It’s been a few years now since we first read of the coming “dining boom” and its potential to replace the disappearing mining boom. Long term trends suggest emerging middle classes throughout Australasia will expand demand for our agricultural exports. Yet the instability of market forces in the agricultural sector and the subsequent volatility in the share prices of publicly traded agricultural stocks keeps some investors from pushing the “Buy” button. Here are some reasons to reconsider.
While some Aussie retail investors may take a dim view of investing in agriculture, the M & A activity (Merger and Acquisition) over the last few years suggest foreign investors disagree. The price war over Warrnambool Cheese & Butter Factory (WCB), the acquisition of Goodman Fielder (GFF), the potential bid for Treasury Wine Estates (TWE), and the failed takeover bids for Graincorp Limited (GNC) provide ample evidence of the long term potential of our agricultural sector.
Investors who believe in following the smart money should be aware of the heightened interest of some heavy weight Aussie investors getting into agriculture. Most notable among them is one who made a fortune on the mining boom – Fortescue Metal’s Andrew Forrest. If you follow the financial news you know his latest idea is a grand plan to improve irrigation throughout Australia, and he is going after Chinese investing dollars to turn his dream into reality.
If that isn’t enough to whet your appetite, consider the falling dollar and the price of oil. ASX agricultural companies producing in Australia count costs in Australian dollars but many get paid in US dollars. The ABC recently published a story titled – Agricultural exporters making millions from lower Australian dollar.
The dollar was at 83 cents at the time; has fallen to float around 77 cents, with some economists predicting further falls. In addition to the favourable exchange rate, lower oil prices are reducing operational costs.
Add together long term trends, smart money investments, and favourable exchange rates and it seems only common sense to at least consider some ASX agricultural stocks.
We have an even dozen in the following table. All of them operate domestically as well, and some are diversified. The table lists each company’s major export commodity and uses valuation measures favoured by professionals charged with determining the value of a potential acquisition target. Here is the table.
Share Price (52 Wk % Change)
Clean Seas Tuna
Treasury Wine Estates
Enterprise Value (EV) is considered superior to Market Capitalisation since the formula for calculating EV includes both the company’s debt and cash on hand. In the eyes of a potential buyer, EV gives a fuller picture of the worth of a company. The EV/Sales Ratio essentially takes what the company is worth and divides it by its revenue. The EV/EBITDA (Earnings before Interest, Taxes, Depreciation, and Amortisation) is particularly useful for agricultural companies with substantial fixed assets as the ratio eliminates depreciation. Professional analysts feel this ratio is a better measure of a company’s ability to generate operating cash flow. In both cases, lower ratios are better.
With that in mind let’s begin by looking at the two largest ASX listed agricultural stocks by Market Cap – cattle producer and landholder Australian Agricultural Company (AAC) and grain operator Graincorp Limited (GNC).
A cynical investor might characterise AAC as “all potential and no performance.” The EV to Mkt Cap comparison and the tangible P/B ratio suggests the company is not without value, but the other ratios clearly indicate Australian Agricultural is having trouble generating revenue and earnings. Between FY 2013 and FY 2014 the company increased revenue from $62 million to $322 million but still posted a $40 million dollar loss. Half Year 2015 results released last November showed a decrease in revenue and operating cash flow over the previous corresponding period but the company’s posted loss did show an $18 million dollar improvement over the prior loss.
The company has made significant infrastructure improvements and is a likely beneficiary of the recently signed Free Trade Agreement with China. Investors appear to like the potential turnaround here as the highly volatile stock has been on the rise over the last six months, coinciding with the descent of the dollar. Here is a five year chart for AAC.
The fact that US based Archer Daniels Midland was willing to pay a premium for Graincorp stands as testament to the company’s value. The initial bid came in 2012 at $12 per share which ADM later raised to $13.20. Some analysts thought the company was worth more but by the end of 2013 the deal died, killed by the government, egged on by farmers who rely on GNC.
Graincorp exports malt to brewers and distillers in Europe and the United States with operational facilities in those areas where costs are in the local currency. However, the vast majority of this company’s operations are in Australia where its transport, storage, and distribution infrastructure exports principally wheat and barley produced by local growers.
On 26 February GNC management cut its own forecast for 2015, and the cuts were huge, with an anticipated profit drop approaching 50%. Predictably, the share price collapsed, falling from $10.18 to $9.54 in a matter of days. Despite the revised guidance, GNC still shows 11.5% forecasted earnings growth over two years, with the reported EPS for FY 2014 of 41.4 cents per share falling to 24.6 cents in FY 2015 and then recovering to 51.4 cents in 2016.
Between the strength of the Aussie dollar five years ago, weather related issues, and the back and forth over the acquisition, GNC shareholders have had a wild ride. Here is the chart.
While commodity prices have been problematic for dairy companies, demand is said to be at all-time highs. Bega Cheese (BGA) was first in line to try to acquire a majority stake in rival Warrnambool Cheese (WCB) but the company ultimately lost out to Saputo Dairy, a Canadian firm. However, shareholders of both companies benefited from the ensuing price war, with Saputo buying the minority stake Bega held in WCB. Saputo is the majority shareholder with about 87%. Here is a two year chart for the two.
Bega’s share price recently tumbled following a reported 68% profit decline for the Half Year 2015, despite an 8% increase in revenue. Sanctions banning imports of dairy products into Russia hurt, as did commodity price fluctuations. The company exports its dairy products to more than 40 countries around the world, with the China Free Trade Agreement expected to help China meet its growing demand for dairy products from both Bega and Warrnambool.
The chart above shows while Bega shares were declining the stock price of WCB was going up. Although WCB also reported a profit decline in its Half Year 2015 results, management stated the loss was due to a change in its accounting treatment of milk costs. The company will change its reporting schedule to match that of Saputo.
Webster Limited (WBA) formerly operated in two agricultural segments – walnuts and onions. The company sold its onion operation and is now on the move to grow both organically and through acquisition. Webster’s EV/Sales ratio is below 1.0 and the company has a respectable two year earnings growth forecast of 14.1%.
On 27 February Webster announced its intention to acquire diversified agribusiness Tandou Limited (TAN). Tandou operates in three segments – Water, Cropping, and Pastoral. The Pastoral segment produces organic lamb for Australians and exports to the United States, where health-conscious consumers gladly pay premium prices for anything featuring an “organic” label. The company is a major landholder and grows cotton, barley, and wheat, irrigated by its substantial water entitlements. Tandou has plans to expand the use of its water entitlements to serve urban and industrial areas.
The announcement propelled the share price of both companies into positive territory year over year. Here is the chart.
Almond grower Select Harvest (SHV) has actually benefited from poor weather conditions – in the almond growing region of California in the US. With the US controlling about 83% of the global market, the drought in California sent the price of almonds rising, to the benefit of Select Harvest, the second largest producer with 7% of global market share. The almonds are grown and processed exclusively in Australia, allowing Select to reap the full benefit of the falling dollar from its US revenues.
The share price is up 200% over two years and the company’s average annual rate of total shareholder return is 75% over three years. The numbers in our table suggest SHV might be slightly overvalued, but the company’s two year earnings growth forecast is a respectable 11.6% with a Forward P/E of 12.62. Here is a two year chart for SHV.
Capilano Honey (CZZ) is another company with rising costs in Aussie dollars cushioned by favourable exchange rates. Capilano honey is 100% Australian produced and the company exports to more than 30 countries, supplementing its domestic business. The company went public on 10 July of 2012, closing at $1.87. The share price has risen more than 350%. Here is the chart.
In the face of a strengthening AUD and volatile export markets, salmon producer Tassal Group Limited (TGR) made the decision back in 2011 to focus on the domestic market. At the time Tassal was reportedly generating about 10% of its revenue from exports. Today that number is 1.1%. The move paid off for both shareholders and the company. Here is a five year price movement chart for TGR.
Tassal is an aquaculture company, meaning it produces its product in a fish farming environment. Its salmon is high quality, premium priced. Shareholders have reaped an average annual rate of total return of 46% over three years. The company pays a 50% franked dividend with a current yield of 3.6%. Dividends are forecasted to increase 25.1% over the next two years with earnings growth of 13.5% expected in the same period. As an almost exclusively domestic producer, Tassal does not stand to benefit much from the lower dollar. However, the company could decide to begin exporting again. Even without future export revenue, Tassal has a five year estimated P/EG of 0.99 and a Forward P/E of 11.06. The trailing twelve month P/E is 10.69, well below the sector P/E of 15.9.
The other aquaculture company in the table is Clean Seas Tuna (CSS) which now produces Yellowtail Kingfish following its decision to scale back its development effort on Bluefin Tuna. The company exports to Europe and Japan, getting paid in the local currency. The AUD has weakened against the Euro and stayed fairly constant against the Yen so the currency exchange benefit is not as great. This is a speculative stock, with investors hoping for success in the company’s continued efforts to successfully breed the prized Bluefin Tuna.
Clean Seas went public in December of 2005 at $0.50 per share. Investor enthusiasm regarding the propagation of Tuna drove the stock price up to about $1.75 before the GFC crushed it, with the final nail in the coffin coming from the 2010 bad news on the Bluefin Tuna efforts. Here is a ten year chart for CSS.
The final two stocks are both wine producers. While Treasury Wine Estates (TWE) dwarfs rival Australian Vintage (AVG) by market cap, the advantage ends there. Note that AVG’s enterprise value is almost twice its market cap. Australian Vintage has EV/Sales and Tangible P/B ratios under 1 and an EV/EBITDA ratio under 10. The company’s Forward P/E is 8.72.
TWE is the second largest publicly traded wine producer in the world, with the vast majority of its vineyards right here in Australia. Analysts claim the company has been hurt by its decision to focus on luxury wines, especially in the China market where demand for wine is declining. However, wine demand in the US is expected to grow 11% by 2018, which bodes well for both companies. The TWE share price benefited from a brief takeover flirtation from a US hedge fund that began in May and officially died in September of 2014. Here is a one year chart for TWE.
Both companies export all over the world, but AVG has only begun to penetrate the US market. Australian Vintage may be small, but it has better numbers across the board. The company reported Half Year 2015 Results featuring a 16% revenue increase, attributed to export sales; along with a 72% profit increase before one-off charges.
Half Year Results from TWE were similar and the company heralded a new and improved marketing strategy, but as you can see from the chart investors were not impressed. A few weeks after the release Deutsche Bank reiterated its Sell rating on the stock. And now there is talk former suitor US based hedge fund KKR may come back to the table with a better takeover offer.
One thing to remember about these stocks and indeed all the stocks that could benefit from the falling dollar is that the full impact will not show up until the next reporting period. The AUD decline accelerated rapidly only five months ago. Here is the chart.
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