Harvesting Profits from Agriculture Investment

Demand to eat healthier is growing in developed and emerging markets

With careful analysis, we are able to identify many attractive companies. By way of example, Adecoagro, a leading Argentine agricultural producer, has the potential to see a doubling in profits within two years according to our research.

We believe Adecoagro is a well-run business that stands to benefit from an easing of grain export taxes by Argentina’s new business-friendly government. Export earnings should also get a further boost following the recent devaluation of the Argentine peso.

Similarly, Bunge, the US-listed agricultural processing and trading company, has substantial assets in Argentina and should benefit from higher export volumes. Argentine farmers hoarded stocks while conditions to export were less favourable. Positively, we expect these stocks will soon be brought to market due to today’s better incentives for farmers to export.

Structural Growth

We have been increasing our exposure to the Health & Wellness niche, with 25% of our strategy invested in companies active in the space1. We see long-term, structural growth opportunities in this area. Demand to eat healthier is growing in developed and emerging markets, with countries such as Mexico introducing a sugar tax and others witnessing campaigns to act similarly.

Within Heatlh & Wellness, we would highlight Glanbia the Ireland-listed global nutrition company. In our view, Glanbia is a quality company with an excellent franchise. Brands such as Optimum Nutrition, BSN and Isopure cement its position as the leading sports nutrition franchise globally in one of the fastest growing segments of the global foods market.

Another example is Symrise, the German fragrance and flavours maker. We consider the company’s management to be strong in terms of both strategy and execution in what is a highly competitive market. Symrise has been able to outpace the competition in this long-term growth market and with its strong franchise we see this continuing going forward, supplemented by acquisitions.

The Farming Economy

The El Niño weather pattern was remarkably strong in 2015. Historically, this coincides with increased occurrences of La Niña, its reverse sister pattern, which could emerge this year – although there is a nearly equal probability that weather patterns will simply normalise. If a strong La Niña occurs during the summer season in 2016, we could see disruptive weather hit major grain and oil seed production areas hard as we saw during the drought in North America in 2012.

It is too soon to predict crop production for 2016.

The world has been fortunate to experience three years of robust production without any major exporting region facing significant issues. However, we would highlight that our strategy has the flexibility to invest across a range of subsectors, allowing us to benefit from both lean pricing during bumper crops and high prices amid lower production.

In the near term, we are constructive on crude palm oil producers, as we think the crop will be supply-constrained in the short term. Plantation owners believe production for the first half of this year has already been negatively impacted due to the El Niño conditions of lower than average rainfall last autumn.

The global farming economy is seeing currency play a major role in profitability, as soft commodity pricing is in US dollars, but a considerable portion of costs are in local currency. In regions such as the US and UK, where exchange rates are comparatively less favourable for exporters, farmer profitability has been depressed. In contrast, farmers in Continental Europe are benefiting from a weak euro and the Brazilian farmer is enjoying record profit margins due to the substantial decline in the Brazilian real vis-à-vis the US dollar.

Longer Term Investment Case

Short-term challenges seem to have coloured the market’s long-term view of agriculture equities. Yet, the fundamental drivers for agriculture longer term have not changed. Demand for food is still growing and the world is consuming corn at a record pace. The outlook for food demand remains positive with a growing population, which includes a forecast doubling of the middle class to 4.9 billion by 2030.2

This increasing wealth is likely to lead to changing dietary habits with an increasing proportion of meat, fish and dairy as part of the diet, which is grains intensive to produce. It takes eight grams of grain to produce one gram of beef. This growth in the middle class is also fuelling the demand for healthier foods and providing a tail wind for the Health & Wellness sector.

Conclusion

In conclusion, we see opportunities in 2016 throughout the agricultural value chain, particularly in the Health & Wellness niche. Stock selection is becoming increasingly important in the more traditional farming-related sectors with the lower soft commodity prices. Longer term, we believe the investment case remains strong with absolute demand for soft commodities set to rise and increasing pressure on the industry to boost production with all the vagaries of the weather.

The short-term de-rating in the asset class means that it can be accessed today at what we regard as attractive valuations.

In this respect, we note that agricultural equities held in our strategy currently trade at a discount to global equities, with a next twelve months price to earnings ratio of 13.7 against 15.4 for the MSCI AC World Index. At the same time, the consensus sell-side earnings estimates for the companies in our strategy stand at 14.7%, against 8.9% for global equities.

Disclaimer
The views contained herein are those of the author(s) and not necessarily those of Morningstar. If you are interested in Morningstar featuring your content on our website, please email submissions to UKEditorial@morningstar.com