Digging up 5 agricultural stocks

Financial journalist and commentator on 3AW and Sky Business
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With good rain starting to fall in many parts of Australia, investors’ attention is starting to turn to the agricultural stocks.

Of course, the rain is never uniform.

May saw above-average rainfall over parts of coastal South Australia, Victoria, and inland southern New South Wales, but much of New South Wales and Queensland are still in drought conditions. Western Australia’s cropping areas have seen welcome rain this month, but northern NSW and southern Queensland are on track for a third consecutive poor season: there has been good autumn rain, but the extended dry preceding the rain may dissuade many farmers from planting a winter crop, because the required soil moisture is not present.

The Australian Bureau of Agricultural and Resource Economics and Sciences (ABARES) predicts that Australian winter crop production will rebound 20% from last year’s drought-ravaged season – which saw the east coast grain crop come in as the smallest in a decade – but that would only bring it back to about 10% below the 10-year average. ABARES projects a total winter crop of 36.4 million tonnes, with wheat making up 21.2 million tonnes: this compares to long term averages of total winter crop of around 40m tonnes, with wheat about 24 million–25 million tonnes.

With the rain pattering on the windows in the cities, it might be time for investors to take a look at our top agricultural businesses.

1. Ruralco Holdings (RHL, $4.17)
Market capitalisation: $438 million
12-month total return: 44.1%
FY20 projected dividend yield: 3.8%, fully franked
Analysts’ consensus target price: $4.40 (Thomson Reuters), $4.40 (FN Arena)

National rural services firm Ruralco is – along with the listed Elders, and the foreign-owned Landmark – one of the three main players in the rural merchandising sector, which sells supplies to farmers, acts as livestock agents, provides real estate, grain marketing, insurance and auction services, and similar businesses. Ruralco also has a large water broking, trading and water management business in in Queensland, New South Wales, Victoria and South Australia, and a live cattle export joint venture with Frontier, which is there to create an alternative sales avenue for the company’s cattle producer customers. Ruralco has more than 50 specialist business units in its portfolio.

When we looked at Ruralco in January as a potential value stock, it was trading at $3.02 – and the next month, that was realised in a big way, when the company received a $469 million all-cash takeover offer from Canadian fertiliser giant Nutrien Limited, which owns Landmark. As expected, the Australian Competition & Consumer Commission (ACCC) is examining the deal to assess whether it could reduce competition, and affect the position of independent retail stores. Landmark is the biggest player in the Australian farm services sector, with Elders number two and Ruralco number three.

The ACCC has released a statement of issues raising preliminary competition concerns about the deal: Nutrien and Ruralco say they are confident that they can address these concerns to the satisfaction of the ACCC. The putative partners say the combination of Landmark and Ruralco would enhance service, expertise and product delivery to farmers across Australia.

The deal will be consummated by September unless the ACCC scotches it – nervousness about that has affected the share price lately. There doesn’t appear to scope for a higher offer.

2. Elders (ELD, $5.93)
Market capitalisation: $692 million
12-month total return: –26.7%
FY20 projected dividend yield: 3.3%, fully franked
Analysts’ consensus target price: $7.06 (Thomson Reuters), $6.71 (FN Arena)

The number two rural services business, Elders, brought out its half-year result last month, reporting a 34% slump in underlying interim net profit to $26.4 million after a first half (to March 31) hit by “very difficult” drought conditions across large parts of eastern Australia, which cut into wool trading volumes, in particular. Poor summer cropping and grazing conditions, lower cattle prices and the shrinking national wool clip all played into the weak result, but the company said that a return to “normal seasonal conditions” in the second half (March to September), could push the company to a record full-year underlying earnings before interest and tax (EBIT) result, ahead of last year’s $74.6 million.

Analysts generally see a much stronger FY20 for Elders, as the wool market, in particular, recovers. The drought has been well and truly factored-in to the ELD share price, so any sustained improvement in conditions could see a price spike. On Thomson Reuters’ consensus, analysts expect 12.7% growth in EPS in FY20: FN Arena has a more bullish outlook, expecting 16.3% growth.

Elders could be a reasonable buy on recovery potential, backed by a 3.3% fully franked yield, or 4.7% grossed-up.

3. Graincorp (GNC, $8.15)
Market capitalisation: $1.8 billion
12-month total return: 5.2%
FY20 projected dividend yield: 1.8%, fully franked
Analysts’ consensus target price: $8.20 (Thomson Reuters), $9.45 (FN Arena)

The biggest grain business on the east coast, GrainCorp is another stock in which corporate activity has been as big an influence as the actual agricultural business.

Last December, GrainCorp received a $3.3 billion takeover bid from agricultural fund manager Long-Term Asset Partners (LTAP), prompting a 12.3% lift in the share price. But LTAP walked away from the bid in May, and that takeover premium promptly disappeared.

GNC has been hammered by the drought, with its grain intake in northern New South Wales and Queensland particularly affected, and thus, the company’s international grain trading revenue. In May, the half-year result (to March 31) saw GrainCorp post a $48 million loss – down from a $36 million profit a year earlier – and fail to pay an interim dividend, despite revenue actually rising by 25%, to $2.49 billion.

However, the expected improvement in the 2020 crop should help improve earnings – as should a 10-year deal with global insurer Aon, which GNC announced earlier this month. Under the deal, GrainCorp will receive guaranteed production payments that will smoothe the volatility of east coast grain harvests, particularly during droughts.

That deal, plus the proposed sale of GrainCorp’s lucrative global malt business into a stand-alone listed company, have investors looking anew at the stock. GNC will combine its grains and oils divisions into a new company that will own and operate its domestic and international grain-handling, storage, trading and processing businesses. Broker Deutsche Bank is particularly impressed with GNC’s footwork, posting a price target of $11.08 on the stock.

4. Australian Agricultural Company (AAC, $1.09)
Market capitalisation: $650 million
12-month total return: –12.4%
FY20 projected dividend yield: n/a
Analysts’ consensus target price: $1.33 (Thomson Reuters)

Australia’s largest cattle company lives and breathes the Dorothea McKellar description of the nation’s “droughts and flooding rains” – already struggling from drought, AAC was belted by the floods in northern Australia earlier this year, losing 43,000 head of cattle in north-west Queensland, and booking a $100 million hit to FY19 profit as a result of the floods, and drought. The company is also still booking losses associated with the failure of its Livingstone Beef abattoir in the Northern Territory, and the decision to drop its budget 1824 grain-fed beef brand.

These factors helped increase AACo’s full-year net loss by 45% to $148.4 million for the year to March 31, and there was no dividend. But underlying profit for the year was of $23.7 million, a $37 million turnaround from the underlying loss of $13.5 million in 2018.

AACo has been a huge disappointment for investors – the stock is the same price it was seven years ago. But if the company can get its premium branded beef strategy right, it could have a big future supplying wagyu beef to domestic and international markets. The company describes its wagyu herd as “the engine of our business” – in FY19, wagyu herd numbers rose by 3%, while revenue from Wagyu meat sales lifted by 4.5%. The majority (68%) of wagyu sales go into Asia, and sales in this market surged 26% in FY19.

AACo’s stated mission is to move from being a cattle producer, to a producer of luxury brands, leveraging the company’s heritage as the oldest company in Australia, producing beef for almost 200 years, controlling the world’s largest beef herd on a landmass twice the size of Belgium, and wholly controlling its supply chain. It sees its future as underpinned by export of its wagyu brands: about 20% of AA Co’s 500,000 cattle now carry some Wagyu genetics: its top-of-the-range premium brands are Wylarah and Westholme – both sub-branded as “Queensland, Australia” – and the “heartland” brands, Master Kobe, Kobe Cuisine and Darling Downs Wagyu.

There is a profitable business in there somewhere – perhaps investors buying at these levels might be the first AAC shareholders in a long time to make money.

5. Rural Funds Group (RFF, $2.32)
Market capitalisation: $775 million
12-month total return: 16.3%
FY20 forecast yield: 4.7%, unfranked
Analysts’ consensus target price: $2.42 (Thomson Reuters), $2.42 (FN Arena)

Some potential agriculture investors might feel better suited to being the landlord: RFF is a real estate investment trust (REIT) that owns an $923 million portfolio of 49 diversified agricultural properties, including almond and macadamia orchards, commercial-scale poultry farms, premium vineyards, water entitlements, cattle and cotton assets, all of which are leased to high-quality tenants. The fund is well-diversified both geographically and by crop, and has long-term leases, with a weighted average lease expiry (WALE) profile standing at 11.4 years. The yield is unfranked, but is solid, at 4.5% (expected FY19) and 4.7% (expected FY20), and judging from its recent track record, the trust looks capable of nice, slow incremental increase in its distributions.

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 regard to your circumstances.

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