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Continued from here. This series fell by the wayside since September, as I focused on a flurry of posts covering performance, a little shareholder activism, and some pretty exciting new stock buys/write-ups. Oh, and some bubble bursting..! 😉 As a reminder: i) Asset allocation plays a far greater role in returns than perhaps we like to think – in this series I thought I’d try illuminate some of the logic behind my own portfolio allocation & stock selection, rather than individual stock picks, and ii) this portfolio allocation pie-chart might prove handy:

Allocation

The prior Century post & Inflation post are v relevant too: They highlight why I believe inflation won’t prove an issue in the near/medium term, and how to prioritize the choice of real assets (property, natural resources, agri) as inflation pure plays. My expectation of delayed inflation, despite QE Infinity, has choked back my real asset allocation. Also, I consider many of my real asset holdings more special situations, than inflation plays.

Agri (5%):

Soft commodities/farmland are usually the last to substantially benefit when investors are fleeing inflation in earnest. However, the risk/reward of agri stocks is generally far superior than natural resource stocks. Particularly when one considers the low correlation to the economy/markets that true agri investments can offer – which I think argues for a constant agri allocation, regardless of inflation views. But find a great investment theme, and brokers/promoters are sure to ruin it! In a recent Agriculture ETFs post, I surveyed the gamut of closed-end funds, commodity ETF/ETNs, physical ETFs & stock ETFs – and found little opportunity. Mainly due to the lack of exposure to actual biological assets & growth – precisely the exposure you should actually seek out when making agri investments. We’re not talking processors or picks & shovels providers here – you really need:

Farmland, crops, livestock, dairy, forestry, plantations, chickens/eggs, fishing, aquaculture & water.

Farmland (& Crops/Livestock/Dairy):

Farmland’s the best agri investment you can make – it’s the ultimate store of value, and the No. 1 source for biological assets & growth! However… On the one hand, you have companies run from a financial perspective – the less said the better, these are usually promotional in nature & can be expected to lurch from one agricultural crisis/write-down to the next.

Most companies now recognize somebody with agri/farming experience needs to be in (daily) charge, boots on the ground. Unfortunately, this solution isn’t much better. Anybody bitten by the farming bug knows it’s a vocation, not a job. Like a priest & young boys, all a farmer ever sees (& can’t resist) are virgin fields just waiting to get ploughed… That can prove an expensive proposition. Too many farmers don’t even know if they’re turning a profit – they’re bloody clueless when it comes to (free) cashflow & return on investment!

And that’s the problem with most farmland stocks. Yes, many have far cheaper (i.e. non US/Europe) land, which offers marvelous upside, but they usually don’t have sufficient funding for the capital investment needed to improve the land & enhance productivity/yields. Crop/livestock/dairy production tend to actually exacerbate this problem – it ramps up the funding needed for more employees, mechanization, fertilizer/irrigation, inventories, etc. Only a small(er) % of stocks are EBITDA-positive, a fraction of those are net income positive, and almost zero stocks boast positive operating (let alone free) cashflow.

If investors are feeling bullish, they’ll likely ignore all that for a decent period, focus on any positive management metrics, and remain tickled pink at the sheer cheapness of the land. Unfortunately, they gradually see less & less chance of realizing their investment/inherent value, and start bailing out – the stock usually then collapses in tandem with a poorly timed/priced placing or two that dilutes intrinsic value to hell.

The solution? a) Investors must focus on free cashflow & debt – nothing else matters! You’ve got to screen for & invest in companies that can actually fund themselves on a sustainable basis, otherwise you’ll face an almost irresistible stock decline, b) For management, there is a solution: Just buy some land. For God’s sake, don’t farm it (lease it out, if you can). Ensure ample cash on hand, minimize expenses, host a nice AGM, and sell the land in 10-15 yrs time – I’m pretty sure returns will be more attractive, in most cases!

Fortunately, I recognized this exact issue & bailed out of Black Earth Farming (BEFSDB:SS) with little pain – my posts here & here predicted Black Earth & its peers’ subsequent operational & funding issues, plus the relentless decline in their share prices since. Take another look, those posts list most of the available E Europe/Ukraine/Russia agri stocks. These present some v interesting opportunities – a few have eschewed wide-scale land ownership, and may be the better investment choice for the moment. Other stocks to consider:

London has some stocks focused on Africa – Agriterra (AGTA:LN) & Zambeef Products (ZAM:LN). Anglo African Agriculture (AAAP:PZ) is a new/tiny stock – interesting to see what Konrad Legg can do with this. Down Under, we’ve PrimeAg Australia (PAG:AU) (in which Jim Rogers is now showing an interest), Tandou (TAN:AU) & Australian Agricultural Co (AAC:AU). Ozzie farmland looks v cheap vs. the rest of the developed world, but unfortunately reflects its poor utility (in terms of the nutrition & irrigation required – explaining the importance of water entitlements). [Jared Diamond’s ‘Collapse’ includes an interesting, but perhaps over-stated, Australian agriculture study.]

Cristina Fernandez has single handedly destroyed any interest I, or most investors, had in Cresud (CRESY:US). BrasilAgro (LND:US), SLC Agricola (SLCJY:US) & Adecoagro (AGRO:US) are all Brazilian – each time I’ve checked, valuations didn’t appear to offer enough reward vs. risk. Camposol (CSOL:NO) is a Peruvian asparagus/avocado farming company, rather bizarrely listed in Norway. In the US, Alico (ALCO:US) is one of the few true farmland companies. Other companies mostly focus on & derive their value more from land development than agriculture, inc. St. Joe (JOE:US), Tejon Ranch (TRC:US), Consolidated-Tomoka Land (CTO:US), Maui Land & Pineapple (MLP:US) & Alexander & Baldwin (ALEX:US). Considering this bias, their higher land values, the % of land that might ultimately be eligible for development, and the timeline involved, these don’t strike me as being particularly cheap.

For reference, agricultural land values start with Ukraine at rock-bottom levels of approx. $200+ per acre. This reflects the fact land is held on long term lease. Russia is next, with values double/triple those in Ukraine, reflecting full ownership. Values steadily increase as we move from Australia to Brazil, then the US, and end up in the UK/Ireland & W Europe at $8,000++ per acre. Jesus, if you buy W Europe farmland, clearly you don’t believe in the relentless power of arbitrage..!

Real estate agents recommend lie about location, location, location, but I still prefer Russia (& Ukraine) farmland – it offers the most long term upside potential in terms of price & fertility (well, once some companies prove they’re self-funding!). On the other hand, the best farmland – weighing price vs. fertility vs. market access vs. political risk – might actually be in Canada. Unfortunately, there are no listed farmland stocks: Keep an eye on Sprott Resource Corp. (SCP:CN), I suspect they’ll spin-out One Earth Farms eventually.

Forestry:  

There’s a much longer history of listed forestry companies, but you run into many of the same issues. The classic company model was integrated, complete with sawmill, pulp & paper operations. This type of value-add makes perfect sense – but boy, what a lousy industry! Even worse: Like a man with a hammer, all a sawmill manager ever wants to do is cut down trees! Regardless of the market, regardless of price… When you have an asset you can leave idle for years instead, increasing in value, harvesting to ‘feed the beast‘ often proves to be poor value for shareholders.

Fortunately, the more recent trend has been to reverse this integration. Spinning out a company’s forestry tracts has provided some welcome value recognition, but I don’t think it’s really solved the problem. Timber REITs may not have to feed their sawmills – but now they’re faced with the absolute imperative of maintaining their dividend, so the end-result’s the same. This lack of discretion gets duplicated across the globe, which explains the regular bouts of price declines you see in forestry products.

Most of the largest timberland companies are US based, including Weyerhaeuser (WY:US), Rayonier (RYN:US), Plum Creek Timber (PCL:US), Potlatch (PCH:US) & Deltic Timber (DEL:US).

My preference is for pure play timber holding companies/funds. Here, the problem’s the same old lack of cash(flow)… Expenses must be kept low, and ample funding and/or mature timber’s needed for funding. Precious Woods (PRWN:SW) & Rusforest (RUSF:SS) are classic examples: They both own valuable forestry assets, but have proved unable to fund themselves – hence, the 99% share price declines. Phaunos Timber (PTF:LN) & Cambium (TREE:LN) (which now looks set for a wind-down) are global funds suffering from a milder version of the same issue – but both seem intent on raising liquidity, and look relatively & absolutely under-valued (vs. US stocks which have rallied nicely this year).

For reference, underlying timberland values were surprisingly stable after the financial crisis – a reminder timberland offers a consistent & inflation resistant return if you can afford the illiquidity. [Re future prospects, keeping track of Jeremy Grantham & GMO should prove rewarding.] I find a much tighter spread in global timberland pricing (vs. farmland) – government ‘intervention‘ affects farmland far more! I generally use an avg. $1,200 per acre (about $3,000 per hectare) – note hardwoods are rarer & more valuable, and can command $3-5,000+ per acre.

Plantations:

Hard to say if plantations are more forestry or farmland – I guess it depends on the crop! Crops include palm oil & rubber, but also citrus, cocoa, sugar, and tea (grapes should be included here too). However, plantation values generally trade at far more valuable multiples, particularly vs. the price of regular farmland in the parts of the world we usually find them: Asia, Africa & South America. Average prices of $5-10,000+ per acre aren’t uncommon – in fact, that pricing could be the commission for vineyard acreage, a very rarefied market! Plantation land/companies tend to be far more mature, they’re often colonial legacies. They’re usually conservatively run, cashflow positive (unless they’re building acreage), have v productive crop yields, and often pay dividends! They’ve enjoyed attractive crop price run-ups in the past 5-10 yrs, which has greatly contributed to their generally strong balance sheets.

These stocks are now attracting increasing visibility. They are, perhaps, the Rolls-Royces of the entire agri sector, and appealing to more conservative investors. Er well, if those weren’t the very investors most put off by their geographical locations! Once again, I ask: Do you really think investing in Asia (or even Africa!) is more dangerous than standing on Wall Street in ’08, waiting to be steam-rollered?!

MP Evans (MPE:LN), New Britain Palm Oil (NBPO:LN), REA Holdings (RE/:LN), Asian Plantations (PALM:LN), Anglo-Eastern Plantations (AEP:LN) & Equatorial Palm Oil (PAL:LN) are all London-listed palm oil, rubber & cocoa producers, while Wilmar (WIL:SP) & Sime Darby (SIME:MK) are Singapore & Malaysia-listed. There’s plenty more Asian-listed companies to screen for, plus a no. of ex-colonial France/Luxembourg/Belgium-listed stocks (some linked to Bollore SA (BOL:FP)).

Camellia (CAM:LN) does tea plantations, while Cosan (CZZ:US) is a large sugar producer. Treasury Wine Estates (TWE:AU) asserts its position as the world’s largest pure-play wine company. We then have Limoneira (LMNR:US), a large US citrus grower, and let’s finish with Asian Citrus Holdings (ACHL:LN), the lemon orange producer. The Chinese company sham bears certainly seem to be winning the battle here…discuss!?

I haven’t researched the sector in greater detail myself, for two reasons: i) I love the cashflow/balance sheet strength, but the high land values generally deter me – I just don’t see them offering the same upside potential, and ii) I’ve already got a small (undisclosed) plantation holding – it’s a special situation stock, proving virtually impossible to accumulate, but it may easily offer 300-400% of ultimate upside!

Chickens/Eggs:

Presuming quality & bio-security, chicken/egg production comes down pretty much to cost – the producer with the best economies of scale & cost advantage will inevitably dominate… A growing number of Russia/Ukraine agri producers are now achieving the size & quality/bio-security that’s required to export/compete aggressively in international markets. Mexican & Brazilian companies may maintain an edge in terms of N American access, but that leaves the rest of the world wide open for Russia/Ukraine companies.

I don’t see much point  focusing on US producers these days: a) they prefer to focus on their processing activities, b) for a no. of reasons, they’re increasingly secretive about their own production capacity, and/or mostly prefer to now rely on contract producers, and c) they trade at a multiple of Russia/Ukraine producers, despite their growth & cost disadvantage. Here’s a revealing comparison between Cal-Maine Foods (CALM:US) & Avangardco (AVGR:LN) – now basically the two largest global egg producers.

Industrias Bachoco (IBA:US) is a Mexican chicken/egg producer. Pilgrim’s Pride (PPC:US) (now 75% owned by JBS SA (JBSAY:US)) is typical of most US companies – it appears to be a producer but, on closer examination, production’s actually farmed-out to contract growers (though Pilgrim derives some benefit from breeding). We shouldn’t forget the other white meat – somewhat atypically, Smithfield Foods (SFD:US) still appears to produce a large % of its own pork.

In the end, I can’t think of a better choice than Avangardco itself – eggs are cheap & affordable protein, it has a dominant market share in Ukraine, exports are ramping up aggressively, and existing/new capacity is primed for potential EU & Russia approval & exports. My recent letter (to AVGR management) spells out their latest results/growth vs. current valuation, and highlights how a share buyback & some other measures would raise the share price & intrinsic value. I currently have a 2.6% portfolio holding.

Fishing & Aquaculture:  

Fish is another cheap & healthy source of protein. Of course, deep sea fishing’s only cheap because it appears colossally mis-priced. One respected study suggests 90% of larg(er) fish stocks have now been depleted since 1950! It’s obvious quotas/prices haven’t adjusted sufficiently. The industry looks set to enjoy steadily rising prices, but I suspect that will be more than offset by diminishing prospects & volumes. I lean towards the farming camp, but here are some deep sea stocks:

Austevoll Seafood (AUSS:NO), Aker Seafoods (AKS:NO), Pescanova (PVA:SM) & Norway Pelagic (NPEL:NO). Copeinca (COP:NO) might be the better bet, as its business is based on anchovy fishing.

Aquaculture, on the other hand, seems incredibly promising. It offers the same kind of cheap & v intensive production that the poultry industry’s enjoyed for the the past decade or two. But it doesn’t have any animal activist issues (OK, except for the idiots who liberated some farmed fish…which promptly died!). Despite developments to date, there still appears to be huge opportunity to improve yields & bio-security. I’ve followed the fascinating story of AquaBounty Technologies (ABTX:LN) & its AquAdvantage salmon, for example – thankfully I never invested, as I suspected shareholders would never win the prize here.

To date, the industry’s positioned its product as a premium but every-day food. With higher productivity/bio-security & rising emerging markets demand, I believe there’ll be an increasing emphasis on volume, as fish earns a larger share of cheap protein supply. This implies more aggressive pricing, but I expect continued productivity & industry consolidation will more than compensate. It does suggest the larger & stronger companies will benefit most.

That’s an important point: The industry occasionally lurches from surplus to deficit – for example, in 2011-12, we’ve seen Norwegian salmon prices collapse 50% (from admittedly high levels). It also suffers periodically from virus outbreaks, forcing wide-scale quarantine & destruction. These may just be bumps along the road, but it’s a reminder these companies would be better run on a debt-free basis to absorb this volatility. Of course, they weren’t! By 2011, after 4 yrs of fat, the industry seemed to have forgotten the 2006 crash, and was enthusiastically geared up just in time for the latest crash… This latest cycle should produce the usual crop of winners, losers & consolidation.

I believe this is an interesting & potentially v profitable sector to invest in for years to come. I track about a dozen companies, mostly Norway-listed – the largest and/or most attractive include: Grieg Seafood (GSF:NO), Salmar (SALM:NO), Leroy Seafood LSG:NO), Cermaq (CEQ:NO), Marine Harvest (MHG:NO) & Scottish Salmon Co (SSC:NO). I have a small (undisclosed) holding – I didn’t review debt so closely when I began buying (everybody looks comfortable when times are good!), but a great entry price has kept me in profit. My main focus now is to try determine industry prospects vs. share prices vs. balance sheet/cashflow stengths (or weaknesses), before thinking about a potentially more significant position.

Water: 

Another marketing dream…more like a lost cause! Deconstructing a water ETF would be an entertaining exercise, but really just a repeat of this post. Assembling an ETF portfolio seems to be a real bloody joke – just jam in any stock that appears even vaguely related to the investment theme… For water ETFs, that boils down to utilities, particularly when you note their larger market caps.

The idea you’re going to make windfall profits from plodding utilities is ludicrous: a) Like bonds, these safe stocks are rapidly becoming dangerous investments due to yield compression, and b) any secular rise (let alone a step-change) in water costs will inevitably sqeeze them, not help them – governments will impede/forbid them to raise prices accordingly!

Another ridiculous selling point is that America’s water infrastructure’s now 50-100 yrs old & needs to be desperately replaced! I’ve no idea if that’s true, or not – it may just be a steaming pile of lobbyist speak lies – but so what? The same story was true 10 yrs back & nothing’s changed! Aren’t half of America’s decaying bridges due to collapse in the next few years – where are the new bridges?! Anyway, didn’t all Americans switch to bottled water? 😉 Don’t rely on strapped federal, state or municipal authorities to splash out the cash anytime soon on infrastructure. Same goes for other Western governments. That could really put the kibosh on the picks & shovels providers. And btw: Desalination reminds me of ethanol – an energy intensive waste, when far more sensible approaches are available…

Perhaps the only real potential is to invest in companies owning/investing in water rights/entitlements. Opportunities are limited – there are just 3 (US) companies I’ll mention:  Pico Holdings (PICO:US), Cadiz (CDZI:US) & JG Boswell (BWEL:US) (a big cotton producer). These might potentially enjoy attractive prospects & returns, but again don’t expect some overnight windfall – outsized profits would inevitably attract government control & interference.

OK, that’s it! I hope you’ve enjoyed the survey, the pros & cons of true agri exposure & each individual ‘sector‘, and the stock opportunities I’ve listed might just merit your further research & possible investment. I believe the long term opportunity & diversification agri offers is both obvious & attractive. I guess that’s why I’ve focused more on the cons & pitfalls to consider when investing – you can’t win the race if you fall at the first hurdle or two.

Good luck!

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