Global agriculture is a compelling and readily comprehensible investment theme, but tapping into the growth in the sector isn't always that straightforward - especially for UK investors - as home-grown options are thin on the ground and under-capitalised, so the viable equity options are invariably located offshore. You could let somebody else make the decisions for you, but a managed fund isn't for everyone, while exposure to soft commodities through derivatives is an area best left unexplored.
However, the ability to create a relatively low-risk, income-generating portfolio is being facilitated by the push towards consolidation across the wider agricultural complex. Contrary to what you may read in the weekend newspapers about the rise of artisan food producers and a return to sustainable farming practices, the global farming industry is following the trend towards industrialisation that has characterised the US sector since the 1950s. Within a decade or so, a relatively small number of multinationals will wield disproportionate influence over the process that governs what's grown in the field, to how it ends up on the end of your fork.
Two of our farm tips performed creditably over the past few months despite mixed signals from the agricultural sector as a whole. Switzerland-based biotech developer Syngenta AG's (SYNN.VX) share price has risen 15 per cent since we reiterated our 'buy' call in August, while the market valuation of farm machinery giant Deere & Co (DE.NYSE) is up by 11 per cent since July. This is a decent aggregate return over a relatively short time, although it's worth noting that neither stock was re-rated to reflect the impact of the drought that ravaged farming regions in the US and Latin America.
Towards the end of last year, Syngenta felt able to raise its 2020 sales target by $3bn (£1.85bn) to $25bn, on the back of new technological developments, and the successful reorganisation of its business model. Curiously, Syngenta remains one of the preferred agricultural plays for US hedge funds. This somewhat dubious distinction would have been enhanced towards the end of September, when it initiated a €403m (£335m) deal to acquire Devgen NV - a Belgium-based hybrid seeds specialist. The move gives Syngenta control of an established integrated seed business in the strategically important Indian and south-east Asian markets.
The concentration of a small number of corporations within the world's proprietary seed market is a source of great controversy. Critics claim that the dominance of a handful of players – most notably, Monsanto (NYSE: MON), Syngenta and DuPont (NYSE: DD) - has not only eroded competition, but also poses a potential threat to food security as a consequence of the reduction in seed diversity. Whatever the ethical, scientific or free-market implications, the Devgen deal probably makes a good deal of commercial sense.
Making hay during the drought
When we updated the investment case for Syngenta in August, we pointed out that it was difficult to assess the full impact of the US drought. For consumers, the planting/harvest cycle of US agriculture dictates that most drought-linked food price increases will only become apparent during the first quarter of this year. However, we did venture that the drought might eventually be seen as a harbinger of "increasingly erratic weather" patterns. A widespread acceptance of the climate change doctrine would present "longer-term opportunities" for companies such as Monsanto and Syngenta as they will find it easier to leverage their technical expertise - both companies are developing strains of crops designed to thrive in arid conditions. There's evidence to suggest that seed and fertiliser companies enjoyed a strong autumn in the US as farmers were quick to lock in contracts for 2013.
Despite moving into 2012 with a bullish outlook, Deere & Co experienced difficulties in some of its mature European markets. However, it continued to aggressively pursue market share in stronger-growth regions such as Brazil, Russia and China. Analysts remain positive on prospects for the group in 2013, although revenue growth in its principal markets could be subdued despite the efforts of central banks to boost global liquidity. Short-term performance will always fluctuate, but, even excluding dividends, shares in Deere & Co have returned in excess of 250 per cent over the past decade. The long-term investment case is as compelling as ever.
Farm M&A bucks the trend
Agriculture is increasingly a top-heavy industry from a global perspective; a fact borne out by a recent assessment of M&A activity in 2012. The findings - published by intelligence provider Mergermarket - show that while the aggregate value of global M&A declined by 3 per cent from 2011, the agricultural sector recorded the largest increase in value, up almost 41 per cent to $14.3bn. The scale of some of the deals has certainly been eye-catching. Last month, commodities trader Glencore (GLEN) finally received regulatory approvals that allowed it to complete the $6.2bn takeover of Canada's largest grain handler, Vinterra Inc, while ADM is currently pursuing a $2.8bn hostile bid for Australia's GrainCorp (ASX: GNC) - one of the few grain traders yet to be swept up by the wave of industry consolidation. We expect to see more of the same in terms of M&A activity through 2013, particularly given the state of sector balance sheets, and the desire of conglomerates like Glencore to expand their agricultural interests.
The move for GrainCorp reflects the desire of agribusiness giants like ADM to pursue an integrated business model. It's relatively straightforward to achieve this in world grain markets, but some soft commodities present a more complex challenge. For instance, one of the most fragmented worldwide production profiles is linked to cocoa. There are as many as 5m households that produce cocoa as a cash crop, mostly in small family-run farms in a narrow tropical belt across West Africa, south-east Asia, and Latin America. Cocoa farmers generally have limited access to capital, and are constrained by their land holdings. These factors mean that it is very difficult to increase production to meet rising global demand. A study published by global consultancy Bain forecast that Chinese demand would increase by 11 per cent annually over the next five years, while parallel research conducted by global information provider Nielsen gave a figure of 30 per cent.
A way to milk the Kiwis
This inability to exploit demand trends has frustrated specialist chocolate manufacturers such as Barry Callebaut (SIX: BARN), but the relative inelasticity of supply certainly provides opportunities for anyone willing to utilise exchange traded products, although agriculture and energy were the two commodity classes to see net withdrawals by investors from exchange traded products last month, according to Societe Generale. Exchange traded products certainly aren't suitable for every investor, but there are other ways of gaining exposure to specific agricultural commodities.
Last month saw the launch of the NZ$525m (£276m) Fonterra Shareholders' Fund (FSF: NZ) on the New Zealand Stock Exchange. Fonterra is a global, farm co-operative that is responsible for around one-third of global dairy exports. The Fonterra fund effectively gives access to the dairy co-operative's dividend flow, and the growth in Asian dairy demand. Asia has emerged as the strongest growing region for milk and dairy product consumption; Chinese consumer spending on dairy products has jumped by 40 per cent since 2006, while industry analysts predict that the dairy market will nearly double between 2010 and 2016. Investors buy the economic rights to Fonterra shares, but the units have no voting rights and New Zealand dairy farmers retain control of the co-operative. The units have attracted heavy interest, and no shortage of criticism in New Zealand due to the resultant level of foreign ownership.
