Hungry for profit

That represents a miniscule proportion of the 894m acres given over to farming in the US, but the US Department of Agriculture (USDA) gives the average price of US farmland at $3,106 (£2,264) an acre, so it still represents a sizeable commitment, even for someone as well-heeled as the Microsoft (US:MSCO) co-founder.

Corporate agribusiness may dominate the landscape, but there are sound financial reasons why private landowners like Gates have been keen to expand their holdings, not least the prospect of attracting government subsidies.

With a sizeable proportion of US farmland organised through tenancies, subsidies are routinely diverted to landowners instead of the actual farmers. It might be a stretch to characterise this as a modern state-sponsored form of feudalism, but the landowners can get paid regardless of how their tenant farmers fare throughout the year.

Subsidies aside, the main point is that the software tycoon recognises that a solid – and improving – investment case exists for a more prosaic area of endeavour: food production. The land purchases are also intertwined with policy areas synonymous with the Bill & Melinda Gates Foundation, namely environmental stewardship and sustainability.

A simple question of demographics

Farming may represent something of a departure from software development, but it is understandable why a tech magnate like Gates senses a long-term opportunity. The United Nations (UN) predicts the world’s population will reach 9.7bn people by 2050 – up from around 7.8bn today – and analysis from McKinsey shows that crop demand for human consumption and animal feed will double over the next 30 years. To achieve this, we will have to drive technological innovation to meet the twin challenge posed by soil degradation and dwindling water resources, to say nothing of a possible rise in global surface temperatures.

By now, everyone should be aware that investment in the global food and agribusiness sector is being spurred not only by population growth but also by increased protein consumption in developing markets, most notably China.

Over the next decade, the Organisation for Economic Co-operation and Development (OECD) estimates that meat consumption in developing countries will grow five times faster than in their developed counterparts. Overall, the OECD predicts that global meat consumption will rise by 12 per cent between 2020 and 2029, which reflects slowing momentum in developed countries as they reach saturation.

Higher demand for meat will not only benefit suppliers such as Tyson Foods (US:TSN) and UK-listed Cranswick (CWK), but will also create the need for more animal health products for livestock. Zoetis (US:ZTS) – which was spun out of Pfizer (US:PFE) in 2013 – looks particularly well-placed as the world leader for medicine and vaccinations for cattle, and the number two and three player for pigs and poultry, respectively.

While livestock are reared to provide food for humans, they, too, need feeding, underpinning demand for cereal crops such as corn and legumes such as soybean. China has a voracious appetite for these soft commodities. It is the world’s top soybean importer, accounting for around two-thirds of all international purchases, and half of these imports are used to feed the country’s pigs. As China restocks its herds in the wake of ASF, it has been importing corn and soybean in vast quantities. The US Department of Agriculture estimates that China will import 17.5m tonnes of corn in 2021, up from 7.6m tonnes in 2020.

Surging Chinese demand coupled with supply-side pressures have sent prices soaring, with corn hitting $5.49 per bushel earlier this month – its highest level since 2013. Dry weather from La Niña delayed planting in Argentina and Brazil, and heavy rains in some areas are now preventing harvesting. There has also been an impact from protectionist measures to preserve domestic supply and stave off food price inflation. Both Argentina and Ukraine – the world’s third-biggest corn exporter – have introduced caps on their corn exports.

Bumper crop prices should bode well for the companies positioned along the agricultural supply chain as farmers have more money in their pockets to spend on equipment. It also spells good news for large multinationals such as Bunge (US:BG), Cargill Inc and Archer-Daniels-Midland (US:ADM), which are at the forefront of global crop storage, processing and distribution.

For investors looking for more direct exposure to soft commodities prices there is the exchange traded commodity (ETC) route – for example, the WisdomTree Corn ETC (GB00B15KXS04) – or exchange traded funds (ETFs) such as the Invesco Bloomberg Commodity UCITS ETF (IE00BD6FTQ80), which has just under a quarter of its portfolio weighted towards grains.

Mechanisation – a first step

China has been trying to increase mechanisation within its farming sector, partly as a response to a steady decline in the rural population, but also to improve yields and drive down the marginal cost of production. It is worth remembering that the same dynamic played out in western economies as they industrialised, with an increase in yields concomitant with a decline in the share of the population engaged in agriculture.

Western companies have been quick to respond to the challenge. Deere & Co (US:DE) has a long-established presence in China, with production of automated farm equipment taking place across half-a-dozen sites in the country. The company remains a vital cog in China’s rural transformation, even after suffering from the trade war between the world’s largest economies.

China used to be a nation of rural smallholdings, but the exodus to the cities and the gradual swing towards large cooperatives has underpinned demand for heavy-duty farm machinery. The comprehensive mechanisation rate for crops is expected to reach 77 per cent by 2026, although progress in this area is partly dependent on long-term assumptions on grain prices – a long-standing corollary on investment levels.

Jeremie Capron, director of research at robotics investor ROBO Global, agrees. “The farming machine business is very cyclical," he notes. "You have the commodity cycle that impacts the farmers’ income and their ability to invest in machines – that's one driver – the other is just the natural replacement cycle of machines.” At any rate, the agriculture equipment market is worth around $150bn and is projected to grow at an annualised rate of 6 per cent over the next five years.

Digitalisation and the fourth agricultural revolution

Perhaps the most significant way agriculture is likely to change is through digital channels. Artificial intelligence, analytics and connectivity are transforming myriad industries, but their accelerated application has given rise to musings over a fourth agricultural revolution.

Analysts at McKinsey are in no doubt about the scale of the investment opportunity, stating that “if connectivity is implemented successfully in agriculture, the industry could tack on $500bn in additional value to the global gross domestic product by 2030”.

We have already seen an increasing focus on automation and robotics. Meat processing companies, such as Tyson, have stepped up the automation of their operations in the face of the pandemic to maintain production levels, while allowing workers to socially distance. Food supply chains came under pressure due to a series of high-profile outbreaks of Covid-19, not only at abattoirs, but also in the speciality produce sector, forcing some growers to abandon their produce at harvest time.

Yet even prior to the pandemic, Tyson had taken steps to counter a chronic labour shortage in the industry, with a 26,000 square foot facility near its headquarters in Arkansas applying advances in machine learning to meat processing. Typically a highly labour-intensive endeavour compared with other areas of primary production, the aim is to eventually eliminate jobs that can be highly repetitive and at times downright dangerous, and success here should translate into improved margins.

Capron does make the point that the farming industry is something of a laggard in terms of technological adoption, with “the application of the more recent developments around sensing, computer vision and autonomy still in the making”. He believes that at some point we are likely to witness an accelerated take-up in the sector, coming on the heels of logistics and, latterly, healthcare. “Our view is that agriculture is probably the one after healthcare, in terms of the development, penetration and adoption of those technologies,” he adds.

Google and the need for improved connectivity

The farming industry, as a relatively low-margin affair, might not be uppermost in Big Tech’s list of priorities, but that didn’t stop a team from Google's parent company from recently meeting with officials from USDA to discuss the prospect of substantially increasing crop yields and reducing water usage by using advanced sensors, nano-technology and software to optimise how plants are cultivated.

However, the fourth agricultural revolution will only become a reality when adequate infrastructure is put in place – and the signs are generally positive. By 2030, McKinsey expects “advanced connectivity infrastructure of some type to cover roughly 80 per cent of the world’s rural areas" and that the key is to develop more effective "digital tools for the industry and to foster widespread adoption of them”. The advent of superfast 5G mobile networks will be crucial in triggering change across a range of industries, and there is no reason to think that farming will prove an exception.

Nitrate fertilisers and renewable farm inputs

Although the tech or ‘value add’ corner of the food industry holds attractions for both retail and institutional investors, the outlook is mixed across well-established areas such as the fertiliser market. Again, investment here is bound up with commodity cycles, and therefore vulnerable to depressed crop prices.

Essentially, it is a volume trade, dominated by a relatively small number of corporations on a regional basis, the likes of Yara International (NO:YAR), Nutrien (CA:NTR), The Mosaic Company (US:MOS) and CF Industries (US:CF). The Asia-Pacific region now accounts for around 60 per cent of global demand, with that proportion set to increase over the coming years.   

The three essential plant nutrients are nitrogen, phosphorus and potassium. The production of all three elements is an energy-intensive affair, but environmental campaigners have reserved special ire for nitrogen-based fertilisers, the largest product group by volume.

In the early part of the 20th Century, the German scientists Fritz Haber and Carl Bosch won the Nobel Prize in chemistry after they worked out how to produce ammonia on an industrial scale. The process involves mixing nitrogen from the air with hydrogen from natural gas (essentially methane) at high temperature and pressure to create ammonia. Between 60 and 70 per cent of the natural gas is employed as a feedstock, with the remainder used to power the transformation process. In China, ammonia is primarily produced from coal gasification.

The process has done much to alleviate world hunger, but has never played well with climate change activists, particularly as the industry has flourished in North America because of the abundant supply of feedstock owing to the shale gas boom. That means that some of the main industry players could see their valuations face pressure through institutional mandates linked to environmental, social and governance (ESG) principles.

It’s not easy being green, but two of the world’s biggest fertiliser producers, CF Industries and Yara, have hatched a plan to boost their environmental credentials by reconfiguring ammonia plants in the US and Norway to produce clean energy for the maritime industry – one of the heaviest contributors to global greenhouse gas emissions.

Demand to gradually swing in favour of organic inputs

We should see an increase in this type of imaginative offsetting in response to institutional pressure, along with further technological innovations. But it is the projected growth in bio-based and micronutrient fertilisers that catches the eye. Analysis from Global Market Insights points to a 3.2 per cent annualised growth rate for the global fertiliser market over the next five years, but that pales in comparison with a projected rate of 7.5 per cent for the organic fertiliser market.

Soil degradation is a related issue that doesn’t always attract the coverage it warrants. Relentless tilling, multi-seasonal harvests and overuse of synthesised chemicals have driven yields at the expense of long-term sustainability.

The onus may be on sustainable, biodegradable and renewable farm inputs, but that stands at odds with the increased appetite for animal protein in emerging market economies. Without synthesised fertilisers, it is hard to imagine that intensive farming, or the rearing of livestock, would be feasible, at least on its current scale.

Yet the application of nitrate fertilisers, though successful in a broader sense, is a dreadfully wasteful affair; a high proportion of the nitrates are never absorbed by crops and are simply sluiced out of the soil into waterways or evaporate into the atmosphere in the form of nitrous oxide – a major greenhouse gas. Agriculture accounts for around 70 per cent of all freshwater demand and produces around a third of greenhouse gas emissions. It is not difficult to appreciate the imperative for change, lest we are confronted with some retrograde Malthusian dilemma.

The climate change conundrum

The food and agriculture industry therefore faces a dilemma – how to feed an ever-growing population while doing so in a sustainable manner. Farming is resource-intensive and water and land are finite commodities.

It takes more than 1,800 litres of water to produce a kilogramme (kg) of wheat and more than 15,000 litres of water to produce a kg of beef. From Egypt to California, farmers are feeling the pressure from water scarcity – something that is only likely to get worse. Analysts at Morgan Stanley estimate that climate change could threaten at least 36 per cent of the production of the four largest crops – rice, corn, wheat and soybean – amid the increased risk of droughts, flooding and hurricanes and prevalence of pests.

Meanwhile, agriculture uses almost half of the world’s habitable land, and of that 80 per cent is used for livestock farming. As the world’s population grows, the amount of agricultural land per capita is shrinking – particularly as some farmland is swept up by urbanisation – and climate change is also reducing the viability of farming in certain areas. Expanding farmland typically comes at the expense of natural habitats, most notably the Amazon rainforest.

Prime farmland in optimal climates should therefore be in demand and see their value increase – at least that’s the thinking of real estate investment trusts (Reits) focusing on farmland. This includes Gladstone Land (US:LAND), which buys agricultural land in the US and leases it out to farmers. Having amassed 94,000 acres worth just shy of $1bn, this has proved to be a stable asset base – occupancy rates have never dipped below 99.5 per cent – enabling Gladstone to pay out a monthly dividend.

Technology can be used to make farming more sustainable, particularly through the use of precision agriculture. Traditionally, farmers make decisions based on whole fields, applying a blanket layer of pesticides and fertilisers. But advances in drones, machine vision systems and data processing are now making it possible to apply these crop chemicals much more selectively. Such an approach saves farmers money on inputs, means there is less run-off of polluting chemicals and can increase yields as land is used more efficiently.

Jeneiv Shah, manager of the Sarasin Food and Agriculture Opportunities Fund (GB00B77DTQ97), says that Deere is “by far and away at the forefront” of farming automation, benefiting from “a tremendous brand, very strong loyalty and an immensely valuable distribution network all across the globe”.

A plant-based revolution?

Environmental concerns are not only changing how we produce food, but are also influencing the type of food we eat amid the rise of plant-based meat and dairy alternatives. Once the preserve of dedicated vegans, these products are now designed to appeal to so-called ‘flexitarians’ who wish to keep eating meat and dairy to some degree, but incorporate more plant-based proteins into their diet to lower their carbon footprint.

Plant-based dairy is not a new phenomenon but as demand has started to take off in developed economies, its share of total milk products has increased to 9 per cent, from 4 per cent in 2007. Plant-based ‘milks’ are still fairly resource-intensive, but they are friendlier to the environment than cow’s milk. According to a 2018 study by Oxford University, producing a litre of cow’s milk emits 3.2kg of carbon emissions and requires 9 square metres of land and 628 litres of water, while a litre of almond milk emits 0.7kg of carbon and uses 0.5 square metre of land and 371 litres of water.

The lower footprints are also a hallmark of the alternative meat market. Impossible Foods says that production of each of its burgers uses 96 per cent less land and 87 per cent less water and is responsible for 89 per cent fewer greenhouse gas emissions than a regular beef burger.

Beyond Meat (US:BYND) is the obvious pureplay investment in this space, although diversified food companies such as Nestlé (CH:NESN) and Unilever (ULVR) are both making a big push into plant-based alternatives.

There are also ingredients and flavourings companies such as Givaudan (CH:GIVN), DSM (NL:DSM) and Kerry (KYGA) ,which are “essentially outsourced R&D engines” according to Mayssa Al Midani, manager of the Pictet Nutrition Fund (LU0448837160). “They really help the plant-based alternatives companies replicate the sensory experience of animal-based products and the benefit of investing in these suppliers is that they have exposure to a large number of products and brands,” she says.

Still, analysts at Morgan Stanley estimate that meat alternatives will only have a 3 per cent share of the wider meat market by 2030. China could be key to unlocking momentum as it is the second-largest consumer of meat after the US.

“I think the reality is, we're unlikely to see a mass, overnight change in consumer behaviour,” says Shah. “I think it will more likely be a complimentary rise, structurally growing to become an increasing percentage of the whole protein industry.”

Indeed, if we are to feed close to 10bn people by 2050, it seems unlikely that this will be a case of either/or when it comes to meat and meat alternatives – we will need diverse food sources to ensure that everyone’s plate is filled.

How to get a taste

From farm machinery to futuristic lab-grown meat, there are many opportunities for investors across the entire global food supply chain. Some are riskier than others and often require a long-term mindset, as agriculture is subject to the vagaries of the climate and geopolitics.

Those looking for broad exposure across the agricultural themes discussed could consider a specialist ETF such as the iShares Agribusiness UCITS ETF (IE00B6R52143). If you fancy a more tailored approached, we have identified 10 companies that are well-positioned to capitalise on the future of food and take a closer look at some of them below.

Deere & Co – play the tech angle via the most iconic brand

It came as no surprise when market valuations for machinery manufacturers such as Deere improved after details of Joe Biden’s $1.9tn stimulus package emerged. The group produces equipment used in agriculture, construction, forestry and turf care, so it stands to benefit from the delayed roll-out of infrastructure projects in the US now that the Democratic party controls Congress.

Though Deere has had to contend with increased competition in its core markets over the past decade, it is essentially a ‘value-add’ play which competes with industry rivals based on functionality rather than price alone. To this end, it has regularly incorporated advanced technologies to improve its crop management products since its initial foray into the manufacture of Precision Ag machines 25 years ago.

Times have moved on since the self-polishing cast steel plough (an earlier Deere innovation) and the group’s product range now offers a range of cutting-edge technologies, from satellite guidance to hands-free USB and wireless systems. The group’s tech offering received a substantial boost in 2017, when Deere brought Blue River Technologies into the fold via a $305m deal that secured specific expertise in the field of real-time autonomous agricultural robots.

The technologies – including 75 connected software tools – optimise yields and reduce wastage from tillage through to harvesting, by recording what was sprayed, where and the prevailing weather conditions – all critical determinants in crop management. Plants with the exact same genetic make-up can have very different outcomes based on the consistency of depth and spacing across the field in which they have been planted. Weather conditions and the amount of accessible sunlight are also critical. Deere’s tech-driven approach takes a lot of the guesswork out of the equation.

The quest for ever-more precise data to optimise yields means that GPS is standard on all of John Deere’s biggest machines, and we are likely to witness further refinements in this area with the roll-out of 5G technologies.

Deere & Co is already at the forefront of many of the areas in which farming is becoming increasingly intertwined with advanced digital technologies. This means the structural drivers of the investment case are well understood, hence the solid and enduring institutional support.

The stock has outstripped the S&P benchmark in recent years, complete with an annualised Ebitda growth rate of 10.5 per cent, although a recent upwards earnings revision did not go unnoticed, so the price-to-book ratio suggests the market is up to speed.

Nestlé: changing with the times

The name Nestlé might conjure images of KitKat bars and Nescafé instant coffee. But the Swiss consumer goods giant has spent the past few years expanding its portfolio of more than 2,000 brands to include alternative meats and more sustainable ingredients – signalling its willingness to move with the times.

Indeed, the group pointed to “an engaged generation of consumers... driving a new food ideology” in its 2019 annual report, acknowledging "trends toward more natural and organic foods, plant-based proteins and simpler, healthier ingredients”. It added that such consumers “expect brands to provide experiences beyond the product, be authentic and act as a force for good – both socially and environmentally”.

In turn, those changing values have compelled Nestlé to rethink its product development strategy as well as the types of businesses it chooses to acquire. Four years ago, it bought plant-based food company Sweet Earth. It has also launched a meatless ‘Sensational Burger’ in several countries, setting itself up to compete with major pure-play businesses Impossible Foods and Beyond Meat. Such is the level of rivalry between the various companies that Nestlé was forced to change the name of its beef-free patty from ‘Incredible’ after a legal dispute.

At the same time, the group has outlined its commitment to regenerative agriculture. In December, it said it was taking steps to halve its emissions by 2030 and achieve ‘net zero’ status by 2050. Such measures include helping famers and suppliers to move forward with practices to improve soil health and restore diverse ecosystems. Nestlé has offered to purchase their goods at a premium and buy bigger quantities in return.

Nestlé will publish its full-year numbers later this month. But nine-month figures released in October revealed that – in management’s words – the group had “remained resilient in a difficult and volatile environment”. Growth was broad-based across its pet care, dairy and health science divisions, although Nestlé also flagged double-digit growth in vegetarian and plant-based foods – indicating that its recent M&A activities and product debuts are already bearing fruit. Overall sales rose 3.5 per cent to CHF61.9bn.

Nestlé’s increasingly diversified food portfolio, its pledge to invest in a sustainable future and its willingness to adapt to changing consumer behaviours should position it well for continued growth. While the shares trade at a similar earnings multiple to peers Unilever and PepsiCo (US:PEP), they could represent good value for long-term investors.

Cranswick: more than a flash in the pan

Increasing protein consumption around the world should be a boon for FTSE 250 food company Cranswick, which supplies the UK’s top supermarkets, from Tesco (TSCO) to Waitrose, with fresh pork and poultry products. It also sells into the catering industry and boasts a fast-growing export business, with a particular focus on Asian markets.

In the group’s domestic UK market, trading has been buoyed by a shift towards home-cooking during the pandemic. Cranswick raised its full-year guidance in an early February trading update, citing the continuation of strong earnings momentum from the first half into the third quarter.

Meanwhile, the group’s pork products have proved particularly popular in China after the outbreak of African Swine Fever (ASF, see above) has increased demand for imports. For the six months ending 26 September 2020, Cranswick’s Far East export revenues were up a quarter and accounted for a tenth of total group sales.

Investors may question how long the good times can last, and whether the boost to trading from virus-induced ‘stay at home’ guidance and ASF could amount to little more than a flash in the pan. Broker Panmure Gordon sees no reason for strong organic growth “to change while the lockdown remains in place, or to reverse sharply thereafter”. Analyst Matthew Webb notes that while Covid has clearly spurred the group’s recent progress, Cranswick has simultaneously benefited from new business wins. Together with continued investment in capacity expansion, these factors suggest that the company "does not expect the changes in demand patterns due to Covid to reverse quickly or fully”.

Indeed, Cranswick has repeatedly ploughed money into its farming and processing operations to scale up its resources, including a new poultry facility in Suffolk and a £20m investment in a new cooked bacon facility in Hull. Such expenditure implies a belief that demand can be sustained – and that extra resources should help the group to meet spikes in grocery shopping activity, virus-induced or otherwise.

At 3,484p, the shares trade at 18 times forecast earnings; lower than their average forward multiple over the past five years and roughly in line with the valuations commanded by peers Associated British Foods (ABF) and Greencore (GNC). Arguably, there could be scope for a rerating on the back of recent upgrades, increasingly diversified revenue streams and recent investments.

Gen-ius livestock enhancement

As farmers balance the rising demand for animal protein with the supply of finite but necessary agricultural resources, the need to efficiently breed herds is acute. Equally, livestock must be as healthy as possible in order to stand out in a highly competitive market.

Little wonder, perhaps, that leading animal health group Genus works with some of the world’s top pork, beef and milk companies, serving more than 50,000 customers in more than 75 countries. The group specialises in genetic improvement, using its scientific technology to enhance the quality of food-producing animals. It does this by breeding its own pigs and cattle with desirable traits such as feed efficiency and disease resistance, before sending these traits to its customers via breeding animals or sperm and embryos.

A strong run in recent months prompted Genus to upgrade its profit expectations for the year to June following good momentum in its porcine and bovine divisions. Genus’s PIC business has benefited particularly from the restocking of China’s pig population in the aftermath of ASF.

Looking ahead to its upcoming interim results, Genus expects to post revenues of £285m-£287m, up from £271m a year earlier, and adjusted pre-tax earnings of £47m-£49m, up from £36.6m.

But the group’s growth is more than temporary. Revenues have risen at a compound annual rate of 9.2 per cent since 2016. Moreover, its barriers to entry look robust. It is the only listed porcine and bovine genetics company globally and its rivals are mostly private companies and regionally based farmer-owned cooperatives. As farms rely increasingly on technology to breed high-yielding animals while focusing ever more on sustainability, Genus’s proprietary genetics should only garner greater popularity.

The group’s shares have risen more than two-thirds over the past year compared with a decline of roughly a tenth for the broader FTSE All-Share index. At 5,360p, they trade at a fat 50 times forecast earnings. However, that valuation should be seen in the context of diversified growth, a progressive dividend payout and an expanding animal health sector which – by one estimate – is valued at $40bn.