Dividend Growth Stocks Of Tomorrow: Calavo Growers, Inc.

Summary

• Calavo Growers procures, processes, and sells avocado and avocado products to the marketplace.
• The company has grown immensely over the past decade, thanks to surging demand and an increasing dependence on imports from the US.
• The stock is trading at a discount to historical multiples, but we would like to see an additional margin of safety to protect against the possibility of slowing growth.

Dividend growth investing is a popular and largely successful approach to generating wealth over long periods of time. We will be spotlighting numerous dividend up-and-comers to identify the best "dividend growth stocks of tomorrow." Our analysis today touches on Calavo Growers, Inc. (NASDAQ:CVGW), an agricultural company that processes and sells (mainly) avocados and avocado products. The company rode a surging avocado market throughout the decade, posting double-digit growth rates. The business is also in great financial shape. The stock has taken a recent slide and looks inexpensive relative to decade multiples. However, the momentum of the avocado market could be tough to sustain for the long term. We would look for a margin of safety to protect from a slowdown in avocado demand.

Calavo Growers is a company that procures, processes, packages, and distributes whole avocados, avocado products, and other produce products. The vast majority of the business is centered around avocados. Calavo Growers sells throughout the United States, and to select international markets. The company operates in three primary operating segments.

(Source: Calavo Growers, Inc.)

The Fresh segment deals in the sale of fresh avocados and tomatoes. The Foods segment processes avocado products such as guacamole and salsa and sells it to the market. The RFG segment produces and sells prepared food products. The company generates more than $1.1 billion in annual revenues.

(Source: YCharts)

Over the past 10 years, the company has seen strong growth. Revenues have grown at a CAGR of 13.24%, while EBITDA has grown at a CAGR of 12.79% over the same time period.

Fundamentals

Growth of the company has generally been driven by continued demand from consumers for avocado and avocado products. To better understand how it has processed this growth, we will look at some key operating metrics.

We review operating margins to make sure that Calavo Growers is consistently profitable. We also want to invest in companies with strong cash flow streams, so we look at the conversion rate of revenue to free cash flow. Lastly, we want to see that management is effectively deploying the company's financial resources, so we review the cash rate of return on invested capital (CROCI). We will do all of these using three benchmarks:

• Operating Margin - Consistent/expanding margins over time
• FCF Conversion - Convert at least 10% of sales into FCF
• CROCI - Generate at least 11-12% rate of return on invested capital

(Source: YCharts)

We see right away that Calavo Growers isn't a very cash flow-efficient business. The company converts revenue into FCF at a low- to mid-single digit rate. Its operating margins have also gyrated over time. This is largely due to the company's sensitivity to the avocado market. Given that Calavo Growers' business is centered around selling avocado and avocado products, it only makes sense that commodity prices will have an impact on how profitable the business is. We can see how the company's operating margins follow avocado prices closely. What we do like is that the company appears to be well-run. Calavo has consistently generated a solid return on its invested capital, and that has trended higher over time.

Another important aspect of any potential investment is that company's balance sheet. A company with a healthy balance sheet can better navigate unexpected downturns in the business, as well as have more flexibility to pursue growth opportunities (such as a strategic acquisition). An over-leveraged company can expose investors to a myriad of risks.

(Source: YCharts)

Calavo Growers maintains a very strong financial position. Its cash on hand of almost $8 million exceed the gross long-term debts of $5.4 million, making the company debt-free on a net basis.

Dividend and Buybacks

While Calavo Growers is currently working on building up its current eight-year growth streak, the company's dividend history goes back to the early 2000s. The dividend today totals an annual payout of $1.10 per share and yields 1.36% on the current stock price. This makes Calavo Growers a poor income-generating investment at current stock price levels.

(Source: YCharts)

The dividend has exhibited strong growth (not a huge surprise given strong top line growth). Over the past 10 years, it has grown at a CAGR of 8.2%, and has carried that momentum in recent years (three-year rate is 6.9%). The company's payout also remains pretty conservative at just 31.72% of cash flow. This gives management a margin of safety to both grow the dividend in future years and afford the dividend should FCF drop off. Calavo Growers is not currently buying back stock, so with zero debt on the balance sheet, we expect dividend growth to continue in the 6%-8% range until the company's top line growth slows.

Growth Opportunities and Risks

Given how concentrated Calavo Growers is in the avocado business, the company's growth opportunities and risks are similarly concentrated. Avocados are nutrient-rich and a source of healthy fats. The increasing demand for healthy and fresh foods has pushed avocado consumption higher in the US. This isn't just true for pure avocados, but avocados are now being cross-sold as additives to other foods and products.

(Source: University of California)

The global avocado market is projected to grow at around 5.0% annually through 2024, so Calavo Growers should continue to see demand for its products. It's possible that growth momentum could slow, but the overall "picture" of avocado demand seems steady.

There are some factors that specifically impact Calavo Growers within these market dynamics. That is because the company sources roughly 90% of its avocado product from Mexico. We can see in the above chart that the US market has become increasingly reliant on imported avocados. This has been a tailwind for Calavo Growers. Virtually all of the avocado crops in the USA are grown in California. The wildfires that have ravaged the state in recent years have only further hampered the country's crop production. If the US market becomes less reliant on imports or overall demand plateaus, it could cause a slow down in revenue growth for Calavo.

The company's concentration in this specific crop is also a potential risk factor, and investors need to keep this in mind. A disruption to the supply (or trade relations) chain in Mexico would be disastrous to Calavo Growers. The company is also vulnerable to fluctuations in demand for avocados. For example, some sort of damaging news (say a study shows that avocados are bad for your health) that hurts market demand would directly impact Calavo Growers.

Valuation

While the market has seen all-time highs throughout the past year, Calavo Growers has had a bit of an up and down year. The stock now trades at $79 per share, just above its 52-week lows ($75-100).

(Source: YCharts)

Analyst projections for the company's full 2020 fiscal year earnings are currently at $3.37 per share. The resulting earnings multiple of 23.48X is currently a 27% discount to the stock's 10-year median P/E ratio of 32.44X.

To gain additional context on the stock's valuation, we will look at Calavo's cash streams. The stock's current FCF yield of 3.94% is near the highest it has been since the market was coming out of the recession.

(Source: YCharts)

The stock's premium valuation has been fueled by strong growth on the back of a surge in avocado demand. The current trajectory of avocado demand seems likely to lose a bit of its steam in coming years, so we would like to have a margin of safety built into our approach. The stock's end-of-year slide has placed shares into a valuation range that still isn't a bargain, in our view, but is manageable for bullish investors. Given the company's lower-margin operating model, we would ideally like to see shares in the 20X earning range, resulting in a stock price of approximately $67 per share.

Wrapping Up

Calavo Growers has been doing well in a surging avocado market that has pushed the company's revenues up significantly in recent years. However, the stock is ultimately an agricultural play, and it's difficult to justify such high valuation multiples for a business that is as cash flow-inefficient as Calavo. The company's appeal depends on an investor's given outlook on the avocado market, but we would like to see a margin of safety to account for a potential slowdown in demand.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.