Until the beginning of this week, the market seemed to be getting more and more bearish every day. After watching the major market indices all decline by more than 10% in October, they staged a short-lived rally at the beginning of November, only to turn back again with a resounding series of consecutive down days last week that pushed the market once again into correction territory. This week has seemed like something of a respite as the market has has rallied off of lows only a little above the 52-week bottom it reached in April. That could be a good thing, but it isn’t a given, which means that it is still smart to be cautious and conservative.
Maintaining a careful, deliberate and conservative approach to the market also means that paying attention to defensive-oriented industries can be a good way to keep you money working for you even as you try to minimize risk. Utilities and food stocks are two examples of basic needs industries that often work well when you think market risk could be increasing. These are businesses whose models are less sensitive to economic cyclicality, because consumers will still need to purchase those products and services even when the economy is forcing them to think more carefully about where they spend their money. That means these are industries who are less likely to be forced to discount their products to keep generating useful revenue.
Food stocks are an area that I like to focus on, for the simple reason that no matter what the economy is doing, consumers aren’t going to stop providing for their families. Employment difficulties, or a decrease in income may force a family to tighten their belts, but they will still make allowances for food in their monthly budgets. The problem, of course, is that not all stocks are created equal, even when they’re in the same industry. That means that even if an industry is getting positive attention and building bullish momentum in the market, there will still be stocks in that industry that underperform and represent risks to your investment dollars that other stocks in the industry don’t. The challenge for a value investor is that the market is pretty good at pricing a company’s fundamental strength or weakness into its stock, and so a company with poor fundamentals will often be found trading in the lower extremes of its historical ranges. That lower price could make the stock look appealing at first glance for a value investor; but it is also the classic definition of a value trap – a stock that looks like a great bargain but really isn’t.
Fresh Del Monte Produce (FDP) is an example of a recognizable name in the food industry that is trading at a significant discount compared to its historical levels. As of this writing, the stock is rebounding off of a 52-week low point at around $33 per share, and is more than 36% below the high it reached in May of this year. If you focus strictly on valuation measurements along with its technical pattern, the stock looks like a compelling value, with long-term upside that any bargain hunter would be thrilled to uncover. Once you start digging into the fundamentals, however, I think the reason the stock is trading so far below its highs becomes clear; I also think that it becomes clear this is a stock that is hard to justify as anything but a very speculative investment. You would probably do better putting a couple of bucks into a slot machine that you will with this stock.
Fundamental and Value Profile
Fresh Del Monte Produce Inc. is a holding company. The Company, through its subsidiaries, is engaged in sourcing, transportation and marketing of fresh and fresh-cut produce together with prepared food products in Europe, Africa and the Middle East. Its operations are aggregated into business segments on the basis of its products: bananas, other fresh produce and prepared food. It sources its fresh produced products, such as bananas, pineapples, melons, tomatoes, grapes, apples, pears, peaches, plums, nectarines, cherries, citrus, avocados, blueberries and kiwi from Central and South America, Africa, the Philippines, North America and Europe. It sources its prepared food products from Africa, Europe and the Middle East. It distributes its products in North America, Europe, Asia, the Middle East, Africa and South America. It markets its products under the DEL MONTE brand, as well as under other brands, including UTC, Rosy, Fruit Express, Just Juice, Fruitini and other regional brands. FDP’s current market cap is $1.6 billion.
- Earnings and Sales Growth: Over the last twelve months, earnings declined nearly -160%, while revenue growth grew 12.2%. The picture got worse in the last quarter, as earnings declined -200%, and revenues by almost – 16%. The company’s margin profile also shows significant deterioration, turning from a practically nonexistent .13% over the last year to -2% in the last quarter.
- Free Cash Flow: FDP’s free cash flow is attractive, at a little over $135 million. That translates to a surprising 8.4% Free Cash Flow Yield. As I think you’ll see, however I think this number is a red herring.
- Debt to Equity: FDP has a debt/equity ratio of .36. I believe this number, which looks conservative, is also misleading, and the reason I’m not happy about the Free Cash Flow or the Debt/Equity numbers is simple. The company has very poor liquidity, with only $22.5 million in cash and liquid assets in the last quarter against $629 million in long-term debt. Consider also that Net Income is currently negative, and you should be concerned about FDP’s ability to service the debt they carry.
- Dividend: FDP pays an annual dividend of $.60 per share, which translates to a yield of about 1.8% at the stock’s current price. This is also a concern, since the company reported -$.14 in diluted earnings per share in the last quarter. The sustainability of the stock’s dividend has to be in question.
- Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for FDP is $36.57. This number has declined in each of the past two quarter, but it does also translate to a Price/Book ratio of .9 at the stock’s current price. Their historical average Price/Book ratio is 1.2 – which puts the stock’s long-term target price above $43 per share. That sounds very attractive; but one of the things that any stock usually needs to sustain a move of 30% over a long period of time is good fundamental strength that gives investors a reason to keep buying the stock. I just don’t see where those fundamentals exist right now for FDP.
Here’s a look at the stock’s latest technical chart.
- Current Price Action/Trends and Pivots: The stock’s downward trend is easy to see since May. The fact is that the stock is showing some good signs of stabilization right now, with consistent support in the $29 range. Considering the fact that stabilization coincides with the market’s recent bottoms at the end of October and last week, however, I would be concerned those bottoms have less to do with any fundamental belief in the stock itself than it does in speculative traders’ willingness to use broad, but short-term market momentum for the equivalent of a “dead cat” bounce. Any kind of sustainable upward trend won’t be possible unless and until the stock can break above the gap that occurred at the of July, to about $40 per share. A break below $29 could see the stock push into the low $20 range, which is a level the stock hasn’t seen since early 2012.
- Near-term Keys: The stock’s current bullish push might offer a tempting bullish short-term trade using call option; after all, the stock’s next likely resistance level assuming the stock pushes above its November pivot high is around $38. That is a highly speculative play, however that to me is the kind of sucker’s bet that inspired today’s headline. If the stock breaks below $29, there could be a useful opportunity to short the stock or buy put options with a target price between $22.50 and $25 per share.