Few trends are as compelling as Australia supplying more food to Asia. An extra 2.7 billion middle-class consumers in Asia by 2030 will mean sharply higher demand for meat, vegetables, fruit and dairy. But getting exposure to this trend, at a fair price, is hard work.
There are only 36 food and beverage stocks listed on ASX. Takeovers have reduced the sector’s size, most stocks are small or mid-caps, and the sector generally looks fully valued. It is hard to find any agricultural bargains.
As such, looking beyond the agriculture sector to find companies exposed to the so-called “dining boom” that still offer value makes sense. I identified small-cap transport stock Lindsay Australia for The Bull in August at 38 cents due to its refrigerated-food business.
Lindsay rallied to 42 cents soon after that story, but has drifted back to 36 cents on low volume. It offers reasonable value for long-term investors who want exposure to the North Queensland agricultural sector, which is well positioned to export more food to Asia.
Fonterra Shareholders’ Fund (FSF) is another interesting idea for investors prepared to look beyond traditional agricultural stocks. It listed on ASX through a November 2012 Initial Public Offering, raising $414 million at $4.33 a share – the year’s second-largest IPO.
Chart one: Fonterra Shareholders’ Fund (FSF)
FSF, a New Zealand unit trust, was established as part of Fonterra’s Trading Among Farmers scheme. It gives outside investors exposure to New Zealand’s Fonterra Co-Operative Group, the world’s largest dairy exporter and a strong performer in China.
FSF has an interesting structure. It allowed Fonterra to raise funds, while ensuring its dairy farmers kept control of the co-operative. One of Australia’s great dairy co-ops, Murray Goulburn Co-operative Co, has hinted it might list a similar structure on ASX in the next few years.
Like FSF, a Murray Goulburn trust would allow investors to gain exposure to the co-op’s income stream by buying units in an ASX-listed trust. Investors would receive the same dividend as farmers in the co-operative, and there would be better price discovery of Murray Goulburn’s valuation through trading of its units. And dairy farmers would keep control of their co-op.
I like the look of FSF and will closely follow Murray Goulburn if it lists such a trust. The dairy industry has terrific long-term prospects: the world is expected to need an additional 35 billion litres of milk by 2020, or another 70 per cent on current levels.
World demand for milk represented by the internationally traded milk pool is expected to grow to 85 billion litres a year by 2020, from about 50 billion litres. That means an extra 35 billion litres of milk will be needed within six years – possibly more if emerging countries in Latin America, Europe and Africa also start consuming more milk.
For now, the best-value exposure to this trend is through FSF. It should do better in 2015 after sharp increases in milk input costs and asset write-downs led it to lower earnings toward the bottom of its guidance range. Volatility in milk prices capped a tough year.
Credit Suisse believes FY14 will be a “transition year” for FSF. In a September 10 research note, it wrote: “A recovery in margin for Fonterra is on its way. Additionally, we estimate there is between NZ$700 million and NZ$1 billion upside that could accrue to FY15F group earnings (and shareholders/unitholders) if the current cheese and casein blended price relativity to Fonterra’s reference commodity basket is sustained.”
It added: “Overall global growth in milk collected, processed and sold into the export market will likely cap a meaningful recovery in dairy commodity prices in the next 3-6 months, if not longer. While this brings little joy to the dairy farming community, for Fonterra it should provide significant relief from the sharp increases in milk input costs the group has had to absorb and endure over the last 12 months in its consumer brands and foodservice businesses. Significant margin relief for Fonterra is now on its way.”
Longer term, FSF should benefit from continued strong growth in dairy export volumes to emerging markets. And I like its strategy to become a value-adding consumer and dairy foodservice business, with major dairy hubs across the world.
Like FSF, Murray Goulburn also wants to move up the value chain through innovation. Rather than export only dairy commodities, it sees great potential to sell higher-margin branded dairy products, such as infant formulas and cheese spreads, to middle-class Asian consumers.
Credit Suisse has a 12-month share-price target of NZ$7.65 (A$6.93) for FSF. It traded at A$5.69on ASX this week, down from a 52-week high of $6.50, having underperformed the market this year. If Credit Suisse is correct, FSF could deliver a total shareholder return (including dividends) of up to 25 per cent over 12 months.
Morningstar estimates a 5.1 per cent yield in FY15. It values FSF at $5.40 a share and has a hold recommendation, although says its “2015 estimates could prove to be conservative”. FSF suits long-term income investors who want exposure to rising global dairy demand, without as much risk as buying small, pure commodity plays. FSF is due to report later this month.
Tony Featherstone is a former managing editor of BRW and Shares magazines. The column does not imply any stock recommendations. Readers should do further research of their own or talk to their adviser before acting on themes in this article. All prices and analysis at September 17, 2014.