Collinson: Feeding the growth in agriculture

Patrick Collinson

America’s searing summer, which has seen temperatures hit 43C (110F) day after day, has left the once-rich cornfields of the Midwest brown and shrivelled.

It is estimated that, in total, 45 per cent of the corn and 35 per cent of the soya bean crop has been destroyed.

But some investors have been able to feast on the famine. So far this year the ETF for soya beans is up 44 per cent, wheat is ahead 34 per cent and corn is up 25 per cent.

But despite the rise in global food prices, the agricultural funds have had surprisingly weak performance. Allianz RCM Global Agricultural Trends is up just 3.6 per cent over the past year, Baring Global Agriculture is up 4.6 per cent, First State Global Agribusiness is ahead 6.2 per cent while Sarasin Agrisar leads the pack with a gain of 9.7 per cent. Eclectica Agriculture is actually down 2 per cent.

Few agricultural stocks have re-rated to reflect the way that the price of underlying commodities have risen – and therein may lie an opportunity. The ‘super-cycle’ of agricultural investing, unlike the hard commodity trade, is not yet long in the tooth.

A recent note from Fidelity entitled “Food: from crisis to crisis”, highlighted World Bank estimates that demand will rise by 50 per cent by 2030. Much of that will be driven by population growth and a big shift in Asian diets to more meat and dairy products. This has a significant knock-on effect on grain demand as it takes 7 kilos to produce 1 kilo of meat. 

Fidelity reckons there could be a “second green revolution” as increased fertiliser usage improves yields in Africa and Asia. It tips fertiliser companies such as Potash Corp, Uralkali and Mosaic as potentially star stock (but more about them later).  

James Govan, manager of the £132m Baring Global Agriculture fund, is thinking along the same lines. “The things we are investing in are about expanding food supply, such as fertilisers, drought-resistant seed, irrigation equipment and so on.”

Although farm output volumes are down in the US, farm incomes are up because of rising prices, which is likely to spark an investment boom in machinery and fertiliser.

Govan also likes Potash Corp (his largest single holding), Agrium and Mosaic in the fertiliser space.

Potash Corp controls 20 per cent of the world’s potash supply, is the world’s largest fertiliser producer as well as being the third largest phosphate and nitrogen producer on the planet. It’s why it’s nearly always at the heart of every agricultural fund. It may also explain why so many of the funds are showing poor performance figures.

Potash Corp makes up 8.8 per cent of the Baring fund (and is a large part of the Allianz RCM and First State funds). It had a fabulous run until the first quarter of 2011, but was hit hard by the euro crisis and fears of a China slowdown. Over the past year it has fallen from C$60 to C$40.

But Govan’s other major fertiliser stock, Agrium, which is 4.4 per cent of the fund, has had a rather better time. It’s at $96 after trading as low as $65 earlier this year. Agrium is a marketer and distributor as much as producer of fertiliser, and it’s closeness to the farmers has helped.

But it would be wrong to characterise an agricultural fund as just about fertiliser and machinery. Govan describes his fund as having three major components – upstream, midstream and downstream.

Upstream comprises of the obvious fertiliser, feed and machinery companies. Midstream is processing and distribution, where volumes are key, while downstream is customer-facing, such as Nestle and Kraft, or even Tesco.

“We have sold a lot of our downstream names this year – we used to hold Nestle and Kraft – because they were looking like they were reaching full value. We consider the upstream sector as more attractive,” says Govan.

“We wouldn’t say the fertiliser companies are at full value. A lot of them have had strong earnings, but have not re-rated.”

The collapse in energy prices in the US following the success of fracking is a massive boost to agro-chemical and fertiliser companies as they are such large users of energy. Fertiliser companies elsewhere will find it tough to compete.

In the machinery space, Govan likes Deere & Co, which at 7.7 per cent of the fund is his third largest holding.

At the company’s Illinois HQ Govan was earlier this year happily test driving Deere’s latest models – not realising he was a fund manager rather than a farmer.

Deere’s share price has more than doubled over the past three years, as it’s a direct play on rising farm incomes. “There is a very strong correlation between farm incomes, which are a function of output+price, and machinery spending. Agricultural volumes in the US will be down this year, but the price is higher, so demand for equipment will remain strong.”

After the drought in the midwest, one of the most in-demand companies has been irrigation systems manufacturer Lindsay Manufacturing, based in Nebraska. It shot up as the drought hit, jumping from about $55 to $75 in a matter of weeks, and although it has edged back a bit since, Govan remains a fan.

Govan is completely sold on the long-term outlook for agricultural investment, even if over the last year returns have been surprisingly weak. “These drivers – population, diet change and so on – are strong and irreversible and will not change even if there are bumper harvests.” Yet overall valuations on agricultural stocks remain low – the Dax Agricultural index is on a price/earnings of 11.9, largely in line with the general market. “I think the outlook is robust,” he adds.

But there are some interesting short-term figures coming out of the ETF market. After the exceptional rises this year in the likes of soya beans, wheat and corn, speculators are getting nervous. According to ETF Securities, there has been an outflow of $622m from agricultural ETFs in the past year, much of it in recent months. Where there are inflows, it is into funds shorting agricultural products.

Maybe agricultural funds are in a super-cycle. Maybe Potash Corp is now a great buy. But if you are going to invest, expect a lot of volatility along the way. And don’t tell your ethical friends. As Friends of the Earth says, the hunger of people should always come before the hunger for profit.

 Original Article Here