Green shoots for drought-hit agricultural stocks

For investors, the agricultural sector has been in drought for some time. This is a difficult scenario for many to accept given the perception that Australia has a competitive advantage due to its abundance of land and clean environment.

At present, agriculture contributes more than 2 per cent to total GDP. But it is estimated that if the auxiliary services that support and benefit from the sector are included then the percentage rises to above 10 per cent.

From a volume perspective, estimates from various sources suggest that we produce enough food to feed about 60 million people each year.

Australia exports about 70 per cent of what it produces agriculturally but even if we doubled or tripled production we would still be some way off coming close to meeting the complete food needs of a rising Asian middle class with a growing appetite.

Therefore, the focus for most producers has been on delivering high-quality produce that can command a higher premium in domestic and global markets.

Although this may sound like a great narrative for investment, the reality for agri-businesses and their investors has been far less predictable.

Variables such as volatile soft commodity prices and currencies, changeable weather conditions, labour and water shortages, operational problems, and changing consumer tastes, can make this a difficult sector to function within let alone invest in.

Green shoots

But the sector has produced green shoots over the past 12 months that could offer rewards to investors who rode through the cycle. With many trading at multi-year highs, it is easy to see why investor attention is back on this sector.

From an investment case, we must be pragmatic and remember that the cyclical challenges of the recent past will eventually return. When they do, they will add considerable stress to the operating models of these businesses.

This has nothing to do with the businesses themselves, rather it reflects the cyclical environment that they operate within. Therefore, investors need to be realistic with their expectations and proactive in the management of their exposures to such companies.

Although those who operate in the space are in it for the long haul, investors who take a similar approach can expect no better than a similar boom/bust cycle. So these stocks do not lend themselves to a buy/hold/forget style of investor.

But for those with a shorter investment horizon there are three companies in the agriculture space that recently reported and, through the strength of their results, support the idea that the sector is having its moment in the sun. With the wind at their backs, investors will hope their yields remain strong for the coming 12 months.

GrainCorp

GrainCorp announced at its interim result that it had generated a return from continuing operations of $27 million, which was ahead of most analysts’ expectations. However, it was not just the return to profitability that investors were pleased about.

Rather it was the commentary around the recent autumn rains that had lifted soil moisture across growing areas, resulting in farmers reportedly planting their biggest crops in six to seven years.

After years of drought have hit crop yields in recent years, the outlook for the next two years is better than it has been for the company for quite some time.

Australian Agricultural Company

After two years of losses, AACo returned to profitability with the release of its recent
full-year result. The beef producer also delivered its strongest level of operating
cash flow in three years.

While rising beef prices have helped buoy revenue, the company’s focus on delivering high-quality wagyu beef, which increased sales more than 19 per cent during the period, coupled with a strong cost reduction focus, helped the bottom line.

And though COVID-19 has hit demand in the months since AACo's books closed it believes it is well placed to support demand for quality beef.

Elders

Elders today is a very different proposition from the company that eroded so much investor capital before the global financial crisis.

The modern Elders is a simpler and more focused business that, as it says, is diversified across agri-related divisions. Management is underpinned by a strong financial discipline and focus.

In its latest result, the company achieved 68 per cent growth in underlying net profit and, pleasingly, operating cash flow returned to a strong positive position allowing it to maintain its dividend of nine cents per share.

The company remains hopeful about the year ahead, with the recent rain boosting customer sentiment across all its business divisions.