July 10, 2013
The impending vote to wind up PrimeAg Australia, and a spate of profit downgrades, underline the problems of a listed agricultural sector facing a capital shortfall of up to $850 billion. Especially if the sector is to meet its potential as the “food bowl of Asia”. However, consolidation among food producers – and growing offshore interest –highlight the opportunities for ag companies including AACo, Ruralco and Ridley.
PrimeAg shareholders are expected to support the board’s plan to liquidate the company’s rural land and water portfolio at the general meeting on Monday. Shareholders are also likely to approve two capital returns and the sale of around 60 per cent of the company’s portfolio to US fund TIAA-CREF, reflecting the fact that the listed rural landholder almost never traded above the book value of its assets. “The land plays haven’t set the market alight. They’re quite capital intensive and don’t seem to produce a lot of cash. It’s a real asset play,” Perpetual head of equities Matt Williams said. “The experience hasn’t been great and hasn’t made investors keen to put more money in that part of the market. Because it’s a long-term land play, these things are much more suited to a sovereign wealth fund or a super fund that has long-term liabilities.”
PrimeAg’s demise has sparked rumblings that listed beef company AACo, which has traded below its asset value for a long time, may look to privatise. Equity investors’ wariness of agriculture stocks has not been confined to landholders. Commodity price risk, and production at the mercy of the weather, has made the sector too uncertain for many fund managers.
The swath of recent profit warnings has highlighted the risks. In March, feedstock and rendering business Ridley Corp released a woeful trading update that sent its shares tumbling 18 per cent, prompting Commonwealth Bank analyst Jordan Rogers to cut his 2013 earnings forecasts by 27 per cent. Last week, rural services provider Ruralco warned that profits could plunge by up to 70 per cent, smashing the share price by about 15 per cent over two days, while rival Elders announced material downgrades to its rural services division in March.
Crop protection group Nufarm joined the club with its own profit warning last month, citing the strong Australian dollar and adverse weather conditions. Nufarm shares plunged 17 per cent. Despite all that, Australian agriculture has the potential to enrich the nation through increased jobs, production and exports. According to ANZ and Port Jackson Partners, Australia could increase the real value of its agricultural exports at least by 125 per cent by 2050, pushing their annual export value to $73 billion in 2050. Under a high-case scenario, exports would grow by 250 per cent to $113 billion in 2050. However that growth will require capital. To increase exports for the base figure, it would require investment of $600 billion in farms and supply chains, and $400 billion to fund generational change on farms. For the high case, the capital needs would surge to $1.6 trillion.
That puts the cumulative capital gap at $515 billion, blowing out to $850 billion in the high case. Yet equity investors are tentative about allocating capital to the sector, and debt funding is unlikely to bridge the gap. With the current stress in the Western Australian wheat belt, a property bubble in north Australian beef land and pressures from the live export ban, the major banks may be on the brink of a loan-loss cycle to their agriculture books. “What creates loan-loss cycles for banks in cyclical industries is bouts of euphoric, increasingly leveraged, lending when cyclical conditions are good, premised on rising collateral values, followed by credit rationing when conditions are bad,” CLSA analyst Brian Johnson said in a research note. “Australian banks’ agricultural lending portfolios demonstrate this cycle better than most.”
Plummeting land values in the West Australian wheat belt have driven property transactions to a virtual standstill and a small number of farmers have walked off the land. In some cases, banks have already stretched financing beyond their usual lending standards. Insolvency firm PPB Advisory expects 2013 will be a difficult year for rural property, with a large number of properties already on the market and values having come off by between 20 and 30 per cent in some regions. Contrary to the supposed flood of foreign investment for food security purposes, PPB is expecting a capital contraction in the agriculture market.
The reality is that despite heavy public scrutiny of foreign investment in Australian agriculture, the Foreign Investment Review Board reported a rise in proposed investment in the agriculture, forestry and fishing sector from $1.4 billion in 2010-2011 to $3.6 billion in 2011-2012. The $3.6 billion figure represents about 2 per cent of the total value of approved transactions in 2011-2012. “The romantic notion of the Aussie farmer, with a nation built on the sheep’s back, is part of people’s psyche,” FIRB chairman Brian Wilson says. “The fact is, like all industries, farming is becoming more corporatised and will become more capital intensive to play its part in an increasingly competitive supply chain. “History has shown that Australian corporates in the sector have not been highly successful. If we are going to develop the agriculture sector to its potential, there is a material investment gap. “As it stands, much of that is going to need to come from foreign sources. We will be in a race for capital and a race for development with the likes of South America, Africa and New Zealand.”
With a rising Asian middle class and a forecast increase in global population from 7 billion to 9 billion by 2050, foreign investors with longer-term views are starting to enter the sector. Along with TIAA-CREF, the likes of the Canadian Pension Plan Investment Board have signalled their intent. The consolidation theme running through the food processing segment of the agriculture sector has also helped rekindle investor interest.
Return on capital across the listed sector is weak, with the vast majority of stocks at, or below, their cost of capital. In the case of PrimeAg and AACo, the market’s valuation from a price-earnings perspective was always going to push the share price below the net asset backing, given the poor return on assets. But the potential for corporate action has given new life to fund manager interest. “There’s a story around rationalisation in the dairy industry that will continue to play out. There’s Bega and Warrnambool, and Fonterra’s stalking the land. You can’t tar everything with the same brush and it’s in those areas in which the rationalisation story is more prominent that investors have done the best,” Mr Williams said. Indicative of the mergers and acquisitions interest in the sector, Bega has retained a shareholder cap and built a sizeable stake in Warrnambool Cheese & Butter Factory in a bid to ward off a takeover.
If the market values agriculture assets based on their takeover multiples, rather than a relative earnings multiple basis, then the sector is far more likely to trade near the value of the underlying assets, which should encourage investors.