The world’s population has doubled and redoubled in a century, but food prices have not risen. So where are the investment prospects in agriculture? Not in the produce but in equities …
There is a sobering fact for investors excited by the prospects for agribusiness, amid talk of soaring demand from voracious, urbanising and soon-to-be meat-eating emerging markets.
The real price of food has not risen for a century, judged by trading statistics for corn and wheat prices in America. Over that period we have seen the world’s population double and double again. So if another billion or two mouths want feeding, don’t assume food prices will rocket.
Look at Russia, the world’s biggest country by land mass, which is hopelessly inefficient in both the production and distribution of food. Lifting Russia (and its satellites, such as Ukraine) to the standards and intensity of production in western Europe could be as revolutionary to global food prices as was opening China to manufacturing.
”Eucalyptus trees grown in sub-tropical Brazil can reach maturity in six to seven years, half the time it takes in Australia”
The odd thing about the facts on food prices is that they are presented to me by Skye Macpherson, co-manager of the First State Global Agribusiness fund. She points to figures from the Rogers International Commodity Agriculture index. These show that the return over the past five years has been only 0.1%. Her message is don’t invest in exchange traded funds. You’ll go nowhere, and maybe for a long time.
And money certainly doesn’t grow on trees. During five years in which Chinese factories have gobbled up the world’s forests, the S&P Global Timber and Forestry index has declined by 13.8%.
But next to these indices there is an altogether more attractive line. It’s the Dax Global Agribusiness index, which over the same period shows a gain of 115.4%. So buy agricultural equities, not the stuff coming out of the ground. (article continues below)
Macpherson is happy to trot out the facts and figures about world population growth, but she’s more interested in which companies will win as production expands rather than expecting an explosion in underlying commodity prices.
That said, she sees urbanisation, rather than population growth in itself, as providing a bedrock for higher demand. And every year about 70m people, more than the entire population of Britain, are moving into cities.
Living standards and food quality are likely to be the main growth area. One of her favoured holdings is China Yurun Food, a leading pork processor in a country where pork is the predominant preferred meat. The government is trying to increase cleanliness and environmental conditions in slaughterhouses after several scandals, and Macpherson sees Yurun emerging as a winner. As consolidation sweeps the industry she is confident it can fulfil its plan to take 10% of the domestic market. In Hong Kong, the average person consumes the equivalent of one pig a year, and if China goes the same way, the country will soon raise and slaughter 1.4 billion pigs a year.
Macpherson hails from Australia, whose economy has been transformed by Chinese demand for raw materials. She says similar dynamics are at work in soft commodities. As recently as this year, China moved from self-sufficiency in wheat and corn to becoming an importer. It remains self-sufficient in rice, dairy and beef, but one wonders how long this might last.
But why not just buy a global equity market fund rather than invest in an agribusiness fund? Macpherson acknowledges a high level of correlation between returns on emerging markets and agribusiness, but says agribusiness is higher up the risk/reward – and volatility – scale.
What’s more, the businesses she is investing in are largely based in the West. At present the fund is 55% invested in America and Canada, a function of large holdings in Potash Corp, Deere, Monsanto and Archer Daniels Midland. There is, by the way, barely a British-quoted name in sight. Potash Corp is in an interesting situation. It is the subject of a bid by BHP, and Macpherson is hardly about to sell her holding. The shares are trading at $146 (£93), significantly above the offer price of $130, and she reckons that BHP can raise the bid all the way to $180 before it becomes dilutionary.
Macpherson sees fertiliser producers as a core part of the portfolio. She points to a giant scheme in Brazil to bring former cattle-grazing areas into arable use by adding lime and nutrients to an otherwise sandy and acidic soil. But, again, rather than buying the output, she’s more interested in the inputs, such as tractor companies (for example, Agco, Deere) and the processors at the other end, such as Bunge.
Any mention of Brazil and agriculture raises the spectre of Amazon rainforest destruction. Is this the sort of fund that ethical investors should avoid? Macpherson talks the talk – such as saying that First State is fully signed up to initiatives such as the UN Principles of Responsible Investing – but, more importantly, walks the walk. At the core of First State’s approach is a commitment to company visits. “If a picture tells a thousand words, a visit tells a million,” she says. It’s not just about ethical standards – that will form only a small part of any trip – but it allows Macpherson to take a fully-rounded perspective on a company and its operating procedures.
And in agriculture, geography matters more than in most other sectors. For example, she says that eucalyptus trees grown in sub-tropical Brazil can reach maturity in six to seven years, half the time it takes in Australia (and without cutting down the rainforest). Timber is one of the main overweights in the fund, with bargains to be had following the downturn in American home building, which has sent many companies to valuations 30-40% below their net asset value.
But valuations are a worry. Given the number of agribusiness fund launches, isn’t there a lot of “hot” money chasing the few stocks out there? Is this just a bandwagon that small investors will clamber on, late to the party, only to see the wheels soon fall off?
Macpherson is relaxed. First, the money raised in fund launches that is going into agribusiness is just a small fraction of the sums that have gone directly into soft commodities. Secondly, valuations remain attractive, with the portfolio on average trading at about 15 times next year’s earnings. “This is not a sector that is overvalued,” she says. “Monsanto is now on just 17 times, compared to its peak of over 50.” Macpherson is confident the sector is similar to natural resource funds five to 10 years ago – and look what’s happened since.