Deep Dive: AppHarvest
(Ryan) What they do: AppHarvest is attempting to be/already is a tech enabled farming company. So right now they have one completely built out massive (60 acres) greenhouse in Morehead, Kentucky and it uses a glass-structure model in order to receive sunlight during the day. And they’re in the process of building out 2 more, they want to build out 12 altogether by 2025.
The currently operational one is used exclusively for harvesting tomatoes. And the facility has a closed loop water system. So Kentucky is the 12th wettest state and they collect rainwater in a 10 acre rainwater retention pond and recycle it through to use it on the tomato crops. And this strategy also uses 90% less water than conventional agriculture. There’s a good video that goes through the whole facility.
But they don’t go directly to grocery stores. They use a single distributor, Mastronardi. And that distributor has ongoing agreements with grocers like Walmart, Costco, Publix, Kroger, and now Wendy’s. But that doesn’t necessarily mean the tomatoes are all being supplied to those grocers.
(Ryan) History: Jonathan Webb was originally from Kentucky but he went and worked for a solar energy company in Washington DC for most of his early professional years. Apparently while he was in DC he heard lawmakers talk constantly about food imports skyrocketing and most of the specialty crop production moving outside of the US. Which it has. According to AppHarvest’s slide deck the % of domestic tomatoes that come from importation has gone from 41% in 2009 to 60% in 2019. Similar figures for cucumbers and peppers.
This gave him an idea and a couple of years ago he came back to Kentucky to start AppHarvest. He assembled a team of people with agricultural know-how and used basically this untapped labor source in Kentucky to start the farm. I’m not quite clear how they got the funding to build it, but it’s built now and I believe they actually own it. And they announced the SPAC merger a while back and officially went public on February 1st of this year.
Fairly easy to identify. Estimates are U.S. fruit & veggie market to hit over $1 trillion in annual spend by 2025. These are just outside research estimates and back in a 13% CAGR
However, AppHarvest identifies a $6.71 billion “TAM” of leafy greens. Not sure how to use that information
Some other indicators for increased demand for products AppHarvest plans to sell: plant based or similar diets are growing at a rapid rate in the U.S. (survey data)
Competitors include Fresh Del Monte produce, Nestle, Sunkist. There are a lot
Founder/CEO is Jonathan Webb (linkedin picture has him in a jean shirt & a ball cap I thought that was cool)
Previously led a solar energy project for the Department of Defense
Seems to be deeply ESG motivated in terms of sustainability & also community outreach for food security programs
Just 36 years old
President is David Lee
Was a member of the board
Former CFO & COO of Impossible Foods
Martha Stewart is a Director with a pretty hefty options package as well
That’s the highest profile experience
12 directors & executives together own 38.9% of the company
Webb personally owns 18.7%
Market cap of $1.84 billion, ticker APPH
EV is closer to $1.5 billion, however, the cash buffer is on pace to disappear rapidly
They just got to revenue, so not no valuation metrics to speak of
Based on projections, they trade at 4.75x 2025 estimates. Del Monte is at an EV/sales below 1
Most important thing for valuation here: future dilution and debt. One or both is coming
$2.3M in net sales for Q1, up infinity %
They sold 3.8 million pounds of tomatoes
They do have negative gross margins. Gross loss was $4.5M. (Launching commercial operations, sales, and training new hires)
Net loss of $28.5M
Acquired a company called Root AI in the first quarter
Guidance: They did reaffirm revenue guidance which is good.
Expecting net sales of $20-$25M for the year
(Brad) Balance sheet and liquidity:
Merger boosted cash position from $20 million to $297 million
SPAC merger really cleaned up the balance sheet. Had about $30M in debt that was converted to stock when it closed. Interest expense went from around $618K to $0. While no traditional debt:
$31 million in accrued expenses & accounts payable
$30 million in private warrant liabilities
Also the company bought Morhead farm for $125 million & took out $75 million in roughly 4.5% interest debt. Looking to raise another $200 million to finance capex
Root AI for $60M (10 in $ 50 in stock
Company thinks it has cash on hand to fund operations for the next 12 months per the recent 10Q
Anecdotal Evidence/Customer Stories:
(Ryan) Video going through the facility was fascinating.
(Brett) CNBC interview with CEO was a turn-off. We know the prevalence of fraud over the past few years, and he acts similarly to them. To caveat, plenty of people who act like this are not charlatans either.
Future growth opportunities:
(Ryan) The growth path isn’t complicated. Finish having the entire first greenhouse operational. Replicate that process of your first greenhouse on your following buildouts. I don’t think there are that many notable tweaks that need to made to grow cucumbers other than maybe required water levels.
(Brett) Getting a product to market is the main one here. But outside of that, there is a sneaky one in this being a huge candidate for government subsidies. I wouldn’t bank on it or invest because of it though.
Brad: Climate change brings with it the intensification of weather/climate systems. This makes growing food outdoors more & more challenging in most parts of the World. I think this favors a pretty durable trend in the shift to App Harvest’s greenhouse style farming
Highlights and lowlights:
(Ryan) Highlights: There are climate advantages of operating in a greenhouse versus traditional agriculture and this certainly seems like the way the world is heading. Also so far, so good on the first facility it appears. Lowlights: There were a lot of red flags with the CEO (started crying in an interview). Promotionalism over ESG (despite the greenhouse being powered by natural gas) and promoting the stock. Jeffrey Ubben serves on the board, he’s been on the BoD of Nikola since inception. They currently have a non-compete clause outside of Kentucky and West Virginia with their only customer.
(Brett) Highlights: Sounds innovative, and if they’re right, they will be doing billions and billions in revenue within a decade, and I like David Lee. Lowlights: A lot, but I’ll highlight one. They expect the cost of capital for new term loans/mortgages on facilities to be 4% – 5%. Even with optimistic unit profitability numbers in the SPAC, I am skeptical ROIC will be > cost of capital. And while the Root AI acquisition seems smart, I’m not sure the ROI of these robots to pick produce are at the levels where it gives AppHarvest any sort of cost advantage.
Brad: Lowlight: This is essentially a late venture capital stage investment. Their gross profit margin is roughly -200% & there is so much execution risk left here. It’s not the company’s fault (except maybe it went public too early) but this is so early on & there will be a LOT more dilution to fund the success of this company going forward. HIghlight is the space it’s operating in. I think the opportunities here are bountiful & if it can execute (big if) there’s a long runway to enjoy.
(Ryan) This is a much much bigger company who is supplying fresh, superior tasting produce across the country to grocers and restaurant chains. They successfully build out several fully operational greenhouses which shrinks the cost of capital for building out new ones.
(Brett) The technology is legitimate, and they can get the 30x yield enhancement, allowing them to achieve a scale advantage. If they achieve a scale advantage, they can sell organic produce likely for less than what regular produce goes for, and customers flock to the products. This creates untapped demand over the next decade.
(Brad): Climate change makes the need for indoor agriculture more needed. If it can maintain leads in key performance metrics like water consumption/fertilizer usage & sustainably there is something here
(Ryan) All the yellow flags turn out to be red flags. They overproduce or don’t get the greenhouses operating at full capacity because the grocers already have existing suppliers. They continue this scorched earth strategy, and can’t meet their financial obligations resulting in bankruptcy.
(Brett) Heavy dilution, capital intensivity is a major headwind to per share FCF growth. The product ends up being a commodity/highly replicable, and the tech advantage just leads to higher input costs and no savings for the consumer
(Brad) There’s nothing they do that’s special and companies like Home Depot or Scott’s miracle can come in & dominate
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Disclosure: The authors and podcast guests are not financial advisors. Brett Schafer and Ryan Henderson are portfolio managers at Arch Capital. Clients of Arch Capital may hold securities discussed on this podcast.