Crop boom winners: stocks to watch

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New Britain Palm Oil

New Britain Palm Oil manages 40,000 hectares of oil palm plantations in Australasia, principally in Papua New Guinea. The company raised additional capital of approximately £68m through the placing of new shares at 250p when it listed on the London Stock Exchange (LSE) in December 2007. Since then, the shares have more than doubled to a current price of around 528p, valuing the group at more than £740m.

New Britain has recently reported a large increase in sales, profits and earnings for the year ended December 2007, with sales of $225m (£113.61m) – up 68 per cent from 2006 – and pre-tax profits of $121m (up 81 per cent). Earnings per share increased from 39¢ to 60¢. The rapid growth in sales and revenues was due in great part to the huge jump in the world price of palm oil, which rose from $470 a tonne in 2006 to around $780 in 2007. Gross revenue was also helped by an increase in total crude oil production of more than 13 per cent on the previous year.

Given the doubling in the share price over the past three months, the company is now valued on an historic price-earnings (PE) ratio of 17. Analysts' projections for the next two years are not generally available yet, but profits and earnings are unlikely to rise at anything like the past year’s percentage rate over the next two seasons. There will, however, be further financial gains to be made from new plantings, as well as the yield increases in fresh fruit bunches that will result from established plantations as they enter the full production stage, which usually occurs from the third year after planting onwards.

REA Holdings

This is a well-established plantation company that has, over the past decade, rejuvenated its East Kalimantan oil palm plantations in Indonesia. The group has 67,000 hectares and is in the process of expanding that to around 120,000 hectares as a result of the 2008 acquisition of two Indonesian companies that together own 37,000 hectares. The group has also acquired an additional block of 20,000 hectares a little further away from the existing operations.

The group's results for the year ended December 2007 are likely to reflect a similar increase in sales and profits to that reported by New Britain. One advantage REA has is that the percentage increase in potential planted area appears much greater than New Britain, although REA states that last year's planned programme fell far short of target, so any benefits may be some years away and far too distant to influence short-term share performance.

With earnings per share of 21p last year the shares, at 582p, are valued on a demanding 27 times earnings ratio for 2006. Results this week showed EPS of 91.9¢, putting the shares on a PE ratio of 14.

The longer-term prospects for the group appear exciting, with substantial additions to the planted area planned over the next few years and without the need for significant additional capital expenditure on fixed capital equipment, additional gross margins should flow through to the bottom line, even with product prices falling back from their current peaks.

Anglo Eastern Plantations

Anglo Eastern has approximately 45,000 hectares in Malaysia and Indonesia devoted mainly to oil palm and to a lesser extent, rubber.

For the year ended December 2006, sales amounted to $79.1m (up 23 per cent from $64.3m in 2005). Pre-tax profits were $26.7m (up 25 per cent from $21.5m). Earnings per share (before adjustments) were 38.3 cents (up 24 per cent) and the dividend was 10.8 cents. Anglo Eastern’s valuation is fairly similar to that of REA Holdings, which is hardly surprising as both groups operate the same type of production system in the same part of the world. Indeed, REA Holdings sold Anglo Eastern Plantations in 1989 in order to generate funds to develop a more centrally located operation in Eastern Kalimantan. The scope for future earnings growth, however, appears somewhat lower for Anglo Eastern.

MP Evans Group

The MP Evans Group has plantations in Malaysia and Indonesia and also a significant interest in a large cattle farming business in Australia. The group’s strategy is to sell its relatively valuable, but low-yielding Malaysian estates and to reinvest the proceeds in Indonesia, with the aim of adding 6,000 hectares of newly planted oil palms a year.

The long-term objective is to raise annual palm oil production from 60,000 tonnes to around 400,000 tonnes, with group assets split 70 per cent in Indonesian plantations and 30 per cent in Australian cattle production. These ambitious targets will take some time to work their way through to the bottom line. In the meantime the shares appear to be discounting the likely growth in profits for the next two years.

PGI Group

PGI, valued at £60m, operates in Africa, continental Europe, the UK and the US and is involved in a mixed bag of activities, including the production of tea, coffee, roses, nuts and vegetables as well as investment in Russian real estate.

The company, whose chairman is Rupert Pennant-Rea, ex-editor of The Economist and ex-deputy governor of the Bank of England, has a poor trading record with sales having fallen from £47m in 2002 to £17m in 2006, although rising slightly to £18m in 2007. Pre-tax profits for the ended December 2007 show a recovery to £3.6m, producing earnings per share of 1.13p and a small dividend of 0.25p. Given the mixed trading record of this company and the somewhat un-focused nature of its businesses, the current valuation (the shares are trading on a PE of 39) seems to fully value any potential gains to emerge from a recovery of its interests in Zimbabwe.

Hidong Estate, Inch Kenneth Kajang Rubber and Narborough Plantations

These three small quoted companies are all based in Malaysia and all produce palm oil. Their trading records are poor, although Narborough, capitalised at £7m, produced earnings of 2p a share in 2006, valuing the company at 27 times earnings.

Gem Biofuels

Gem Biofuels was floated on the Alternative Investment Market (Aim) in October 2007 at 60p a share. Since then, investment sentiment has turned against companies involved in biofuels and the share price has fallen by almost 50 per cent to 32p, valuing the company at around £9m.

The company concentrates on the production of biofuels through the cultivation of jatropha on more than 490,000 hectares of land in Madagascar. Jatropha is a bush with seeds that contain up to 40 per cent oil, giving a total sustainable oil production of between 2 and 2.5 tonnes per hectare, equivalent to approximately 15 barrels of oil. At the company’s agreed contract sale price of $500 per tonne the gross value of the final product, after harvesting, transport and processing could be around $1,000 (£500) per hectare. The company’s prospectus estimates that total project oil production could be 45,000 tonnes by 2010 rising to over 200,000 tonnes by 2014.

One of the advantages of this project is that jatropha is a tough sub-tropical plant that is ideally suited for growth in countries such as Madagascar, which have relatively low wage costs and, as it can be successfully grown in poorer soils, it does not compete with food crops. A disadvantage is that it takes five years for the plants to reach full production, so it will be some time before we see full output from Gem Biofuels.

As the timescale for this operation is long, it’s difficult to apply specific valuation yardsticks to Gem Biofuels. However, if the company reaches its 2010 target of 45,000 tonnes of crude oil it is possible to envisage total sales in that year of around $22m and gross margins, after deduction of harvesting, transport and processing costs, of around $300 a tonne. After deduction of establishment costs, overheads and financing expenses, pre-tax profits, excluding re-investment in additional areas, could be in the order of $50 per tonne of oil.

In short, the shares, at a 50 per cent discount to the October issue price, are an interesting long-term gamble on the potential for the niche market production of biofuel from jatropha.

D1 Oils

D1 Oils floated on Aim in 2004. The group produces, transports and refines biofuels with production sourced from a number of countries. D1 Oils is expanding the area dedicated to jatropha, with a total of just under 200,000 hectares potentially available for the production of fuel oil.

Despite the initial enthusiasm for the stock, the share price record has been disastrous, with the shares languishing at 36p, compared with a peak of almost 10 times that in 2005. The main problem is the large losses that have been chalked up since inception. These have risen from £3m in 2004 to over £12m in 2006 and over £10m for the six months ended June 2007. Heavy losses from the two refineries in the UK have hit the company hard. Losses of over 30p a share are estimated for 2007 and 2008. The verdict on this share must be to avoid it for now, although it may represent a speculative recovery stock.

Asian Citrus

Asian Citrus is the largest producer of oranges in China with a total farmed area of 6,800 hectares planted with more than 2m summer and winter orange trees. The original plantation was designed and set up by American citrus experts with particular care taken to protect the citrus against damage from severe weather conditions.

Between 2004 and end June 2007, the company expanded sales from RMB257m (£18.55m) to RMB480m and more than doubled pre-tax profits from RMB164m to RMB374m. For 2007, earnings amounted to RMB319m, equivalent to approximately £23m at current exchange rates. This equates to an historic earnings multiple of 7.6, given the company’s market capitalisation of approximately £175m. The relatively low valuation is due to the recent announcement by the company that full-year results for 2008 will be below those for 2007 as the very cold weather in January and February 2008 has reduced the quality of the current harvest and it has been necessary to accelerate the replanting programme. As a result, the shares have fallen from a peak of around 340p at the start of the year to the current level of 238p.

The erratic share price history reflects the vulnerability to extreme weather conditions of all agriculturally-related shares. The current fall in the shares represents a potentially useful opportunity to make an investment in the Chinese citrus industry, although the dividend yield of 2 per cent does not provide much comfort.

Investment in UK Farmland

The UK applies strict controls on ways in which land may be used for development. These factors mean that there is significant demand for farmland not only from farmers, but also from wealthy individuals seeking peace and seclusion and from developers looking for space to build or improve houses in attractive locations. So, although UK farming profit margins have been under severe pressure over the past decade, the open market price of farmland has moved upwards almost irrespective of the underlying returns from its agricultural use.

Leading UK property agents such as Knight, Frank & Rutley report that the value of UK farmland with vacant possession increased by a staggering 25 per cent in 2007 and this trend appears to have been insulated from the weakness in the rest of the property market.

Clearly the recent rapid increase in farming incomes will put some support under the value of farms and farmland in a period of falling values for other UK real estate. The difficulty for private investors is that there are few ways, apart from direct ownership of farms, in which they may participate in the growth in values. However, there is currently an investment opportunity in the form of Braemar UK Agricultural Land.

Braemar UK Agricultural Land

Braemar Securities, a Cheshire-based and Aim-quoted property management group is offering shares in this unquoted company whose objective is to invest directly in UK farms. The property advisers and farm manager is Humberts and the fund valuer is Knight, Frank & Rutley. The minimum subscription is £10,000 and Braemar is charging an initial commission of 6 per cent. In addition, Humberts is entitled to management fees as well as fees on the purchase and disposal of any properties. And when the fund closes after a five-year period, Braemar is entitled to a fee equal to 20 per cent of any gain over a pre-set hurdle rate.

This investment has the advantage of being a direct play on the movement in farmland values over the next five years, although it suffers from the disadvantages of lack of a ready market in the shares, a relatively high cost structure and a fixed term for winding up the fund. As the company proposes to buy and farm the land in which it invests, the probability is that, after deduction of management costs, annual contractors’ charges and all other direct and variable costs, the annual net income will be very small. This is because the crop gross margin – despite much higher output prices for cereals – will be hit by higher input costs for seeds, fertilisers, fuel and other variables.

However, if farmland prices achieve annual gains over the next five years in line with the past five years, this investment could deliver a gross annual return of approximately 15 per cent, which after deduction of all operating costs, fees and taxation could result in a cumulative net annual return of around 7 per cent over the period.

The closing date for this issue has recently been extended until June 2008.

Conclusion

Although the biggest percentage price increases in the essential traded agricultural commodities such as rice, wheat, maize and oil seeds have now taken place, the outlook is good for efficient producers of these crops, even though rising input costs, especially fuel and fertilisers, are squeezing margins.

Unfortunately this sector is poorly represented in the London stock market with the greatest number of established quoted companies being the oil-palm plantations. In most cases, these are now no more than fair value given the substantial gains in share prices that have already taken place. However, REA Holdings and New Britain Palm Oil are possible purchases on a medium-term view.

Direct plays that appear to have scope for future gains include Landkom, the rapidly expanding Ukrainian farming operation, the ETFS Agriculture fund, Asian Citrus and possibly Gem Biofuels. In the case of Asian Citrus, I would defer any action until more information is provided about the effect on yields caused by the severe weather earlier this year. With Gem Biofuels, I would await the first full-year results.

COMPANIES INVOLVED IN ANNUAL CROPS:

Landkom International

Landkom is a fast-expanding farming operation using the deep black-earth soils of the Ukraine for the production of annual cash crops. The company is concentrating on wheat and oilseed rape using large scale farming techniques based on 10,000 hectare blocks. For the year 2007-08, Landkom has already planted 10,400 hectares and is adding 8,000 hectares monthly to its total register.

The company has carefully researched the most efficient method of aggregating the vast number of small land parcels in Ukraine and has initiated a land lease system that meets both national and local government requirements by which the land parcel owners receive an inflation proofed rental of $35 per hectare.

By March 2008, Landkom had secured 65,000 hectares available for cropping in the next season and is planning to build up to 350,000 hectares by 2010.

Landkom's shares floated on Aim in November 2007 at 52p and have subsequently risen to 91p. The company placed an additional 10.8m shares at 100p in March 2008 in order to raise more cash to fund expansion. Following this placing there are now 200m shares in issue and the group is valued at approximately £190m.

The company's growth potential has been spotted by fund managers Odey Asset Management who have recently enlarged their holding to over 6 per cent of the issued equity.

The company's broker has produced a detailed analysis of the earnings potential and estimates that net losses of around $14m in 2008 could be replaced by net income of $11.7m in 2009 and over $29m in 2010, putting the shares on a potential PE ratio of 6 by that year.

Although there are clearly risks inherent in a company involved in large-scale annual cropping this does appear an attractive investment on a three-year timescale.

OTHER OPTIONS

For those interested in researching other large scale farming operations in Eastern Europe, it is worth looking at Black Earth Farming and Razgulay. Some care is needed with these as neither has a London quotation – the former is listed in Sweden and the latter in Russia.

Plantation companies