One of the most frequently cited long term global economic trends is the rise of an Asian middle class.  It is no secret that the demand for better quality food is an outcome of increased consumer buying power.  Despite the strength and the proximity of the Australian agricultural sector, the performance of ASX agricultural stocks to date indicates a high degree of investor scepticism regarding the ability of our agricultural sector to capitalise on this trend.  A ten year price movement chart for two of the largest agricultural stocks on the ASX says it all.  Here is the chart for beef producer Australian Agricultural Company (AAC) and grain producer and distributor Graincorp Limited (GNC.)

The GFC hit both companies hard and recovery has been minimal, in stark contrast to many other ASX stocks.  Despite the global concerns about the demand for iron ore and volatile prices, the beneficiaries of the pre-GFC mining boom have shown evidence of investor interest.  Here is a ten year chart for our largest iron ore producers, BHP Billiton (BHP) and Rio Tinto (RIO).  

It would seem most investors aren’t buying into the argument the mining boom will be followed by the dining boom.

However, “whale watchers” have certainly noticed a growing number of big-name investors getting into the sector.  The latest is mining titan Andrew Forrest of Fortescue Metals who in May bought Harvey Beef, the largest beef processor in Western Australia.  Forrest has also been in the financial news of late calling for Australian agriculture to “to market itself as one brand to be internationally competitive,” similar to what New Zealand has done with the Fonterra co-operative of dairy farmers.  The Fonterra story was a driving factor in the bidding war over Australia’s Warrnambool Cheese (WCB) with privately held Australian dairy co-operative Murray-Goulburn ultimately losing out to Canada’s Saputo Corporation.  Murray is reportedly considering an entry on the ASX to raise capital for expansion.  Murray CEO is adamant in his belief Australian agriculture needs consolidation to be able to compete on a global scale.

The Business Council of Australia (BCA) commissioned international consulting firm McKinsey & Company to prepare a study of Australian competitiveness, released under the title Compete to Prosper: Improving Australia’s Global Competitiveness. The focus of the paper is what governments can do to promote an “innovative and dynamic” economy.  Of interest to investors casting a wary eye on agricultural stocks is the paper’s conclusion that “agriculture is the only industry in Australia that is “strongly competitive” and still has plenty of untapped potential.”  

The federal government is in the process of drafting an Agricultural Competitiveness White Paper which will include feedback from industry players.  Industry leaders have long been calling for more spending on rail infrastructure and some believe relaxing of the competition standards to allow greater scale through consolidation is necessary for the agribusiness sector to thrive.

With a few exceptions, agricultural stocks have performed poorly, and the announcement of Russian sanctions on agricultural products from Western nations, including Australia, is not likely to move the needle upward anytime soon.  However, investors with tolerance for risk and thirst for reward should be taking notice of the positive potential here.

To that end we are going to look at two categories of ASX agricultural stocks – food producing exporters; and the companies that serve and supply them.  

Food Producers

The following table lists six ASX food producers with exporting capability and additional potential, ranked by market cap.

GrainCorp Limited (GNC) is the largest agricultural stock on the ASX.  The company produces, processes, stores, and ships a variety of grain products, from wheat to barley and malt.  GrainCorp operates its own grain export facilities.  This company has had a tough year stemming from the twin risks that keeps many investors on the sidelines – weather and volatile commodity prices.

Half Year 2014 Results showed a dismal drop of 43.3% in NPAT (net profit after tax) and a 13% decline in revenue.  Shares were trading at $8.84 prior to the release but only dropped about 1%.  Apparently some investors remain convinced GrainCorp, which had been a takeover target, will again be approached by US agribusiness Archer Daniels Midland.  That company offered to buy GNC for around $12 a share back in 2012.  A two year price chart shows the initial reaction to the deal and the subsequent reaction when the government quashed the bid.  Here is the chart.

Since the earnings release GNC has seen some positive news.  First, the ACCC (Australian Competition and Consumer Commission) granted GNC’s request for regulatory relief at one of its export terminals and it is expected the other terminals will get the same consideration.  GNC is facing competition from port facilities being built by Qube Holdings (QUB) and Hong Kong’s Noble Group.

Second, the company announced a $200 million dollar “Project Regeneration” designed to increase the capacity and efficiency of its storage facilities and port network.  Finally, GrainCorp has taken a 10% stake in Egyptian flour mill Five Star Flour Mill, paid for with cash reserves.

Bega Cheese (BGA) started the bidding war for rival Warrnambool Cheese (WCB) but dropped out in December, later selling its existing stake in WCB to eventual winner Saputo. Bega exports its products to Asian markets through distributors located in Singapore, Hong Kong, China, Malaysia, Taiwan, Viet Nam, and Indonesia.

Bega reported solid Half Year 2014 results back in February, showing a 4% revenue increase along with an 18% rise in NPAT.  Perhaps of more importance to investors was management’s statement that demand for dairy products in China is going up while domestic Chinese dairy production is declining.  

Bega’s P/E and P/B could be considered an indication the stock is overvalued, but underlying the relatively modest P/EG of 1.42 is a 2 year earnings growth forecast of 17.9%.  In addition, the stock price is up 80% over two years, with little notice of the company’s failed bid for WCB in December of 2013.  Here is a two year price movement chart for Bega Cheese.

Australian Agricultural Company (ACC) is the country’s largest producer and exporter of cattle and beef products and has property ownership interests as well.  AAC was also plagued by weather conditions in FY 2014 and the results reflected that.  Revenues declined 20.7% and NPAT was a loss of $39.9 million, although that was an improvement over the FY 2013 loss.  On the positive side, operating cash flow increased and gearing dropped.  The results were reported on 28 May and the stock price fell, but has since recovered a bit.  Here is a six month chart for AAC.

Investors liked what they heard in the 13 June announcement the company had bought two properties near the new Darwin processing plant that will provide improved sorting and holding facilities for cattle.  

The Darwin facility will eliminate the need for northern herds to travel to processing plants in the south and may be one of the reasons AAC’s share price has held up despite its lackluster profit performance.  The company is currently trading below its book value per share of $1.41.

Clean Seas Tuna Limited (CSS) and Tassal Group Limited (TGR) both stand to benefit from the Asian appetite for quality sea food, and both operate in a sector with potentially massive promise – aquaculture.  Basically, aquaculture is fish farming.  Successful companies produce their own products without the cost and risk of fishing the open oceans.  

Tassal Group is the larger and more successful of the two, beginning its farm production of salmon more than 25 years ago.  The company went public on the ASX in 2003, closing its first day of trading at $0.39.  The first years saw the company struggling with lower margins from exports, and six years ago Tassal changed its focus to higher margin domestic consumption.  The move appears to have worked.  In its latest Annual Report, the company announced it would not be forecasting export sales in the near future.  However, the report went on to note the rising price of salmon on the global market, with the demand far exceeding available supply.  It would seem then Tassal Group could re-enter the export market when the time is right.  The 2014 Half Year Results showed a 42% increase in NPAT, even though revenues declined by 0.7%.

Successful aquaculture on a large scale must be wetting the appetites of investors looking for disruptive technologies.  How else could one explain the share price comparison over the last two years of the much larger and profitable Tassal Group with the tiny Clean Seas Tuna that has yet to earn a single dime.  Here is the chart.

Clean Seas unintentionally demonstrated how difficult fish farming could be when its ambitious plans to grow lucrative Southern Bluefin Tuna failed.  Simply put, the hatchlings never reached adulthood.  In December of 2012 the company boldly announced it was abandoning that dream in search of another – the propagation of Yellowtail Kingfish.  Many investors bailed out and the share price fell before beginning its rebirth a scant six months later.

In November of 2013 the company’s Production Update reiterated its successful Yellowtail Kingfish production to date and announced it expected its maiden operating profit in FY 2015.  Patient investors have endured capital raises to fund operations and the stock price, while volatile, has continued in an upward trajectory.

Tiny Farm Pride Foods (FRM) is, at the moment, strictly for punters.  The company has been producing eggs in Australia for more than 70 years and now exports to Asia.  The share price had risen about 80% year over year when the ACCC stepped in and filed a court case charging the Australian Egg Corporation, an industry wide provider of marketing and research services, with operating as a cartel.  Although the case is still before the courts, the industry’s position is that a massive oversupply of eggs led to a meeting of the country’s top 25 producers to deal with what it saw as a crisis.  What the ACCC saw was an attempt to artificially restrict supply through culling of birds and widespread donating of eggs, to force a rise in the price of eggs.

Getting dragged into court is never a good thing, but given the low P/E for FRM and the fact its book value per share of $0.41 is about four times its share price, this company may be worth watching until the court action is complete.  Here is a one year price chart for Farm Price Foods.

Agricultural Services and Supply Stocks

Now we move on to companies that benefit from sector growth overall.  We looked for stocks with the best growth prospects.  All of the companies have Price to Earnings Growth Ratios less than 1.0.  Here are three companies with potential.

On 27 March 2013 Nufarm lost the rights to distribute Monsanto’s week killing product, Roundup. The stock price has yet to recover.  Here is a two year price chart for NUF.

The company has since announced reorganization plans of both its manufacturing operations and its executive management team. The stock price got a bump on the announcement the company would close its New Zealand manufacturing plant, a cost saving measure.  However, on 15 July Moody’s Investors Service lowered Nufarm's credit rating and the resultant drop was predictable.  

Nufarm is global in scope and bad weather around the world was highlighted in the company’s Half Year 2014 Results presentation on 26 March.  Despite those conditions, the company managed to show a 21.8% increase in revenue and a 124.1% increase in reported NPAT.

Ridley Corporation Limited (RIC) is primarily a provider of animal nutritional supplements for Australian producers in the beef, dairy, poultry, pig, sheep, and aquaculture industries.  Ridley serves companies both large and small, with a substantial presence in Australia’s rural agricultural regions.  In addition, the company provides supplements for laboratory animals and recreational horses and dogs.  

The company had also been involved in the manufacture and sale of salt, but in January of 2013 Ridley announced it had closed its salt operations, moving the land into the company’s property investment portfolio.  The share price dropped and has yet to recover.  Here is a two year chart for RIC.

Like Nufarm, Ridley reported stellar Half Year Results with a 26% increase in revenue and a 178% in NPAT; and also like Nufarm, the share price gains largely evaporated.  

The final company is yet another with impressive performance and future growth many investors seem to be ignoring.  Ruralco Holdings Limited (RHL) provides agricultural products and business services to primarily rural producers.  The company has more than 500 outlets across Australia selling branded products.  In addition, Ruralco offers financing assistance, insurance, and property management and real estate services.  

On 20 May Ruralco reported Half Year 2014 earnings.  Revenues rose 13.7% while NPAT was up 57.4%.  The stock price rose, but soon faded away.  Here is a one year chart for RHL.

While the unpredictability of weather conditions may be scaring off individual investors from agricultural names like Ruralco, private equity appears to be taking notice.  The Australian Financial Review ran an article back in May stating that Kaplan Equity Investment began buying into RHL in December of 2013, with its current stake at 12.4%.  Kaplan also took a 5.32% interest in Australian Agricultural Company, for a total investment of around $65 million.  What do they see others don’t?

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