

Source: Chester Asset Management

We note that although a literal interpretation of the table above implies a high degree of variable costs (ex lease costs and D&A), we believe there is operating leverage contributing to the cost per kilogram savings, as well as the energy savings at Carina West from the H2E project commissioned early FY19. We estimate fixed costs at 40% and have an additional table not reproduced in which we reconcile this to our cost per kilogram.

Water costs in FY19 have increased significantly however ongoing strategic management of SHV’s water portfolio has led to the exposure to current high-water costs being minimized so while the water cost will have a material negative impact on the results it is likely offset by improved yields and almond prices. In relation to water SHV own 1/3, lease 1/3 and have exposure to spot for 1/3 of their requirements.

Other Divisions

We have limited visibility on the Food Division and admit that some of the analysis above may be somewhat skewed by transfer pricing between divisions. However, in the absence of further guidance we assume that the Food Division and corporate costs in FY19 are reasonably consistent with FY18. The bear argument is that higher almond prices could impact the profitability of the segment. However, historic consistent margins of 4-6% (even during the high-priced period of FY15) and recent divisional commentary, including the agreement with PepsiCo, provide argument for higher Food Division earnings.

Chester vs Market

Source: Chester Asset Management and IRESS

Conclusion

Select Harvest. Go Nuts.