Florida real estate has been hit particularly hard during this downturn. A large number of foreclosures have helped to keep housing prices at depressed levels. This same localized housing depression has not extended itself to vacant land and particularly orange groves and sugarcane acreage. Few public companies present the opportunity to make investments in orange groves and there is only one we are aware of, Alico, Inc. (ALCO). The company is headquartered in Fort Meyers, Florida and has orange groves in Hendry, Polk and Collier Counties.
For anyone who has bought produce (or any other food product for that matter) lately, they are aware of the rapid increase in food prices. The company tends over 10,000 acres of orange orchards. Up north, oranges are tough to find for less than $.50. Not all that many years ago you could find them ten for a dollar. Guess what has happened to the company's orange crop? It has become very profitable. The market can't easily adjust to any additional demand for oranges. It takes a few years before new orange trees can come on line and create additional supply. A bumper orange crop could reduce prices and the company is always exposed to crop freezes, hurricanes and other natural disasters. Some of this is covered by crop insurance.
It is not unreasonable to expect strong orange revenues the next few years. As a bonus, the company's groves have exceeded the productivity of the average Florida orange grove with a 13% year over year increase in production. The value of acreage with orange trees planted on it has value far in excess of vacant land. The value is somewhere around $8k-$16k per acre. This exceeds the less than $1,400 per acre value placed on the company's land by Wall Street.
Years ago we held shares with the expectation that the sale of the company's land would return a tidy profit for shareholders. That expectation faded the past few years and the company responded by increasing their agricultural activities. The company's 139,600 acres (soon to be 135,600 acres) are now valued at rock bottom prices and the view to future profits from land sales eased a bit. That doesn't mean that the land is worthless, but investors focus on making a killing in the short term aren't exactly enthralled with an investment that may take years instead of minutes to reflect the true value of the company.
However, all hope is not lost. Alico recently announced the sale of 4,010 acres out of their 139,600 acre holdings. The sale price was for $10.1 million indicating that the land was valued at $2,500 per acre. The buyer was the brother in law of the chairman of the board, who also has land holdings in Florida with orange groves. The company considered the land surplus to their agriculture operations. Our first thought was, "is this more desirable land selling at the highest value the company's land has or was this land that has particular value to him?" Did the buyer want the land for geographic convenience?
Our conclusion is that the land reflects an average value of the company's lands. Next we considered the effect of the proceeds. The land will reportedly have a gain of $9.2 million, meaning that the land was carried on the company's books at $900k, or $225 per acre. Having this fresh sale info prompted a quick reappraisal of the value we placed on the company. Here is what we worked through.
Our starting point was to gather information on orange grove sales. We were able to track down ten recent sales. The company has done an excellent job managing the groves and has some measure of geographic diversity. They maintain insurance on their productions and lock into long term delivery contracts guaranteeing price. The sales we uncovered tend to have smaller acreages than the company's groves.
Here is the list:
Orange groves in good condition sell for more than groves in poor condition or those that are near the end of their useful life. Our estimate is that the company's orange groves are worth at the high end of a $8k to $10k price range. We were able to locate one sale of sugarcane acreage. It sold for $8,000 per acre. Here is the math for the company's sugarcane acreage and orange groves:
The chart above provides the number of acres devoted to orange groves and sugarcane. We added a conservative estimate of the value per acre and calculated the total value of acreage devoted to oranges and sugarcane. This still leaves 120,000 acres that, again, in the interest of being conservative, we will value at $2,000 per acre. (Even though the company's recent land sale indicates the land is valued at $2,500 per acre.) That is another $240,000,000 and brings the total value up to $370,000,000. (Current tax liabilities with land sales are not fixed and prone to being very variable and can even be $0.)
So what make the orange groves so valuable? They need to generate some kind of revenue to support their value. We determined the yearly revenue from both oranges and sugarcane and calculated the revenue per acre to make it easier to digest.
Here is what we found:
The orange groves generate much more revenue and gross income per acre. The sugarcane generates far less revenue and even less income. This does not tell the whole story. Sugarcane can be planted and harvested months later. The company can easily plant more sugarcane and harvest it in a short time frame. Orange trees require a significant outlay of cash to prepare the land and plant the trees. The trees then take four or five years to become productive. Without having access to all of the numbers, it is hard to see which is more profitable over the long term. With the large land holdings the company has, they can easily plant more orange trees while they generate revenue from sugarcane sales to fund the investment. Which led us back to the beginning of our analysis.
This all started with the company's land sale. What will they do with the proceeds of the sale and what will the final proceeds of the sale be? The large gain of $9.2 million is exposed to taxation. This will reduce the sale proceeds down to about $7 million. The company hit it out of the park with their most recent quarterly earnings. They have successfully reduced their long term debt to $46 million from $74 million at the end of their 2009 fiscal year using their cash, investments and cash flow. Their cash flow has accelerated over the past two orange harvests with extremely strong results. The company doesn't need any land sale proceeds to pay down their debt. They are doing just fine with their strong operating cash flow.
It sure would be sad to see a couple million of the proceeds slip through their fingers for taxation. With that we called the CFO to urge the company to consider using Section 1031 of the tax code to reinvest the money in real property and defer taxation. The CFO indicated they were all over it and that a like kind exchange was already being considered. With that we launched into a lengthy conversation of orange groves and the acquisition or sale of existing groves. The company is exploring doing a like kind exchange and is familiar with the strategy used by Consolidated Tomoka which regularly uses sale proceeds of vacant land to finance income properties.
It was very reassuring that the company is at least looking into preserving the whole $10.1 million of the sale proceeds. Now is the right time for the company to complete a like kind exchange, while they have strong operating cash flows.
If you take the $370 million value of the land, subtract the $46 million in long term debt, and ignore that value of the cattle operations and other miscellaneous activities, the company is valued at $325 million. Wall Street values the company at $171 million. The $325 million value is pretty conservative; it ignores the value of the 8,500 head of cattle the company raises and additional revenue generated by rock mines and land leases.
The land sale provides a confirmation of the value we placed on the company's land. Florida real estate may still be in a slump but the sharp drop in housing prices does not apply to orange groves. Their ability to generate strong revenues supports their value. Our research into orange grove sales reassured us of our estimates of their value.
Add the strong operating cash flow with the CFO indicating that the company is exploring doing a Section 1031 like kind exchange and we have the makings of a company that is wildly undervalued. The company could easily see their share price climb sharply without too much help. Another strong quarter of earnings or another large land sale may be just the catalyst that is needed.
While we will never commit to a prediction of future prices, the above analysis does pin down pretty closely the value we place on the company. Our valuation contains no in depth spreadsheet analysis trying to predict future revenues and costs, but hard assets that have easily confirmable market values.
We like the long term prospects for solid earnings and the company is backed by the value of the 136k acres. With increasing sugarcane acreage being planted to provide a buffer against any weakening agricultural prices and a slowly recovering real estate market we see the company as a play on strong food prices with potential upside from land sales or from a surprise sale of any of their operating divisions whether from cattle, oranges groves or sugarcane.