Agribusiness stocks are a bright spot in an otherwise gloomy share market. Several have rallied this year as the lower Australian dollar, free-trade agreements and expectations of sharply higher food demand from Asia boost sentiment.
Organic food producer Bellamy’s Australia; almond grower Select Harvests; livestock-feed producer Ridley Corp; egg producer Farm Pride Foods; and Elders and Capilano Honey are among the market’s best-performing small-cap industrial stocks over one year.
Agribusinesses are prominent in the Initial Public Offerings (IPO) market this year. MG Unit Trust, which provides exposure to the Murray Goulburn dairy co-operative, raised $439 million. Australia’s largest fruit and vegetable producer, Costa Group Holdings, raised $550 million, and Beston Global Food Company raised $100 million.
The gains have come, despite fears about the return of El Niño conditions to eastern Australia in the next two years and forecasts of declining rainfall. Weaker soft-commodity prices, cushioned for local exporters by the lower Australian dollar, are another concern, if economic growth in Asia slows.
Moreover, sharply higher valuations for some ASX-listed agribusiness stocks could prompt investors to ask whether the easy gains are over and if the sector is overvalued at current prices. Caution is warranted given growing hype about exporting food to Asia.
But the long-term thematic for agribusiness is compelling. As the world population grows from 7 billion to an estimated 9.7 billion by 2050, and as an extra 2 billion middle-class Asian consumers upgrade their diets within 15 years, food demand will soar. Australia is superbly positioned for the so-called “dining boom”.
At the same time, chronic underinvestment in the global food chain will create opportunity for food handlers, storage providers and distributors. Transport companies that better integrate food supply chains across Asia have great potential.
Different investment approaches
Long-term portfolio investors need to play the sector differently than active investors. Those with a short-term perspective should focus on smaller agriculture stocks that have higher leverage to single commodities – the well-run Select Harvests is an example. These agribusiness stocks need to be traded out of cycle, much like mining stocks.
Portfolio investors should, ideally, take a global approach to agribusiness and use a specialist managed fund. Investing globally can diversify weather, geopolitical, commodity and country risks. Also, El Niño conditions strengthen the case to use a global fund that can avoid drought-affected areas in Australia, in what is shaping up as a torrid summer.
Paying specialist agribusiness managers to manage your money in this sector makes sense. Weather and geopolitical events that affect food supply add another layer of complexity compared with other sectors. This is not an industry for novice investors, such are the risks.
But there are not many Australian agribusiness funds available. Only a handful specialise in global agribusiness and the sector has traditionally struggled to attract significant institutional capital, although that is starting to change. The Colonial First State Global Soft Commodity Share Fund is the pick of the locally run agribusiness funds.
Long-term portfolio investors who prefer to invest directly in Australian stocks for agribusiness exposure should consider larger companies that supply critical inputs for farms, and are benefiting from operational restructures or other initiatives. Here are some to consider:
1. Incitec Pivot
The producer of fertilisers and industrial explosives has good prospects as its ammonia plant in Louisiana in the United States starts in the second half of next year. The plant’s commissioning will drive a new leg of earnings growth, reduce debt, strengthen the balance sheet, and help Incitec return cash to shareholders through higher dividends or share buybacks.
Incitec benefits from a lower Australian dollar, and weaker gas prices are partly offsetting expectations of lower ammonia prices (gas is a key input in the ammonia production process). Most ammonia production is used for crop fertilisers.
Incitec has rallied from a 52-week low of $2.72 to $3.87 this year. As the ammonia plant moves towards production, operational and commissioning risk is receding and the company is moving past its large capital-investment hump. It has timed its investment well, given expected strong fertiliser demand in Asia and the need to improve crop productivity.
Its explosives business Dyno Nobel has been affected by the mining sector’s downturn. The good news is that prospective investors in Incitec are buying Dyno Noble towards the low point in the resource sector. Good cost-management is helping that business.
Seven of 14 analysts who cover Incitec Pivot have a buy or strong buy recommendation, four have a hold and three have a sell, consensus estimates show. A median share-price target of $4.09 suggests Incitec is fully valued at its current $3.87.
Incitec can do better than the consensus forecast. Macquarie Equities Research’s 12-month target of $4.45 looks more reasonable. Incitec’s share price is due for pause after the recent rally, but its position in supplying fertiliser inputs has long-term appeal.
Incitec Pivot
[1]Source: Yahoo!7 Finance, 22 October 2015
2. Nufarm
The producer and distributor of crop-protection products has soared from a 52-week low of $4.28 to $8.25. A strong full-year earnings result and signs that Nufarm’s operational restructure is paying off have boosted its shares.
Nufarm reported 4% growth in revenue to $2.7 billion and 18% growth in Earnings before Interest and Tax for 2014-15. A robust earnings recovery in the Australian business and improving performance in the US underpinned the better-than-expected result.
Nufarm’s focus on improving its profit margins, rather than chasing greater share in global markets for herbicides, fungicides and pesticides, is working. Like Elders, another agribusiness stock, Nufarm has had a difficult, transformative corporate restructure and emerged in good shape. The earnings result confirmed Nufarm’s potential to transform its operating performance and deliver a step change in earnings growth.
Three of 11 analysts have a buy recommendation, six have a hold, and three have a sell, consensus forecasts show. The median price target of $7.82 suggests Nufarm is overvalued. Some analysts believe the market is overestimating the long-term benefits from Nufarm’s efficiency gains and underestimating the required capital investment.
Nufarm looks fully valued for now, but has more strategic value than its valuation suggests, given rising global demand for crop-production products in emerging markets. It could be a takeover target.
Nufarm has attractive prospects, but long-term investors should watch and wait for better value as some heat comes out of its share-price rally. On a forecast Price Earnings (PE) multiple of about 17 times, Nufarm trades at a premium to its much larger global peers such as Monsanto, Dow Chemical and Du Pont.
Nufarm
[2]Source: Yahoo!7 Finance, 22 October 2015
3. Rural Funds Group
Australia’s first listed agricultural property trust buys poultry farms, almond orchards and viticulture plantations and leases them to farmers. Its manager, Rural Funds Management, is a well-known agriculture investor.
The model of packaging farms into a listed or unlisted managed fund, popular in North America, is gaining traction in Australia. It provides investors with lower-risk exposure to agriculture, compared with owner food producers, and also a steady stream of capital growth from rising farm prices and income from the leases.
Rural Funds Group’s $1.33 unit price compares with its adjusted Net Asset Value of $1.22 (which includes independent valuations of water entitlements), meaning it trades just above its asset backing. Several specialist Australian Real Estate Investment Trusts (A-REITs) are trading at much larger premiums to asset backing and are best avoided at current prices.
Rural Funds Group’s distribution guidance for 2015-16, 8.93¢ per unit, implies a 6.7% yield. As a diversified land owner, it is a lower-risk play on agribusiness than investing in farm producers or soft commodities – and one of a few ways to access income from the sector through a diversified package of farms.
Rural Funds Group
[3]Source: ASX, 22 October 2015
4. Lindsay Australia
Small-cap transport provider Lindsay Australia is often overlooked in agribusiness-related stories. It specialises in moving temperature-sensitive items, such as fresh produce, to major grocery distribution centres and chilled- and frozen-food manufacturers.
Its transport division contributes about three-quarters of revenue and the rural-supplies division, a seller and distributor of farming-input products, provides the rest.
Lindsay has rallied from a 52-week low of 35 cents to 45 cents. It’s an interesting play on the Northern Queensland food bowl, which is well positioned geographically to export to Asia.
About 90% of Lindsay’s revenue comes from food-related producers.
Lindsay has potential to expand into new markets and extend its logistics services. Similar to Rural Funds Group, it suits experienced investors who are comfortable with less-liquid, small-cap securities.
Lindsay Australia
[4]Source: Yahoo!7 Finance, 22 October 2015
Tony Featherstone is a former managing editor of BRW and Shares magazines. This column does not imply any stock recommendations or offer financial advice. Readers should do further research of their own or talk to their adviser before acting on themes in this article. All prices and analysis at 21 October, 2015
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.