Description

Business Description and Background:

Chiquita Brands International (CQB) is my worst performing VIC idea ever, but much has changed since I last posted it in 2009. It is once again a compelling opportunity with the potential to more than double. As a result of managerial missteps since its emergence from bankruptcy over a decade ago, CQB has generated poor shareholder returns and appears to be over-levered.  With an upgraded management team, a credible turn-around plan and a recently-announced, transformative merger (with Ireland-domiciled Fyffes), CQB should be able to generate ~$2.50 of sustainable free cash flow with significantly lower volatility than in the past

CQB has historically been a small capitalization stock with limited sell-side or buy-side interest. With the merger with Fyffes, the current combined market capitalization of the new company is approximately $1.2bn, which should allow for larger investors to make meaningful investments.

CQB has a ~$2.0bn banana business, an under-performing ~$1.0bn salad and healthy snacks business and a ~$0.1bn other produce business.  CQB is one of the largest marketers and distributers of bananas and other fresh produce in the world.

Fernando Aguirre, a 20-year Proctor & Gamble veteran, was CQB’s President & CEO from January 2004 until October 2012.  In my opinion, Fernando was a disaster for CQB and the board finally pushed him out due to persistent poor performance.  I believe some of Aguirre’s major issues included the following: (1) alienating customers by refusing to provide a private-label solution, (2) initiating a misguided attempt at creating a consumer packaged goods business around the Chiquita brand (3) allowing CQB to be passed up by competition in terms of packaged salad innovation, and (4) executing poorly in general.  In October 2012, CQB’s board brought in a turn-around specialist, Edward Lonergan, to address the various operational problems plaguing the business.  Since that time, Lonergan has been making steady progress at CQB, increasing profitability in the core banana business, laying the groundwork for a credible salad turn-around, right-sizing overhead, shuttering non-core businesses and rapidly de-levering the business to about 5x net debt/EBITDA as of the December 2013 quarter. 

Pro Forma ChiquitaFyffes:

CQB recently announced a transformative merger with Fyffes PLC (FFY ID or FFY LN), one of the world’s largest marketers of bananas, pineapples and melons.  Fyffe’s shareholders will receive 0.1567 shares of CQB for every share of Fyffes they own, creating a new entity with a pro forma enterprise value of ~$1.8bn.  The combined entity will be called ChiquitaFyffes PLC (domiciled in Ireland, trading in the US), with current CQB shareholders owning 50.7% and Fyffe’s shareholders owning 49.3%.  On a pro forma basis, ChiquitaFyffes will have the #1 market share in European bananas, the #2 market share in the US bananas, the #1 market share in US melons and the #3 market share in US and European pineapples.  The combined business will be 70% bananas, 21% salads and healthy snacks and 9% other produce, with a geographic exposure of 47% US, 46% Europe and 7% other international.

 Ed Lonergan was a major upgrade for CQB and he has laid the groundwork for a credible turnaround at CQB. However, having Fyffe’s management team take over the combined entity is yet another incremental upgrade, in my opinion.  Ed Lonergan will stick around as Chairman of ChiquitaFyffes.

CQB Standalone:

CQB management put out long-term (24-36 month) financial targets that called for the salad business to print 8% EBIT margins and the banana business to post 4% EBIT margins, which would result in $110mm of EBIT if taken at face value.  Importantly, management explicitly assumed a $1.23/euro exchange rate at the time. Assuming the euro stays at today’s levels of ~$1.38, applying a 60% FX flow-through margin, that 4.0% banana EBIT target would really be ~6.0%, which would get you to an adjusted long-term target for standalone CQB of $155mm of EBIT and $220mm of EBITDA on a standalone CQB enterprise value of ~$1.2bn (excluding value of tax attributes).

Pro Forma Earnings Potential and “New” Lower Volatility Business Mix:

The combined ChiquitaFyffes business is experiencing a number of tailwinds going into 2014 (2015 and 2016 as well).  For starters, CQB’s 2013 “adjusted” actual EBIT results of $53mm include ($18mm) of operating losses in the salad business tied to the opening of a new plant (which should disappear, then flip from negative to positive as the plant will generate a positive return through reduced cost) and ($26 mm) of currency hedge losses that won’t recur to the same magnitude (last year fully hedged at 1.23). These one-time items materially impacted CQB earnings (negatively impacted EBITDA by roughly $45mm and EPS by close to $.80 cents), setting up favorable compares for 2014.

North American banana prices tend to be negotiated on a contract basis for rolling 12-18 month terms.  Gradually, CQB has been layering in fuel and cardboard cost pass-through features into an increasing percentage of these contracts. On the Q4 call, CQB management stated that 75% of 2014’s North American banana volume had already been locked in at “slightly higher pricing”.  Northern European markets, the majority of Fyffe’s businesses, operate similar to North America with longer term contracted prices.  Southern European prices, on the other hand, are typically sold on the spot market, which tends to lead to significant volatility in quarter-to-quarter results.  Standalone Chiquita’s European exposure tends to be more oriented toward Southern Europe, while Fyffes is skewed toward Northern Europe.  Combining Fyffes’ more stable European business with CQB’s more volatile European business should help dampen the volatility in pro forma results, with more than 80% of total pro forma banana boxes shipped in reasonably stable end markets.  (Stabilizing the salad business should also serve to dampen the volatility of the pro form entity, as the salad business should be a relatively stable business, if properly managed.)

While banana pricing can be volatile on a short-term basis, it’s important to note that, broadly speaking, 2013 and also 2014 year to date pricing in the US, Northern and Southern Europe is not significantly different from 5-year annual averages.  In other words, I’m not extrapolating unsustainably high pricing into the future. In the bridges below, I assume North American pricing improves +2.5% yoy as a result of aforementioned contracts, but I assume no other pricing adjustment for CQB or Fyffes.  Furthermore, I assume zero volume growth and zero underlying cost inflation.

Management published official synergy estimates of $40mm, but on the call announcing the merger, management referred to “at least” $40mm of synergies.  Given the nature of Irish takeover rules, any synergy estimate management puts out requires rigorous review and sign-off from auditors and bankers.  In addition, given some degree of regulatory scrutiny from competition authorities, management has no incentive to put out a stretch goal in terms of synergies.  Consequently, that $40 mm official synergy target is likely a conservative, “in-the-bag” number and the true, eventual synergy is likely to be meaningfully higher.  My base case assumes management’s $40mm target, but I think the real bogey could be $50-$60mm.

ChiquitaFyffes should continue to rapidly de-lever.  On my estimates, pro forma Net Debt/EBITDA should approach 1x at the end of 2015; In 2016, I assume ChiquitaFyffes calls their 7 7/8 notes in February 2016 and pays off its converts at maturity in August 2016.  I assume the company elects to refinance ~$300 mm of gross debt mid-year at 6%, resulting in actual cash interest paid of ~$18 mm for 2016. I assume that exiting 2016, CQB will be well under 0.5x levered (pro forma CQB is already down to a 2.7x net debt / EBITDA ratio assuming $40 mm of synergies on 2013 actual EBITDA, compared to nearly 5.0x net debt/EBITDA for standalone CQB).

Given ChiquitaFyffes will be an Irish-domiciled trading company, its normalized tax rate should reside in the low-to-mid-teens %.  It’s also worth pointing out that Chiquita standalone has a $395mm Federal NOL and $620mm worth of foreign NOLs, resulting in a cash tax rate of 10% or less for many years to come.  As an aside, I estimate the net present value of these tax shields in isolation to be somewhere in the $150-$200 mm range (roughly $2 a share to the pro-forma company).

The bridges below provided a buildup to my pro forma 2015+2016 ChiquitaFyffes forecast, assuming the merger took effect Jan 1^st 2015. The bridges assume no change to current operating performance in the Fyffes businesses or the CQB banana business, but allow for improvements in the salad business and for the layering-in of synergies and updated FX estimates. In the case of standalone Fyffes (which will be reporting results in USD once consolidated with CQB), I haircut the implied FX benefit of 46mm by 50% because the benefit seems too large. It’s important to point out that the 2016 bridge uses a conservative $40mm synergy estimate and implies salad EBIT% margins of ~6% vs. management’s goal of 8%.  I do not model in any dividends or buybacks for pro forma ChiquitaFyffes.

My price target assumes CQB trades at 12x free cash flow to the equity of $2.46 (~$29.50) in 2 years’ time.  Discounting ~$29.50 back by 2 years at 10% results in a price target of ~$24.50, resulting in a ~98% return from current levels.

Assuming $40 mm of synergies, and giving credit for 2014 cash flow generation, I estimate pro forma CQB is currently trading at ~5.2x TEV/EBITDA excluding the value of the NOL and ~4.7x TEV/EBITDA including the value of the NOL. 

If I assume pro forma CQB trades at 7.5x 2016 EBITDA, assuming year-end net-debt adjustments of ~$71mm, I get to a ~$26.50 stock.  Discounting back 2 years at 10% gets me to a ~$22 stock price (ex-tax attributes). Adding ~$2/share for the value of the NOLs gets me back up to a ~$24 stock.  Even at 6.5x TEV/EBITDA using the same methodology, I get to a ~$21 stock.  On this same methodology, CQB is currently trading at less than 3.8x 2016 pro forma EBITDA. 

Fyffes management has been fond of dividends, and currently pays out about 25% of earnings in the form of dividends.  Assuming 2016 EPS looks somewhat similar to 2016 free cash flow/share, a ~25% payout ratio on 2016 estimates would imply a dividend of ~$.62/share (or a ~5.0% yield at the current CQB stock price), on an inherently more stable business with a relatively conservative capital structure. 

Key Risks:

*The Fyffe’s deal could fall apart, but even in that scenario, standalone Chiquita is still an interesting investment on the back of its salad turnaround story and FX tailwinds

*Weakening of the euro (or to a lesser extent the GBP) relative the USD

*Banana pricing volatility, particularly in European markets

Catalyst