Is Costa Group Or Lynch Group The Pick Of The Bunch For Investors?
Weekly Reports | 12:13 PM  This story features LYNCH GROUP HOLDINGS LIMITED, and other companies. Mourners grabbing a bunch of roses at the supermarket en route to great aunt Doras funeral  or virtual send-off in the case of Victoria  would be oblivious to the complex logistics that enable a bunch of fresh blooms to be available beside the wonky trolleys every day. We guess the same applies to buying milk or carrots. But flowers pose an added challenge because they are ultra perishable, they need to look extra nice on display and they often cant be grown locally. Flowers are a unique product category that are highly perishable and have a short vase life, resulting in complex and time sensitive supply chain and high barriers to entry, says Lynch Group ((LGL)) chief Hugh Toll. Lynch has certainly nipped the floral business in the bud, having grown, processed and distributed flowers since 1915. Private equity group Next Capital took a majority interest in the previously family owned business in 2015 and the company listed on the ASX on April 6 this year, after a $206 million raising at $3.60 a share. The shares havent done much, but there are some intriguing aspects to the business that suggest the company  one of a few listed floral stocks globally  could come up roses over time. The first is that Lynch dominates the supermarket and convenience store sector, supplying 88 per cent of blooms procured not just by Coles and Woolworths but IGA, Costco, Aldi, BP servos, Big W and Bunnings. The company runs four processing centres nationally, with the produce supplied by company-owned and third party farmers. Lynchs wholesaling arm also services 2000 retail stores and supplies 29 per cent of florists. The company has emerged from a pandemic horror show period that saw consumers rushing the shelves for dunny paper  but not delphiniums. Flowers were the last thing on anyones mind, Toll says. It certainly made us change some things in the business we never thought we would change, and simplify our range and production methods to make things move faster.  While the banning of decent-sized funerals and social events didnt help, the convenience trade is oriented more to consumers self-purchasing flowers to liven up the home. The convenience blooms typically sell for around $10 for a straight bunch and high teens for a bouquet. Not surprisingly, a Valentines Day arrangement can sell for $60 or more, but in the main were not talking about emulating the artistry of royal florist Philippa Craddock. As well as having a shelf life of only a couple of days, the displays have to enough bunches of fresh looking specimens to entice buyers: theres nothing more off putting than a couple of wilted gerberas a few hours off being the next days compost. Arranging the supermarket displays is not left to the night fill guys more accustomed to piling up baked bean cans: the company has its own floral flying squad for that task. Despite managements best efforts, wastage runs into the teens. Its a necessary part of the business given perishable nature of the product and the fact you need good stock volume when customers come through the door, Toll says. The other leg of Lynchs growth prospects lie with the emerging uptake of stems and buds by Chinas emerging middle class. After all, Chairman Mao did once exhort a policy of letting a hundred flowers gloom and a hundred schools of thought contend.  (lo behold anyone who did sprout some free expression, but we digress). Lynch entered the Chinese market 16 years ago, building two farms from scratch. Of the IPO proceeds, $33 million was earmarked to acquiring two more via the acquisition of premium rose grower VDB Asia. Toll says the strategy initially was to supply the Australian market, one advantage being the amenable climate. The Chinese operation got started as a way to source product to Australia  were starting to supply supermarket chain with a simple range, Toll says. We will develop the business to look more like Australias at a retail level, over time.  Industry stats suggest the domestic flower business was worth $1.32 billion in 2015 and $1.37bn in 2019  a compound annual growth of 0.8 per cent. With their wide variety of shapes and colours, roses account for at least about one-third of sales. The sector is expected to expand to $1.46bn by 2024, or 1.3 per cent growth. The Chinese market is worth much more  $19 billion  but largely has been flat. While these growth dynamics are nothing to get excited about, Lynchs dominant position in the convenience sector might be. According to Toll, the supermarket/convenience channels accounts for only 19 per cent of flower sales here, compared with 55 per cent in the UK. The company expects the convenience share of the market to grow to 24 per cent by 2024, at the expense of sub scale operators. If the supermarkets get the huff with Lynch, theres no one with the scale to replace that supplier. Costa Group ((CGC))  Investors have likened Lynch to the countrys biggest fruit and vegetable supplier  not that the flower grower would appreciate the comparison given Costas profit downgrade last week. The key element is that both companies grow perishable stuff and they are dominant suppliers to supermarkets in otherwise fragmented sectors. Both entities have Chinese growing operations and are building a domestic presence there. There are some quite strong parallels, but differences in terms of products and how they brand themselves, Toll says. The supplier of berries, mushrooms, citrus fruits, glasshouse tomatoes and avocadoes, Costa suffered from a lack of rainfall and other woes including a raspberry disease in calendar 2019. The calendar 2020 result swung to a $65 million net profit from a $30m deficit previously, on revenue of $1.16 billion (up 13 per cent). Not quite. At its May 27 AGM the company said that June (first) half earnings would be marginally ahead of last years result, which would be promising news if investors had not factored in a substantially higher number. The stock dropped 24 per cent in response. On broker Citis numbers, Costa is trading on an earnings multiple of 20-21 times for the 2021-22 year and a dividend yield of around 4 per cent  Analyst Ben Gilbert from advisory group Jarden puts Lynch on a multiple of 14-15 times and a yield slightly below 4 per cent. We hasten to add  probably redundantly  that there are numerous variables including growing conditions and labour supply. With the borders shut, worker availability is especially problematic for Costa and its all-year-round mushroom crops. With a $440 million market compared with Costas $1.3 billion, Lynch arguably is the poor mans Costa for investors, although not quite in the same defensive category. Nasturtiums aside, you cant eat flowers when the next pandemic or financial crisis hits. Tim Boreham edits The New Criterion  tim@independentresearch.com.au  Disclaimer: Under no circumstances have there been any inducements or like made by the company mentioned to either IIR or the author. The views here are independent and have no nexus to IIRs core research offering. The views here are not recommendations and should not be considered as general advice in terms of stock recommendations in the ordinary sense. Content included in this article is not by association the view of FNArena (see our disclaimer). 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