The weather gods had been kind to Select Harvest Limited (ASX: SHV). California, the largest producer of almonds (approximately 80% of the world production), had been in a drought since 2011. Almond production, a highly thirsty process, had plummeted in California. Consequently, almond price had been on a tear and it had benefitted producers in other parts of the world. However, almond prices has started to drop as the drought in California has started to ease since late 2016 and is still continuing to improve. At the Awkward Investor, we do not tend to invest in commodities in any form (e.g. companies) as we believe that predicting commodities’ prices is a mug’s game. In the instance of SHV, we believe that SHV is a dud investment . It can be frustrating to analyse and write on a stock which we know we will never take a position in but what the hell ….
SHV has two main business arms — an Almond and a Food division with the Almond division contributing about 80% to EBIT. Therefore, the share price of SHV should be highly susceptible to any swings in almond price. The key to determine a fair value for SHV is to try to determine a long term ‘equilibrium’ almond price. As mentioned above, we are not commodities price guru and has no intention to be. However, in our modest opinion, a long term price chart may be a useful way to ascertain an equilibrium price.
The above chart shows an almond price chart from 1993 to 2017 and, ignoring the occasional spikes it is fair to say that AUD almond price trades between a band of $4-$8 with median price at approximately $6. Based on harvest volume of 14,200 MT for FY16, I estimated that the cost to produce each kg to be $5.94AUD (FY15: $5.48AUD). That is, if corporate costs are ignored, the Almond division needs to sell each kg of almond at an average price north of $5.94AUD to generate a profit. At a long term ‘equilibrium’ median almond price of $6 (I cannot stress enough that this is a guesstimate), the almond division will be close to worthless. But fret not, the Food division is at least worth $2.7AUD a share based on a FY16 EBIT of $10M AUD. At SHV’s current share price of about $6AUD, I find it a little rich that the market is valuing the Almond business at about $3.3AUD per share.
A significant part of SHV’s growth story that management loves to harp on is its ability to do value accretive bolt on acquisitions. In order to do this, management has repeatedly stressed on SHV’s ‘strong’ balance sheet which gives it sufficient headroom for acquisitions. Just like a crazy man will never say that he is crazy, SHV’s debt looks worse than it is. Net debt went from 115M in FY15 to 69M in FY16 and 98.4M in HY17 and a non-astute reader would praise SHV for bringing its debt down significantly since FY15. But is the praise deserved? A closer look at SHV’s accounts actually shows that SHV utilises sales and leaseback transactions to lessen its debt on the balance sheet. What this means is that SHV will sell a land that it owns to a buyer and at the same time lease the land back from that buyer. The upfront money that SHV gets from selling the land is used to pay off its other borrowers and SHV will have to pay monthly payments to the buyer of the land. In a nutshell, SHV is simply just switching borrowers. What SHV has managed to do is to use a common accounting trickery to move its obligation off balance sheet and to make its debt look smaller than it is. Looking at Note 20 0f SHV’s FY16 annual report, SHV is liable for an additional $280M AUD of additional commitment which is not reflected in the balance sheet. This brings its total commitment/borrowing to $380M AUD and assuming a NPAT of $40M AUD in perpetuity (this is extremely generous as SHV has only managed to surpass this amount once in its existence), it would still take SHV 9.5 years to pay off its obligations. From FY17 onwards, total interest and lease payments will be around $20M AUD which is double the EBIT of its Food division. A last point to note is that according to the FY16 annual report, SHV has a debt facility limit of $115M AUD and $5M USD of 11am facilities. With net debt of 98.4M as at HY17, I fear of the prospect that SHV may have to tap shareholders for additional funds.
I would never ask anyone to short a stock. However, anyone thinking of investing in SHV would do good to AVOID. Obviously, if SHV were to bring production costs down or if almond prices find a new normal due to structural changes, its value may be well worth its current share price of $6 AUD.