Should You Add “Green Gold” to Your Portfolio?

by Ryan Fitzwater, Director of Research, The Oxford Club
A fresh avocado cut in half

It’s hard to find a restaurant these days that isn’t preparing and serving avocados. It’s one of the fastest-developing food trends over the last two decades.

We transform avocados into guacamole, wrap them in sushi, fry them in egg rolls, slice them and put them on sandwiches and - my favorite - serve them over eggs.

So it should come as no surprise that the avocado industry is booming.

In fact, avocados are known locally in Mexico (the world’s largest avocado producer) as oro verde, or “green gold.” The name certainly fits as avocados yield greater sales than any other cash crop - including marijuana.

We’ll look at a way to capitalize on this trend in just a moment. But first let’s check out two factors threatening the industry.

Avocados in Jeopardy

First and foremost, producers in the U.S. are having an issue dealing with the avocado’s hefty thirst for water.

California is the world’s ninth-largest agricultural economy - and our biggest domestic avocado producer. About 80% of the California’s water use goes to agriculture.

Unfortunately, right now the state is struggling with a crippling drought. (Investment U’s Resource Strategist, Sean Brodrick, covered this subject in greater detail over on our sister site, Free Market Café. Check out his piece here.) And avocados are at a bigger risk because they require so much water.

It takes around 74 gallons of water to produce one pound of avocados. In comparison, a pound of oranges requires around 12 gallons of water to produce. If the drought persists, crop yields are in serious jeopardy. And that would put upward pressure on avocado prices.

Meanwhile, south of the border, our second problem has to do with a deadly drug cartel...

The Cartel’s New Cash Crop

Last year, the United States imported over $1 billion worth of avocados from Mexico. And all this business caught the attention of a cartel known as Caballeros Templarios, a.k.a. the Knights Templar.

Unlike the order of Christian knights from which they took their name, the members of this cartel are gangsters whose preferred methods involve extortion and murder.

Last year, news broke that the cartel had taken over a large portion of the avocado business in Mexico’s Michoacán region, where around 72% of the country’s avocado plantations are located. And 80% of the avocados grown there are exported to the United States.

Through bribes and threats, the cartel has secured detailed information on every avocado farmer in the area. They approach farmers knowing the exact amount of acreage they have and output they are producing.

According to El Informador, an independent Mexican newspaper, "The Knights Templar demand 1.50 pesos for each foot of planted avocado; 1,500 pesos per hectare for those producers who don't export avocados and up to 3,000 pesos to those who had shipped their product outside the country in the past no matter what season they produce in."

Many previously wealthy avocado plantation owners have been forced into poverty as a result. Those that try to negotiate or refuse to pay are either killed or see their family members killed... or both.

This has given rise to the name “blood avocados” (comparable to blood diamonds).

And just as we saw a drop in lime production when cartels infiltrated the trade, we’re now seeing the same threat for avocados.

But even as drought and cartels threaten supply, our demand is only increasing.

Demand on the Rise

In the 1990s, avocado demand was about 1 1/2 pounds per capita. As of 2012, demand has soared to a record 5 pounds per capita.

And while the U.S. government doesn’t officially track avocado prices, the United Kingdom does.

As you can see, as British avocado palates have grown, so have avocado prices. The average price of avocados has more than doubled since 1995.

It’s all great news for California avocado producer Calavo Growers (Nasdaq: CVGW).

A Growing Avocado Play

Back in 1924, a group of grower-hobbyists banded together to form the California Avocado Growers Exchange. At the time they had no idea their fruit would one day become a household favorite.

In two years’ time, Rudolph Hass had planted the state’s first Hass avocado tree. (Hence the Hass avocado.) That same year, the cooperative adopted the name “Calavo” and its brand identity was born.

For over seven decades, the Calavo cooperative operated as a nonprofit. But as the popularity of avocados began to surge, its members realized it was time to switch to for-profit status. The company went public in 2002.

Soon after, the company began aggressive strategic buyouts of its competition and R&D technological enhancements. In 2005, it introduced its ProRipeVIP® system, which speeds up the avocado ripening process. Instead of taking a week for avocados to ripen, the company can now get them ripe in just a few days’ time.

2005 also marked another cornerstone as Calavo made its first shipment of avocados to China. With over a billion people, China boasts the world’s fastest-growing middle class. And it has an appetite for all things Western - including avocados.

As you can see in the chart below, since going public in 2002, Calavo has outperformed a basket of staple commodities by over 741% (this includes dividends).

The Bloomberg Agriculture Subindex (formerly the Dow-Jones-UBS Agriculture Subindex) tracks futures contracts on coffee, corn, cotton, soybeans, soybean oil, sugar and wheat. As the popularity of avocados grew throughout the early 2000s, the fruit - and Calavo - quickly overtook these staple commodities.

But it isn’t all sunshine and rainbows for the company.

Right off the bat, we know Calavo is facing is the big problem of the California drought. As water becomes more scarce, water input cost will rise and weigh on margins.

The company is currently facing some legal troubles as well.

A Recent Black Eye

On January 15, Calavo announced that it will have to restate previously issued financial statements for the 2012 and 2013 fiscal years, as well as the first three quarters of the 2014 fiscal year.

This relates to misstatements made by the company during its 2011 acquisition of Renaissance Food Group. In particular, it overstated its non-cash operating expenses. As a result, shares of Calavo fell quickly from $48.30 per share to $37.50 - a 22% drop.

Now lawsuits are piling up as shareholders look to recoup their losses. And as in most legal issues involving false or misleading financial statements, shareholders have a case.

The question is, does the recent sell-off mean now is a good time to pick up shares of Calavo? To answer that, let’s see how the company performs on our Investment U Fundamental Factor Test. This will help us evaluate the company’s current financial health and give us a rating on the stock.

Earnings-per-Share (EPS) Growth: When Calavo announced fiscal year results on January 15, it revealed that EPS slumped -9.5%. Hopefully, restated results won’t bring down previous quarters’ positive results as well.

Price-to-Earnings (P/E): The company’s current P/E of 26.17 is well below the industry average of 41.29. From an earnings standpoint, it is very attractive.

Debt-to-Equity : Calavo’s debt load is very manageable. Its debt-to-equity is 24.37%, compared to its peers that are averaging 54.21%.

Free Cash Flow per Share Growth : Last quarter, free cash flow dropped over 173.57%. With lawsuits on the way, the company could struggle to bring this number up in the near term.

Profit Margins : Calavo’s profit margins are currently -0.62%, while the industry is averaging 2.24%. Management needs to focus on the bottom line a bit more to get in line with the industry.

Return on Equity : The company closes out our last metric with a positive mark. Its ROE of 16.55% more than doubles the industry average of 6.35%.

Despite positive factors such as growing demand for avocados and the possibility of a future price hike, Calavo faces a few short-term obstacles. Extreme drought and shareholder lawsuits threaten its bottom line. Couple that with a mixed bag of financial metrics on our fundamental factor test, and the stock has earned itself a “Hold” rating.

*Why did we look at these specific metrics? Find out more here.

Fundamental Factor Test Score

C: Hold (Hits just three key metrics)

Please note that our fundamental factor checklist is just the first step in performing your own due diligence. There are many other factors you should consider before investing. That’s why The Oxford Club offers over a dozen newsletters and trading advisories all aimed at helping investors grow and maintain their wealth. For more details, click here.

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