Australia has long been hailed as the “food bowl” of Asia. Despite this belief, investors have historically been somewhat skeptical about taking the plunge into this cyclical sector, which is subject to the mother of all uncertainties – weather.
On 17 June of 2015 the long awaited China-Australia Free Trade Agreement (ChAFTA) was signed, piquing investor interest. The Deloitte Access Economics Agribusiness Outlook for 2015 highlighted the agricultural sector as having “the strongest competitive advantages for Australia’s economic outlook” as well as the potential to assume the fallen mantle of the once dominant mining sector.
Within the agribusiness sector Deloitte went on to offer the opinion the cattle and beef industry could be the principal beneficiary of the agreement, which went into effect on 20 December of 2015. The prior 12-25% tariffs on imported Australian beef will fade into history within nine years. Not all the review articles on the agreement highlighted the fact there is no existing tariff on live breeding cattle, only on feedlot and slaughter cattle (10-30%) and processed beef. If you are new to investing in stocks that do business internationally, a tariff is essentially a tax on imported goods levied by the host government designed, in most cases, to protect domestic suppliers of the same goods.
Of the 40 ASX agribusiness stocks trading around the time of the signing of the agreement, companies with significant exposure to beef numbered only three – Australian Agricultural Company Limited (AAC), Elders Limited (ELD) and Ruralco Holdings Limited (RHL).
With a market capitalization north of $1 billion dollars, AAC is by far the largest of the three. Yet over the years AAC has rarely graced the lists of hot stocks or must buys. It might surprise investors wary of the agribusiness sector in general, and beef and cattle stocks in particular, to see how these three producers have performed over the long haul. Let’s take a look. Here are five year price movement charts for each company compared to the ASX 200 and the US DJIA (Dow Jones Industrial Average.)
We chose a five year time period for two reasons. First, five years is considered by most market experts to be the minimum time to be considered a “long-term” investment. Second, it was roughly five years ago that institutional investors began to consider agribusiness as a potential sector to replace the mining boom. Note that Ruralco was the only stock not to outperform the ASX 200 or the DJIA. However, it is the only one of the three to pay a fully franked dividend with a current yield of 4.9%. Here are some historical performance measures for these three companies.
AAC has been the only company to achieve positive results in both earnings and shareholder return over three, five, and ten year periods. While Elders and Ruralco are diversified, Australian Agricultural Company is as close to a pure play beef and cattle company as you can get. Its only diversification is substantial property holdings. The company operates farming land for cattle grazing as well as cattle breeding along with a new beef processing facility in Darwin. AAC maintains the largest beef herd in the country
Elders began providing a variety of services to the rural farming community back in 1839. The company has broadened its scope and now offers agricultural chemicals and fertilisers, insurance, financial planning, marketing, and general farm merchandise. The exposure to beef and cattle is broad and deep as well, with feedlots supplying live cattle for international export. Elders Fine Foods exports processed beef from Australia and New Zealand to China.
Ruralco is relatively new to the beef and cattle business, partnering with Frontier International in October of 2013 for exporting both breeding and slaughterhouse cattle. Overall Ruralco owns more than 40 businesses that serve the agricultural community with everything from financing to fertiliser. The company also has partnerships with cattle breeders. The partnership arrangements are suited to an industry with multiple phases to the production process from birth to dinner plate. Typically cattle are bred and raised on farms or ranches before being sold to feedlots once they reach around 500 pounds. Feedlots do what their title implies; the cattle are fed until they get to about 1,000 pounds when it is time to move on to slaughterhouses and meat packers. From there it’s on to grocery stores or specialized commercial processors.
Companies claiming to be “vertically integrated” own multiple facets of the production process, which according to some experts is apparently not that easy to do in the cattle and beef business. A new beef and cattle companies came onto the ASX in 2015 and it is more vertically integrated. The company is Wellard Limited (WLD) which opened on 10 December of 2015 with an opening and closing price of $1.39. The stock is now trading at $0.40 and is likely to go lower very soon. Wellard had already revised its profit guidance from its IPO prospectus twice when it requested a trading halt on 5 August in anticipation of yet another downgrade. The company then requested a voluntary suspension of trading in order to fulfill its disclosure obligations regarding its profit for FY 2016. The statement to the ASX read:
The company requests that the suspension remain in place until the earlier of the commencement of normal trading on August 15, or until the release of an ASX announcement.
The first downgrades were substantial. Less than three months after listing the company dropped its profit forecast from the Prospectus figure of $46.4 million to $42.5 million. In June the company downgraded its forecast to a range of $23.5 to $30 million. Three days later the company downgraded yet again, expecting profit to come in at the low end of that range.
According to the company all three downgrades were due in large part to assorted problems with its livestock transport fleet as well as high cattle prices.
Is this stock for punters only or might bargain hunters find some value here?
Willard is the largest cattle exporter in the country with a fleet of five ocean-going vessels used to export cattle from here and other countries around the world. The company has operated as a Livestock Marketer and Exporter since 1980 and has strong relationships with livestock producers around the world. The business model calls for Wellard to “source” or buy livestock from producers around the world producing more than local demand can absorb. The primary sourcing countries are Australia, Brazil, and Uruguay. Wellard then sells livestock and meat to countries where demand exceeds local production, like China, Indonesia, Viet Nam, Turkey and the Middle East. The company owns needed infrastructure at key stages of the supply chain, such as five quarantine facilities for holding livestock prior to export.
On occasion, the company leases its transport vessels. Wellard also supplies processed sheep meat and has operations in dairy cattle as well. As one might expect from a company in business for more than 25 years, the Pro Forma figures included in the Wellard IPO Prospectus were respectable. Revenue increased 58.2% from FY 2013 to FY 2014 ($273.4 million to $432.5 million and increased another 18.4% in FY 2015, rising to $512.3 million. EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortisation) went from $42,207 to $52,905, an increase of 25.3%.
The company has another vessel under construction and expects to expand substantially in China as a result of a joint venture agreement with Fulida Group of China. This is a 50/50 partnership called the Wellao Joint Venture. Startup plans are for shipment of Australian beef into China and later to build multiple feedlots and an “abattoir” – industry jargon for slaughterhouse – for fattening and then processing cattle imported from Australia.
Judge for yourself, but it seems reasonable to assume an experienced company with a long history operating in a hot sector is at the very least worthy of a place on an investment watch list.
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