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Fresh Del Monte Produce (FDP) - PART 2

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By DCFNewbie
September 30, 2004

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[This is Part 2; Part 1 is located here.]

Fresh Del Monte Produce, Inc. (NYSE:FDP)

2) Operational Reality

- The Industry

As a crop industry member, FDP belongs to an industry with a very large, diversified set of capital structures. From the small rural farm to the large regional cooperatives there is a large spectrum of players that influence price setting and supply/demand conditions.

Curiously enough, only a very small slice of that universe is represented in the equity market. The largest industry player is Cargill Incorporated, who alone is responsible for nearly 60B of revenues. Fresh Del Monte (FDP), the industry's largest public traded company doesn't even make it into the top 10.

That make-up is a very important part of what the crop industry is all about. The fact that their cash-generating assets (land) aren't "movable", favors an expansion strategy based on collateral acquisition. The secular and traditional nature of many of these companies makes vertical expansion more enticing than a horizontal one. Aside from FDP, there doesn't seem to be any significant global players. Most companies seem more than happy in just enforcing regional dominance.

- Company Operations

FDP seems to have a very clear ongoing strategy:

a) Present a bottom-up solution for grocery retailers in the fruit and vegetable segment.
b) To diversify crop-cycle/weather related risk.
c) To engineer and market new products and consequentially obtain higher gross margins.

However, it faces significant obstacles regarding the application of these same strategies.

The first one is the erosion of the gross margins through the diversification of their product line. They are clearly set on eliminating revenue dependence on bananas.

That obviously comes at a cost. Other produces do have worse margins, and additional pressure to find other ramification of the current business to counteract those lingering margins is a must.

With the introduction of fresh cut, pre-packaged, pre-washed fruit, FDP has a chance to essentially sell services together with their produce. Currently that form of distribution amasses to about X% of their total revenue. FDP is clearly trying to leverage their influence near retailers like Wal-Mart or fast-food chains like Wendy's to grow that percentage.

Their already global supply chain also allows for the quick introduction of those and other higher margin products. GM produce is also another big part of FDP's current strategy. The successful marketing of the Gold Del Monde Pineapple was a demonstration that FDP can take calculated risk in presenting the market with new and original products in a segment characterized by the lack of innovation.

Their acquisition demeanor seems to be focused mainly on enlarging distribution and logistic networks. One of there latest acquisition, Del Monte Europe, is a clear sign that the trepid organic growth that the industry allows for, isn't enough to satisfy the management's hunger for expansion. That acquisition alone is worth 340M, more than 1/5th of FDP's market cap.

But FDP is not only out to acquire smaller versions of itself. It's also interested in acquiring companies whose core business may facilitate FDP's operations. Can-Am, it's most recent buy, is one of those cases. With its refrigerated trucking infrastructure, it solidifies FDP's ability to distribute its produce through out US's southeast.

Although not particularly relevant by itself, the potential for these kinds of acquisitions are the true value in FDP. If the goal is to create a global network of distribution for their worldwide produce, then the strategic impact of each acquisition and the price at which they are bought, is fundamental for the long-term success and value growth for FDP.

The company is headed by Mohammad Abu-Ghazaleh, who is both chairman and CEO. Mr Ghazaleh is also the majority owner, his family owns over 55% of FDP. He is known by his very particular attitude to manage the company, and although there are no pass evidences of contempt towards shareholder's, he sees no need to assume a humble position towards Wall Street in general. That attitude has brought a lot of negativism from the analysts following FDP. Ghazaleh has made no efforts to minimize that animosity and is set on managing his company has he sees fit regardless of analyst's opinions or interests.

Other management members include Hani El-Naffy, the COO, who as a long history in running middle-eastern companies. Regarding the CFO, John Inserra, there doesn't seem to be a lot of information available, however it is clear that he has been involved with FDP and related companies for more than a decade. Other members of the Abu-Ghazaleh family occupy board and managerial positions at FDP (obviously representative of the family's ownership status).

The fact that Mr. Abu-Ghazaleh and his family own 55% of FDP is a reason of concern for both investors and analysts. By controlling the board and the executive management, he is essentially free to do what he wishes without any kind of accountability to other shareholders.

The company's balance sheet was pretty decent up until the DME acquisition. With that 340M deal, FDP will contract a further 250M in long-term debt, while essentially erasing the majority of the cash in the balance sheet.

Besides the already mentioned ROE and FCF from previous years, another important metric is the company's ROIC. Since future growth is based on the management's ability to leverage acquisitions with both debt and future earnings a good look into how ROIC has evolved is extremely important:

| 2003 | 2002 | 2001 | 2000 | 1999 |
| 17.7%| 17.9%| 10.0%| 5.9%| 6.7% |

So that is increasing too, as well as the management's ability to create value through acquisitions.

Another important metric in FDP's case is the evolution in gross margins:

| 2003 | 2002 | 2001 | 2000 | 1999 |
|15.6% | 18.7%| 17.5%| 12.1%| 11.2%|

There you see why ROE and ROIC decreased in 2003 (as well as in 2004). By diversifying they are sacrificing gross margins. The only way to counteract this will be through the introduction of other unique GM products and packaged fresh produce.

Next section, 3) Company History/Background



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