Following previous articles on investment drivers, including population growth, global debt and monetary easing and inflation, the continuation of this series will look at investment themes that benefit from the demographic, economic and political situation over the next ten years.
Investment Theme 1: Agribusiness
We have strong expectations in the Agribusiness sector, especially when it comes to food producers. Firstly, it is important to realise that food is a commodity. As a matter of fact it is the ultimate commodity as it is essential for the survival of our species. Like all commodities, the price of food will vary in response to supply and demand. We can simplify this further by stating that supply is a question of hectares harvested and weather conditions and demand is above all a question of population growth. We saw a few weeks ago that world population is growing rapidly and is expected to increase by 30 per cent in the next 25 years. It is not necessary to be a Nobel Prize winner in Economics to expect demand for food to continue to increase in the coming years. Food demand is expected to surge in all categories.
We know about population growth expectations therefore the question becomes “will supply be able to cope with the increase in demand”?
According to research from the Food and Agriculture Organisation of the United Nations the simple answer is yes. “Detailed analysis shows that, globally, there is enough land, soil and water, and enough potential for further growth in yields, to make the necessary production feasible. Yield growth will be slower than in the past, but at the global level this is not necessarily cause for alarm because slower growth in production is needed in the future than in the past. However, the feasible can only become the actual if the policy environment is favourable towards agriculture.”
I would agree that in a perfect world we could feed our growing population without supply constrains. Note that I use the phrase ‘a perfect world’, where government budgets would be balanced and the world would live in peace. However the world is far from being perfect. We see multiple risks ahead that will affect the cost and the production of agriculture goods. These include climate change, deforestation, declining oil reserves, species extinction, water shortage, land exhaustion, pollution and the growing demands for a higher calorific diet from emerging markets.
We put the probability of seeing the environment for agriculture continuing to deteriorate going forward at close to 100 per cent. We should, therefore, expect food inflation to accelerate in the future. Food inflation is the core reason we see agricultural corporations and their providers as a great investment for the years to come. Either they will grow like the rest of the economy or there is a shortage in supply and prices will increase much faster than other sectors. We consider the entire food chain as a lucrative investment, from farms to restaurants.
Nevertheless we recommend staying closer to the beginning of the food chain. Our research indicates that when inflation picks up farmers will be better positioned to increase their prices and pass it forward. The grocery store or the restaurant may not be as lucky and may experience margin squeeze. The market collapse of Chipotle Mexican Grill (CGM) in 2012 is a good example of this. Great brand, great meals and great management, however there is a limit to how much people will pay for a burrito. When the price of pork and rice increased, CGM’s margins got squeezed and we saw the stock’s price drop by close to 50 per cent. Conclusion: the closer to the ground, the better.
For investors looking for growth without excessive volatility the best approach to the agribusiness would be to participate through an ETF. We particularly like the Market Vectors-Agribusiness ETF (MOO) and the PowerShares DB Agriculture Fund (DBA).
MOO is a global ETF which holds 51 positions, presents a four stars Morningstar rating and is geographically well diversified. DBA invests directly in food commodities through futures providing investors with a basket of 11 different commodities – from cattle to wheat.
For the investors looking for higher returns and who can stomach more volatility, we specifically like Adecoagro SA, (Agro). Agro is a pure farming play, the corporation owns and operates more than 40 different farming assets throughout Argentina, Brazil and Uruguay. It is a small cap with high volatility and we should note that it is down 12 per cent since becoming public in January 2011.
The depreciation of the real in Brazil and the political situation in Argentina have hurt the company’s value but we remain confident that this farming conglomerate will deliver great value overtime, especially if you purchase the stock below $8.00 per share.
The agribusiness presents a great risk reward profile going forward; you will either get market return if FAO is right or much better if supply can’t cope with the demand as we predict.