A wide-ranging slump in global food prices has taken the gloss off near-term prospects for companies within the wider agricultural sector. But the recent capture of Syngenta AG (SW:SXX) by China National Chemical Corp (ChemChina) demonstrates that the catalysts driving the long-term investment case are still exerting influence. So despite temporary market weakness, it may well be that the pullback in equity valuations has opened up compelling entry points for investors across a sector that is normally strongly supported.
Syngenta just released a first-quarter update detailing underlying sales of $3.7bn (£2.6bn) - broadly in line with consensus, although encouraging enough in light of a difficult trading environment. The group confirmed that it was pursuing an extensive cost reduction programme with an aim of driving free cash flow of over $1bn in 2016. Trading aside, there was precious little news in relation to the approval process for the $43bn (£30bn) takeover offer by ChemChina, other than that Syngenta still expects the takeover to complete by the year-end.
Any readers who followed our advice to buy into the Swiss agribusiness last December would have seen a return equivalent to about a third of their invested capital, but the move by state-controlled ChemChina also highlights the push to modernise China's agricultural sector - part of a wider investment theme predicated on the need to rapidly expand global food production to meet exponential population growth.
Malthusian logic dictates…
According to the United Nations (UN), by 2050 the global population will have swelled to approximately 9.7bn from the current figure of 7.3bn, with the lion's share of growth generated from Asia and Africa, and much of that attributable to a marked decline in rates of infant mortality. While that's to be applauded, all of those extra mouths are going to require feeding. Without resorting to statistical overload, the ability to meet this challenge is imperilled by several factors, most notably increased rates of urbanisation, water scarcity, peak fertiliser efficiency, pesticide/herbicide resistance and rapidly increasing demand for animal protein; the last issue a consequence of the rise of middle classes in emerging markets.
Perhaps the most troubling problem, one that may even prove intractable, relates to water scarcity. The world's principal aquifers are being depleted at an ever-increasing rate, while many inland waterways are becoming polluted and require costly water treatment solutions. The vast majority of global population growth through to 2050 will take place in the developing world where water is already scarce and management of the resource is often haphazard.
Consider, for instance, recent estimates that point to a doubling of the population along the banks of the Nile over the next 10 years. Aside from the increased economic strain, there are wider geopolitical implications. Indeed, it's widely held that the Middle East is perhaps the most water-impoverished region of the world, therefore particularly susceptible to so-called 'water wars'. This problem, along with those outlined above, necessitate a co-ordinated response on the part of governments, in concert with the wider agribusiness sector. Without wishing to sound overly mercenary, that should open up profitable avenues for investors.
China moves to combat the flight to cities
In the past, we've expanded on the thematic issues governing agricultural investments, but given practical constraints and the sheer breadth of the subject, it isn't possible to do it justice. And you could be forgiven for thinking that the subject has gone off the boil. With agricultural prices in the doldrums, the issue of food security hasn't been generating column inches in the financial pages - even in the throes of a strong El Niño weather system. But the issue remains at the forefront for policymakers in Asia's biggest economies.
Indeed, we argued that ChemChina's tilt for Syngenta was part of a wider strategic initiative to address the accelerated migration of China's rural poor in search of higher-paying city jobs - one of the themes cited above. With people moving off the land, China is turning to agricultural science and farm mechanisation in a bid to secure its future food supplies (large-scale foreign investments, most notably in sub-Saharan Africa, constitute another plank of China's food security programme, but one that we're not covering here).
In 2013, President Xi Jinping committed China to a strategic goal of matching the West in biotechnology, in areas such as genetically modified organisms (GMOs), but the country is years behind the US and Europe in research and development. The Syngenta deal suggests that Beijing is now prepared to simply acquire the Western biotechnology that it can't develop on its own. However, some industry analysts now worry that Syngenta will be given preferred trading status in China, effectively freezing out competition from the likes of Monsanto (NYSE:MON) and DuPont (NYSE:DD) - that remains to be seen.
| Company | Price | Max (1-yr) | Min (1-yr) | Price change (1yr) | Price change (5-yr) | Discount (%) to 3-yr moving avg | PE | Yield | Market cap (m) |
|---|---|---|---|---|---|---|---|---|---|
| Agrium - CAN$ | 109.62 | 138.8 | 107.02 | -14.3 | 26 | 8.5 | 12.3 | 4.4 | 15,146 |
| Archer-Daniels-Midland - US$ | 39.26 | 53.17 | 30.51 | -18.6 | 10 | 9.3 | 13.2 | 3.06 | 23,052 |
| BASF - € | 70.41 | 93.5 | 57.3 | -23.1 | 6.9 | 5.3 | 16.2 | 4.12 | 64,670 |
| Bunge - US$ | 59.28 | 92.85 | 47.79 | -30.9 | -20.4 | 23 | 12.2 | 2.56 | 8,297 |
| Deere & Co - US$ | 82.41 | 97.33 | 71.78 | -6.8 | -13 | 3.5 | 15.1 | 2.91 | 25,986 |
| DuPont - US$ | 65.97 | 74.55 | 47.32 | -2.9 | 26 | 4.5 (premium) | 30.5 | 2.3 | 57,602 |
| Monsanto - US$ | 94.08 | 120.82 | 83.11 | -20.6 | 42.6 | 12 | 29.5 | 2.3 | 41,098 |
| Syngenta - CHF | 400.4 | 430.8 | 298.2 | 21.7 | 29.4 | na | 27 | 2.75 | 37,215 |
Source: Bloomberg & Thomson Reuters
IC VIEW: The main point of this article is to reinforce the view that, despite temporary price slumps, the agricultural sector is set to gain in prominence. The UN estimates that global food production will need to increase by 70 per cent between now and 2050. And given limited availability of arable lands, deteriorating fresh water sources (agriculture consumes 70 per cent of the world's fresh water supply) and other less predictable factors, farmers across the globe will increasingly need to resort so-called 'precision agriculture' to boost yields and profits. Over the long haul, this will generate increased opportunities for the likes of Deere & Co, which has already developed a high-tech suite of applications linked to crop yields, soil-mapping and fertiliser applications through GPS technologies. The Syngenta bid also underlines an appreciation that advanced technologies will increasingly form the shape of things to come in the countryside, while simple demographics compel investors to establish a strategic allocation over the long haul.
FAVOURITES: Bunge (NYSE:BG) is a global food exporter, with a leading position in oilseed processing; it is also involved in food processing, grain trading and the sale of blended NPK (nitrogen, phosphate and potassium) fertiliser formulas. Valuations have been hit by a continued slump in prices for many of Bunge's primary products. At $59.22, the group's shares are 23 per cent adrift of the three-year moving average and trade at just 11 times JPMorgan's forecast earnings. Bunge now offers genuine value, particularly given potential upside linked to the group's operations in South America, which have become all the more competitive due to the depreciation of local currencies against the US dollar.
OUTSIDER: Deere & Co (NYSE:DE), the world's largest manufacturer of agricultural machinery, is faced with a third straight year of revenue and earnings declines in 2016. The trading outlook for the group has been undermined by weak prices across a range of foodstuffs, which have constricted farm revenues and spending on capital items. The situation has been exacerbated by the continuing strength of the US dollar and a recent warning from the US Department of Agriculture that global exports of primary produce will remain under pressure through 2016. Despite these problems, shares in Deere & Co remain remarkably well-supported, although a sharp pullback at this time last year means that the group's shares now change hands at 19 times forecast earnings - a reasonable entry point for investors based on the historic average, coupled with a gross dividend yield of 2.9 per cent. The group's long-term fundamentals remain strong, particularly as China and other developing markets increase farm mechanisation.
