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Few trends are more compelling than rising Asian demand for Australian food. As another two billion Asians join the middle class by 2030, diets will be expanded and upgraded. ASX-listed agribusiness companies look well positioned for the so-called ‘dining boom’.
But the micro performance tells a different story. Switzer Report analysis of more than 50 ASX-listed food and beverage stocks shows a mixed performance. Almost half of them have a negative total return (assuming dividend reinvestment) over 12 months.
For every The a2 Milk Company (220 % total return over one year), there are many more agribusiness stocks with heavy losses. Taking a top-down view on agribusiness is fraught with danger. This is a sector for stock pickers who know when to get in and out of companies based on soft-commodity cycles and valuations.
I have nominated a handful of agribusiness stocks for this report over the past few years, notably: Treasury Wine Estates, Costa Group Holdings, farm investor Rural Funds Group, crop protector NuFarm, Incitec Pivot, The a2 Milk Company, Inghams Group and New Zealand King Salmon Investments.
The median one-year total return on these stocks is 45%.
Disappointments include Graincorp (down 8 %) and Australian Agriculture Company, previously included the Switzer Report takeover portfolio (down 22 %). On balance, the agribusiness ideas have performed well over 12 months.
But the only profits that ultimately matter are those you can fold into your wallet. Knowing when to free up cash in high-performing agribusiness stocks is challenging. Early investors in these stocks might take some profits, but I’m not ready to sell out just yet.
My previous agribusiness feature for this report, in September 2017, nominated Inghams Group, a2 Milk Company and New Zealand King Salmon Investments as ‘three agribusiness stocks that still represent reasonable value’.
Inghams has fallen from $3.86 at the time of that report to 3.57. The a2 Milk Company has rallied from $5.39 to $7.58. Aquaculture provider, NZ King Salmon has jumped from $1.47 in September to $2 after upgrading earnings guidance.
Fruit grower, Costa Group, featured as a contrarian idea for this report in April 2017 at $4.34 (more analysts were issuing hold recommendations) has soared to $6.45.
It is tempting to take profits on these stocks and reinvest in agribusiness companies that look undervalued. Graincorp is the pick of them, but faces challenging growing conditions in 2018. Longer term, the company’s grain Infrastructure and expertise will become more valuable in a world that has underinvested in agribusiness storage facilities.
For now, I’ll stick with Costa Group, Inghams Group, a2 Milk Company and the micro-cap NZ King Salmon as preferred agribusiness ideas.
There is a long list of reasons to take profits in Costa: founder Frank Costa sold part of his holding recently (directors selling stock is always a reason for caution), the valuation multiple is high and avocado prices are expected to weaken after a record harvest.
But Costa keeps defying the critics with exceptional operating performance. At its November annual general meeting, Costa upgraded for a 20% increase in FY18 after-tax net profit, from 10 % previously, largely because of its Africa Blue joint venture.
Management said trading for the first four months of FY18 had been ‘very satisfactory’. I expect another earnings upgrade later in FY18, as the well-run Costa expands here and offshore.
Longer term, Costa will benefit from expanding blueberry sales in China (blueberries are finally on the horticulture priority list for the Federal government to negotiate with China) and the company’s expanding footprint in avocados, an increasingly popular commodity, is well timed.
Critics of Australia’s largest poultry producer say the chicken industry is maturing; that the big supermarkets have all the bargaining power in this market; that poultry is highly commoditised and has limited pricing power; and that Inghams has already extracted most cost savings.
Against that, consumption of white meat in Australia continues to rise; Inghams keeps achieving efficiency gains (the key to unlocking more value in the stock); and the company is successfully launching higher-value-added chicken products.
Inghams said at its November AGM that poultry volumes were running close to the historical average. Yet the share price is down from a 52-week high of $3.93 to $3.58. Stories about escalating ‘price wars’ in poultry may have spooked some investors.
Inghams is by no means the fastest-growing stock on the list. But a forecast price earnings (PE) multiple of about 12 times is undemanding for a company with the dominant market position in a growth industry. Poultry is arguably more defensive than most commodities, given quarantine restrictions on imports, and has less sensitivity to weather because the chickens are grain fed.
Improving production economics are another attraction. Better breeding techniques, feed and nutrition technology and enhanced supply-chain efficiencies are helping big producers pump out more chicken at lower cost. These efficiency gains are making poultry prices more attractive compared to alternative meats and boosting poultry demand.
The a2 Milk Company is the hardest stock to keep on this list after soaring gains over 12 months. Share price rallies do not last forever, but a2 is justifying the rise with stellar gains in operational performance. Few ASX-listed companies have such momentum.
At its November AGM, a2 said sales for the first four months of FY18 were up 69% on the previous corresponding period. After-tax net profit has soared 138%. Strong demand for nutritional products in China, the United States and United Kingdom is underpinning gains.
The positive AGM commentary exceeded my expectation. I wrote for this Report in September 2017: “Look for a positive trading update at the annual general meeting on November 21 to spark renewed market interest (in a2).” The a2 Milk Company more than delivered.
It’s superbly placed to capitalise on rising demand for infant formula in emerging markets and expand into more products, in more markets. However, the market believes a2 is fully valued: a handful of broking analysts have an average valuation of $7.49.
Watch a2 do better than the market expects over the next 12 months, as its market share in emerging and developed markets increases. Although gains will be slower from here, the a2 story has a long way to run. Waiting to buy the stock during bouts of market weakness makes sense.
The micro-cap salmon producer, another dual-listed New Zealand company on the ASX, caught my eye during its $74 million IPO at $1.07 a share in October 2016.
The aquaculture industry has good growth prospects, provided it can lift its collective sustainability performance and convince governments that extra regulations are not required. Some ethical investment funds have divested aquaculture stocks this year over concerns about the environmental sustainability of fish and other seafood farms.
NZ King Salmon is the world’s largest aquaculture producer of king salmon under its Ora King, Regal and Southern Ocean brands. Most of its exports go to Japan and North America.
NZ King Salmon upgraded earning guidance at its November AGM. Underlying earnings for FY18 is expected at NZ$24.5 million to NZ$26 million, from NZ$22.4 million previously. That’s an excellent result for a company that has not missed a beat since listing.
Improving fish survival and fish-growth rates are boosting NZ King Salmon’s earnings. Sales volumes are rising as the company expands offshore, including in its key United States market where premium salmon is in demand at restaurants.
Growth in pet foods (fish is increasingly used in omega-3 enhanced pet foods) is another opportunity for NZ King Salmon and helps maximise whole-of-fish revenue as waste parts of the fish are used for pet foods.
Macquarie’s price target of A$2.18 suggests NZ King Salmon is a touch undervalued at the current price.
The stock could hit that target in a hurry as the market looks closer at NZ King Salmon and reappraises the merits of aquaculture stocks as global fish demand rises, and as the need to develop sustainable fish farms, which reduce dependence on wild-caught fish, increases.