The weather has a big impact on some company earnings, but I’m wary of factoring forecasts for temperature, rainfall or meteorological conditions into stock views.
As we well know, weather forecasts can be wrong. I’ve read that weather predictions during COVID-19 have been less reliable due to the grounding of most commercial aircraft that collect valuable wind and temperature data for meteorologists.
Also, big weather predictions are well known to investors. An efficient share market factors in the possibility of a summer of bushfires or extreme flooding well before the event.
Weather conditions are one of many factors affecting company valuations. It’s dangerous to extrapolate too much, trying to predict how any forecast conditions will affect earnings.
I’ve read reports over that years that suggest a wet summer will boost media (more people stuck indoors watching TVs or reading newspapers), hurt construction companies (as projects are delayed) or crunch tourism companies as the weather keeps people indoors.
Mostly, the effect is short-lived and has minimal impact on share prices, if any. But there are important exceptions, so it still pays to consider crucial weather events or changes, and the companies that could be most affected.
The Bureau of Meteorology’s (BOM) declaration this year that a La Nina event is underway is among the more important weather forecasts for investors. La Ninas are usually associated with wet conditions for northern and eastern Australia, higher frequency of cyclones and floods in some events, and less fire risk.
The last major La Nina events (in the summers of 2010-11 and 2011-12) produced Australia’s wettest two-year period and devastating flooding in South East Queensland.
BOM models suggest that this La Nina will be “moderate to strong” and last until at least February 2021, although conditions are currently weaker than those in 2010-12.
That’s good news. Many farmers need the rainfall, but not so much that widespread flooding destroys crops and road infrastructure. I grew up in country Queensland and have seen agriculture optimism from big rainfall events quickly turn into pessimism due to cyclones and flooding.
This La Nina looks good for our farmers and is a reason (though not the only one) why a few agricultural stocks appeal. Stick to farming if you want to back a La Nina summer, and focus on companies that have good long-term prospects, with or without a wetter-than-usual summer.
Here are two small-cap agriculture-related stocks that appeal. I’ll look at another two agriculture-related stocks in coming weeks.
1. Australian Agriculture Company (ACC)
A few years ago, I was bullish on the beef producer and even nominated it is a takeover target. But AAC disappointed, largely because of droughts and floods, and now COVID-19. AAC’s five-year annualised total return (including dividends) is negative 5%, Morningstar data shows.
Better times are ahead. The rainfall will be good news for many of AAC’s 26 stations, farms and feedlots. AAC had $42 million in elevated drought-related costs in FY20 alone, so it should save on many feed costs as the rains return.
Longer term, I like AAC’s strategy to build a branded beef strategy and to go direct to customers on its gourmet beef products. AAC delivered record sales of premium Wagyu beef in FY20, boosted sales in each of its main offshore markets and successfully launched its Westholme beef brand in 20 countries. It was a good performance in difficult trading conditions.
AAC says its new Westholme brand doubled in volume and value, albeit off a low base (it was 11% of AAC’s total meat sales in FY20). It’s too soon to tell how the branded beef strategy will fare, but early signs are promising.
Australia has the world’s best beef on which to build an upmarket global beef brand and sell directly to consumers and restaurants here and overseas. A prominent beef brand should mean higher margins for ACC and greater differentiation of what has been a commoditised product.
Australia’s relative success in managing the coronavirus pandemic is another plus for agriculture producers. Our reputation for clean, green food will surely be enhanced after COVID-19 as more offshore consumers and restaurants will favour Australian and New Zealand agriculture.
Rising values for AAC’s land and herd in the next few years is another attraction, as is the broader theme of ongoing consolidation in beef production. Cattle prices are at record highs.
Then there’s the unfolding middle-class consumption boom in Asia and people there adding more protein to diets.
AAC hasn’t mostly traded sideways since 2018. In charting terms, the stock has tested support several times around $1 and held that level – a good sign.
Like all agriculture stocks, AAC can be volatile and suits experienced investors who understand the features, benefit and risks of investing in small-cap stocks. Much can go wrong and the risk of more Chinese tariffs on Australian commodity exports is rising.
Still, AAC management is doing a good job in trying conditions and it won’t take much for its shares to break out of their trading range and head higher.
Chart 1: Australian Agriculture Company
Source: ASX
2. Rural Funds Group (RFF)
I last wrote about the farmland investor for this report in July 2018 in a column that outlined my favourite niche Australian Real Estate Investment Trusts (AREITs).
Rural Funds Group rallied from $2.14 at the time of that column to $2.40 in mid-2019, then sank to $1.63 as a short-seller publicly attacked the company’s accounting practices.
RFF denied the claims (the Supreme Court of NSW in February 2020 found in RFF’s favour in its litigation against the activist and awarded $530,201 in damages). But as so often happens when activists attack in the media, the share price tumbled.
I have followed RFF for a long time and found it to be well-run and governed, and conservative. The share price has recovered from the attack and is now back at $2.40.
To recap, RFF owns a portfolio of just over 30 agricultural assets that are leased to farmers. Almost half of them are cattle farms, a reason I like the AREIT.
RFF has plenty of acquisition opportunities, as it buys and consolidates smaller farms in what is still a fragmented sector. The portfolio is diversified geographically, has sensibly reduced almond exposure (as I called for previously) and has good long-term leases.
The fund is shifting its investment focus over the next five years more towards macadamia farming, after unveiling a plans to develop a much larger asset base in this crop. In five years, macadamia farm will provide almost a third of RFF revenue, from a few per cent now.
Farmland is in high demand. The Australian Financial Review last week reported that institutional and private-equity capital is pouring into farming assets as the drought breaks, and other property segments, such as retail and commercial office space, lose appeal due to COVID.
It’s inevitable that more institutional capital will flow into farmland to diversify portfolios and benefit from rising agriculture land values in some areas. That will increase competition for RFF in farm acquisitions, but shows the potential for its asset base to rise in value.
RFF has had a good bounce from its 52-week low, but over three years it has mostly gone sideways (if you exclude the short-seller-induced attack).
This AREIT looks well positioned to benefit from improving agriculture conditions in the next few years. A yield near 5% is another plus.
Chartists will look for RFF to break previous price resistance around $2.40, a level it has flirted with three times in the past few years. If it does, the next up-leg in RFF could unfold.
Chart 2: Rural Funds Group
Source: ASX
Tony Featherstone is a former managing editor of BRW, Shares and Personal Investor magazines. The information in this article should not be considered personal advice. It has been prepared without considering your objectives, financial situation or needs. Before acting on information in this article consider its appropriateness and accuracy regarding your objectives, financial situation and needs. Do further research of your own and/or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at 3 November 2020.