Megatrends have a habit of destroying capital when novice investors arrive late at the party. Promoters use big numbers and trends that seem easy to understand. The focus is on top-down analysis even though bottom-up company valuations matter most.
Consider agriculture. Asia’s booming middle-class will drive unprecedented demand for Australian food, spark a “dining boom” and put a rocket under agribusiness. As megatrends go, rising Asian food demand is a powerful, simple story for novice investors.
Food demand will soar as the world population reaches an estimated 9.7 billion by 2050 and as a new generation of middle-class consumers upgrade their diets.
Another 3.1 billion middle-class consumers by 2030, on OECD forecasts, will eat more chicken, beef, pork and lamb. Two billion of the world’s new middle-class will be Asian.
As the world needs to feed an extra 70 million people yearly, arable land is shrinking because of population growth, urbanisation and rising desertification. Greater climate volatility and acute water shortages in some countries are other challenges.
I could go on with forecasts about food demand. But buying Australian agriculture based on Asian dining-boom predications, without analysing companies and valuations, is dangerous.
The smart money (institutional investors) usually invests in emerging megatrends well before the media covers them. The trend’s tailwinds are already factored into the share price – often excessively so, when the hype peaks (think Bellamy’s Australia at $14.52).
Moreover, global competition for Asian food demand is intense. Australia is expected to contribute only 3% of the value of global food exports to 2050, according to studies reported on the Federal Department of Agriculture and Water Resources website.
The nuances of agriculture stocks are another consideration. Like other commodity suppliers, they are price takers in a global market. Volatile soft commodity prices; the vagaries of weather and pests; and the rising Australian dollar’s dampening effect on exporters are key issues.
For the most part, this is not a sector for conservative income-seeking investors. There is good reason why many small-cap fund managers avoid commodity-based companies; one must form a view on commodity prices, which are hard to forecast.
Another issue is choice. The listed agriculture sector in Australia, growing thanks to several Initial Public Offerings in the past five years, is still small by global standards. Most listed agribusinesses are small caps that specialise in a few commodities.
As often happens in booms, the big winners will probably be service providers: companies selling farming equipment, pesticides, software and so on.
I am especially bullish on agriculture-related infrastructure. Up to $100 billion annually has been underinvested in the global food chain since the 2008-09 Global Financial Crisis, estimates Global Thematic Partners, a leading investor in the agribusiness sector.
Asia needs trillions of dollars in investment to upgrade transport infrastructure, storage facilities, refrigeration and other parts of the agribusiness supply chain. Growing enough food to meet Asian demand is one thing; getting it to another 2 billion consumers is a daunting challenge.
Agriculture technology is another fascinating opportunity. The use of data-analytics, artificial intelligence and robotics in farming will transform the sector in coming decades. I have written extensively on this trend and am amazed by its potential.
Investors need to think laterally about the best ways to play the Asian food boom. That’s not to say good money cannot be made from commodity suppliers or those further up the value chain.
I included Treasury Wine Estates in the Switzer Super Report Takeover Target Portfolio several years ago because of its potential to sell more wine in China and its takeover prospects. Treasury Wine’s annualised total return (capital growth and dividends) over three years is 54%.
I also wrote favourably on Costa Group Holdings last year, nominating it as one of three top floats from 2015. The fruit and vegetable grower has a one-year total return of almost 80%.
Rural Funds Group, a niche property trust that invests in farms, was another favourite. Consolidation of Australian farms is an interesting theme and Rural Funds is well placed to buy more assets and lease them. Its one-year total return is about 40%.
Crop protector and seeds provider Nufarm is another long-term member of the Switzer Super Report Takeover Portfolio. Its three-year annualised total return is 24%, although shares are down this year. Nufarm still looks reasonable value for long-term investors.
Another favoured stock in this column, Incitec Pivot, has a one-year total return of 34%. Like Nufarm, Incitec, a provider of fertilisers and explosives, remains undervalued.
Other stocks have disappointed. I wrote favourably on GrainCorp for this report in March 2017 at $8.86. The stock has fallen to $8.10, partly because of less-than-average rainfall. GrainCorp has latent strategic value – grain storage and logistics facilities will become increasingly valuable as global food demand rises. But its short-term outlook is challenging.
Lindsay Australia, another favoured agriculture-related stock in this column, has disappointed. The micro-cap transport provider is a play on rising demand for refrigerated food-logistics services in northern Queensland. Its annualised three-year total return is 3%.
Beef exporter Australian Agriculture Company, another member of the Takeover Portfolio, has disappointed with a three-year annualised return of 5%.
Finding value in the listed agriculture sector is hard work. Having looked at most stocks in the food and beverage sector on ASX, and several agriculture-related stocks from other sectors, I struggled to find value. Several of the most promising agriculture stocks have rallied hard and are fully valued.
These three stocks still represent reasonable value:
1. Inghams Group (ING)
The leading poultry producer has plenty of sceptics. Some believe Inghams’ private-equity owner extracted most of the efficiency gains before its 2016 float. Others claim Inghams is at an unprecedented price and has several disputes with growers – a claim the company denied.
I wrote favourably on Inghams for this report in March 2017 at $3.12. The stock rallied to $3.86 after a slightly better-than-expected FY17 result and now trades at $3.86.
To recap, the long-term outlook is positive, amid continuing growth in chicken consumption. The chicken industry also has better economies than most agribusiness sectors, is less affected by weather and is a beneficiary of new technology that is improving production and lowering costs.
Inghams is not a play on Asian demand for chicken. It sells most of its product in Australia and, to a lesser extent, New Zealand. But it has good prospects and remains modestly undervalued.
2. The a2 Milk Company (A2M)
It’s never easy buying a stock after it soars. The New Zealand milk producer, dual-listed on ASX, has rallied from $1.70 in early 2016 to $5.39 amid rising Asian demand for infant formula.
The a2 Milk Company’s key infant formula supplier, Synlait Milk, this week reported its FY17 result. Synlait’s increased guidance for canned infant-formula volumes suggests continued strong demand for a2 infant formula.
The company is superbly placed to capitalise on rising demand for infant formula in emerging markets. But the market believes the stock is fully valued at the current price: a consensus of five broking firms (too small to rely on) has an average valuation of $5.31, versus the current $5.39. A forecast Price Earnings (PE) multiple of almost 30 times implies a2 is priced for perfection.
The momentum for a2 will continue in FY18, although price gains will be slower from here and a share-price consolidation or pullback would not surprise. Look for a positive trading update at the annual general meeting on November 21 to spark renewed market interest.
3. New Zealand King Salmon Investments (NZK)
The micro-cap salmon producer, another dual-listed New Zealand company on ASX, caught my eye last year during its float. NZ King Salmon Investments raised $74 million in an IPO at $1.07 a share in October and now trades at $1.47.
NZ King Salmon is the world’s largest aquaculture producer of king salmon under its Ora King, Regal and Southern Ocean brands. Most of its exports go to Japan and North America.
I nominated NZ King Salmon Investments as one of five stop IPOs from 2016 in January 2017 for this report, at $1.20 a share (now $1.50).
The company lifted its FY17 earnings guidance in June and reconfirmed its FY18 guidance – always a good sign for a new float. Reported underlying earnings (EBITDA) for FY17 of NZ$21.6 million was 31% up on FY16.
A highlight was Ora King sales up 27% on FY16; the fish is now consumed in more than 850 restaurants worldwide. Global demand for salmon will surely rise as emerging-market consumers include higher quantities of premium seafood in diets. The company’s exports to North America were up 38% on FY16.
NZ King Salmon is experiencing strong growth in Asia (excluding Japan) off a low base. Asian export volumes are just under a third of those to North America but have plenty of room to expand as more people in Asia follow western trends and include a higher proportion of salmon in diets.
Sustainability is a key issue for NZ King Salmon and other ASX-listed salmon producers. Aquaculture has plenty of critics and the industry has regulatory risk. A New Zealand Government review on whether six of the company’s farms should be relocated to higher water-flow sites highlights the risks, although the market seems to have taken it in its stride.
Macquarie’s A$1.83 price target over 12 months suggests plenty of value in the stock at the current A$1.50. I’m not as bullish, but expect solid gains in NZ King Salmon in the next few years as global demand for its fish rises. Recent price weakness after gains in the second quarter of calendar-year 2017 adds to the opportunity.
As a micro-cap, NZ King Salmon suits experienced investors comfortable with higher risk.
Tony Featherstone is a former managing editor of BRW and Shares magazines. All prices and analysis at September 20, 2017.
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