The Rundown (6/20/21)
This week I’ve spent a significant amount of time reading about Tomato farming on Twitter – so I figured why not cover one of the market leaders in sustainable farming! Hope you enjoy, and as always comment with any questions you have.
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AppHarvest Is Key for Sustainable Food Production
AppHarvest primarily engages in building large commercial greenhouses in Kentucky to primarily grow tomatoes indoors. There are major benefits with this approach compared to traditional farms with more food per acre, less water used, and no chemical pesticides used. This allows the company to control the environment to indefinitely allow for near perfect growing conditions. AppHarvest went public in February through a SPAC with Novus Capital with the company raising $475 million. Since the SPAC, AppHarvest has seen mixed performance with a modest return of 50% compared to the staggering returns set by other companies. But SPAC enthusiasts and investors should take notice as the company is expected to create substantial returns in the future.
There are certain benefits to building large commercial greenhouses compared to traditional farming methods. This includes using up to 90% less water, having the ability to attain harvests year-round, use no chemical pesticides and attain 30x more food per acre than conventional farming techniques. This is a giant step for farming, which is critical considering that the world is still facing significant population growth rates while it deals with uncertainties surrounding climate change.
The demand for indoor agriculture exists because it allows for better usage of water and fertilizers enabling higher crop yields and quality output. While outdoor farming is still relevant today indoor is the long-term growth opportunity. The current market for indoor farming is $11.7 billion and AppHarvest has potential to lead this market segment.
Although Water and Food sustainability are multi-decade concerns, they still need to be addressed and AppHarvest’s model is the one which will lead the market in the right direction. Not using chemical pesticides also has good implications for human health, which will ultimately lead to a reduction in a variety of diseases. AppHarvest is looking to make the world a better place by conserving resources and improving healthcare at source.
Competition from Mexico
AppHarvest uses recycled rainwater for its circular irrigation system, thereby boosting its ESG credentials, but this creates uncertainty over the profitability over the growing commodity market. The domestic market for fruit and vegetable produce has is increasingly being dominated by Mexico in recent years. Imports of tomatoes have grown from 1.6 billion pounds to 3.6 billion pounds between 2002 and 2017.
The company aims to reverse this trend with its indoor farm in Kentucky. This is able to reach 70% of the US population within a day’s drive, which would mean that the produce will arrive at the grocery stores fresher compared to the competition. This should also mean a lower carbon footprint which would help differentiate the product as consumers are becoming increasingly aware of the importance of the food chain to manage climate change.
Broad Market Reach and Improved Revenues
AppHarvest expects revenues to ramp up materially over the next 4 years based on the expansion of its indoor greenhouses. The company has also planned to achieve greater diversification in its product line by growing other fruits and vegetables. Management guidance suggests that the company will reach revenues of $376 million by 2025. This indicates a CAGR of 97% between now and 2025. To achieve this ambitious revenue target, the company expects an aggressive expansion to build 12 active facilities across 6 states.
The company is expected to invest in these new facilities by accelerating capital expenditure which will help increase the total acreage and annual production. The major challenge to scale profitability would be the unique costs of indoor growing, which includes increased electricity consumption and the use of more skilled labour.
AppHarvest’s acquisition of artificial intelligence start-up Root AI should help solve the issues of scaling up. Root AI’s robot, Virgo can evaluate crop health, precisely predict yield and optimize the overall operations by handpicking tomatoes. While it will not entirely eliminate the use of labor, it will be a key factor in efficient and profitable operations if it can work without a high requirement of human supervision.
Not only does AppHarvest expect to produce high quality output through year-round production but it also expects to use less water, pesticides and labour. With its current model, the company has potential to generate higher margins compared to traditional vegetable farmers as well as smaller indoor farming facilities. Not only does AppHarvest have the more efficient model versus traditional methods, but at scale, it can also purchase more PP&E and production inventory at greater discounts versus smaller indoor peers. This is expected to help the company reach EBITDA profitability as soon as fiscal 2023 and will result in generating positive free cashflows during the same year.
Currently the stock is trading at $15.32, which gives AppHarvest a valuation of $1.54 billion. This puts the current valuation at above 50 times the forward price to sales, which is high for a farming company. But considering that AppHarvest is unlike any other farming company with higher than average industry margins and high expected growth, revenues and profitability will soon catch up to the current valuation. The company is also not cyclical because grocery stores are expected to have constant demand for their products. Currently the company is commanding a valuation premium based on the technology differentiation and first movers’ advantage for its scale of production. The US agriculture also has an incredibly large total addressable market and if AppHarvest can capture a small percentage, the current valuations would seem cheap.
AppHarvest is leading the industry with the next generation of indoor growing which have major benefits compared to traditional farming. It includes less water used, no chemical pesticides and more food per acre produced. This allows the company to grow crops through the year and produce 30x more food compared to traditional farming technique. Sustainable growth techniques should help conserve resources and produce healthy outputs, which are expected to be multi-decade problems. These sustainable techniques of growth along with the acquisition of Root AI, should enable higher operating margins compared to its peers. While the company currently commands a valuation premium, the planned expansion ensuring that future revenues catch up to the valuation.