Mission Produce Stock: Going Long Avocados Turns Sour As Prices Fall (NASDAQ:AVO)

It’s easy to be bullish on avocados, as they continue to see strong secular demand growth in the U.S. and globally. The rise of Mexican cuisine, which heavily features the fruit, and its growing cultural influence in culinary circles around the world has been a core driver of this. In the UK, where Mission Produce, Inc. (NASDAQ:AVO) is opening a new distribution center, there are now 700 Mexican restaurants from only a handful at the turn of the millennium. Mexican dishes that lean on avocados in their recipes like burritos and tacos are becoming more frequent meal options in American and European homes. This trend will likely see consumption rates for the fruit continue to rise over the next few years. This comes as the avocado toast food trend has become a near cultural phenomenon with the simple dish now a staple breakfast menu option in cafes across the US, Europe, and increasingly Asia.

Mission Produce is a vertically integrated avocado company that sources, produces, and distributes Hass avocados to retail, wholesale and foodservice customers in over 25 countries. Hass avocados have higher oil percentages and a creamier texture and are the preferred variety globally. The company recently added fresh mangoes to its global distribution mix and owns four avocado packing facilities in Mexico, California, and Peru. It also sources avocados from Chile, South Africa, and Brazil to ensure a year-round supply of the fruit for its customers.

Mission Produce reported its fiscal 2022 fourth quarter earnings ending October 31, 2022, last week and saw the price of its commons react by falling 15%. What went wrong?

Avocado Is A Commodity And Prices Are Volatile

Oxnard, California-based Mission Produce, which only went public in October 2020, reported revenue of $238 million for fiscal Q4 2022, up a marginal 0.4% from the year-ago comp and a big miss of $9.64 million on consensus estimates. The demand growth is clear, with volumes up by a 9% compound annual growth rate, from 2011 to 2022, rising from 227 million lbs to 584.3 million lbs.

For the full-year 2022, the company generated total revenue of $1.05 billion, up by 17% from $891.7 million for its fiscal 2021 and the first time since its founding in 1983 that revenue north of $1 billion was generated.

Management stated this overall year-over-year growth was due to a robust pricing environment for avocados, with their average selling price up by 28%, supported by lower volume growth from key grower Mexico. This trend reversed sharply for the fourth quarter, with the underlying demand and supply dynamics of the commodity shifting to see greater global supply.

This would see prices for avocadoes fall by 35% sequentially compared to its third quarter. To be clear, this is expected seasonal volatility but the decrease was greater than expected and meant that the company’s average selling price for the fourth quarter was down by 10% year-over-year. The 15% pullback of the common shares mirrored its avocado peer Calavo Growers, Inc. (CVGW) which fell by double digits following the publication of its fiscal 2022 fourth quarter earnings last week.

Mission Produce sourced 19% of avocados sold in fiscal 2022 from its own farms. This somewhat helped to mitigate earnings volatility and meant gross margin for its fourth quarter, whilst down nearly 300 basis points at 11.3% from 14.2% in the year-ago comp, was in excess of gross margin of 8.4% sported by competitor Calavo Growers.

Mission Produce was able to grow fourth quarter volume by 6%, underlying the strong demand dynamics for the fruit, but profitability during the quarter was fundamentally undermined by persistent cost inflation and greater global supply increases that were exceptional to the normal pricing backdrop.

Secular Growth Remains But Commodity Pricing Dynamics Will Form Periodic Headwinds

Mission Produce generated gross profit of $26.9 million during the period, down 20% from the year-ago quarter to drive net income for the fourth quarter that was negative at $42 million. This reflected a non-cash impairment charge of $49.5 million, hence, removing this charge from net income would have seen the company generate an adjusted net income of $9.2 million or $0.13 per share. This was down from $17 million and $0.24 per share in the year-ago comp.

After the 15% retracement, the company currently trades at a market cap of $875 million placing its price to forward sales at 0.85x, 24% lower than its peer group median of 1.12x. This comes as cash and equivalents closed out the fiscal year at $52.8 million, down from $84.5 million in the year-ago period and against cash provided by operating activities for the full year of $35.2 million.

The longer-term bull case is clear. Mission Produce should continue to optimize its supply mix and vertical integration capacity whilst expanding capex to boost distribution facilities to fully benefit from rising global demand for avocados. The model is currently profitable, but faces periodic headwinds from periodic unfavorable supply dynamics. Whilst the company is expecting higher global avocado supplies in the first quarter of its fiscal 2023 to drive a roughly 20% to 25% year-over-year decrease in prices per pound, the underlying demand growth story makes this an interesting longer-term consideration.

Volume growth for avocados has been growing by 9% annually since 2011, and Mission Produce expects this trend to continue. Hence, supply volatility will continue to be the inherent driver of value. I’m attracted to the underlying prospect of avocado volume growth, but the volatile nature of commodity prices makes me neutral on Mission Produce, Inc. stock.