Have your cake and eat it too in the dining boom

Photo of Richard Hemming By Richard Hemming

min read

Appetite for ASX-listed agribusiness companies growing.

Food-related companies have been some of Australia’s outstanding performers because of strong and rising demand for their products. Bellamy’s Australia has been the most spectacular. It floated in 2014 at $1 a share and recently traded above $8.

Bellamy’s has capitalised on what can be called the providence factor. It has benefited from the perceived quality of Australian-branded product and the trend towards organic.

The big X factor for this company is China. Bellamy's now has a contract with its manufacturer, Tatura Milk, owned by Bega Cheese, which reduces the risk on the supply side. Bellamy’s has a return on equity exceeding 40 per cent.

Several ASX-listed food stocks have done well: salmon harvester Tassal, almond producer Select Harvests, Capilano Honey, Freedom Foods, Elders and Warrnambool Cheese & Butter Factory. Also, the US chocolate manufacturer Yowie.

If you are lucky enough to be on the food bandwagon, hold on.

Where the opportunities lie

Opportunities still exist in the sector and not just for the big landowners. As an investor, you can’t just go out and buy thousands of hectares of land or thousands of head of cattle.

The China-Australia free trade agreement underlines that food will be an industry that booms in Australia. Dairy, beef and wine producers will all benefit from lower tariffs.

Last year, when the trade agreement was being formalised, Freedom Foods announced that Chinese giant New Hope would invest up to $500 million in dairy farms and processing plants as part of a deal with Freedom. It could be the first of many deals fuelled by the FTA with China.

Many food companies have not had spectacular sharemarket success, but the key differentiator we have noticed is that the successful ones are producers of food that cannot be readily obtained.

Sector specialist Paul Jensz of PAC Partners agrees: “They (Freedom Foods) are in the sweet spot, which is the protein space, and are growing into markets such as China, Asia and India, where the demand is increasing at 8 per cent a year. Yet the supply of these products is growing at half that rate.”

Jensz says there has been a mindset change. “Before, people were looking at agriculture businesses in the same cyclical way you would look at a resources business: buy only when they are in recovery mode or when commodities prices are on their knees”, he says. “But four or five have broken away from the pack and are now earning good money through the cycle. We look at them more in the vein of an industrial company, making money no matter what the conditions.”

The companies he refers to are Tassal, Select Harvests, Bega Cheese (which produces Bellamy’s baby formula) and the rural feed provider Ridleys. Jensz says the big differentiator with these companies is their ability to overcome the cyclicality of agricultural prices and produce consistent returns on equity of close to 15 per cent. Those on the improve are Nufarm, Elders and Ruralco.

Agriculture stocks to consider
Below are five stocks in the sector that we think are worth researching. It makes sense to be picky when it comes to food producers, because there are many farmers who are in the business because they like the lifestyle, not because of a particular return hurdle they have to meet (other than feed their family).

(Editor's note: Do not read the following ideas as stock recommendations. Do further research of your own or talk to a licensed financial adviser before acting on themes in this article).

1. Bega Cheese and Murray Goulburn
These two dairy producers have suffered serious headwinds in the form of record low milk prices, and if you believe that dairy prices will continue to bounce back, Murray Goulburn is the way to go, according to Paul Jensz.

The Global Dairy Trade Price Index has been falling for the past six months, although has turned in the past six weeks. The whole-milk powder price fell to US$1600 a tonne but is back to about US$2500. Jensz says companies such as Murray Goulburn and Bega Cheese will be more comfortable when it is US$3500.

“Both Bega and Murray Goulburn are toll processors", he says. “They take products and add value, selling domestically and offshore. On the whole they don’t suffer too much from dairy price commodity volatility, but Murray Goulburn is the more leveraged of the two.”

2. Rural Funds Group
It is worth noting the growth in valuations for agricultural assets in general. This benefits a sector-focused property trust such as Rural Funds, which owns intensely utilised agricultural land and gives investors a 7 per cent yield, which will grow at index rates of 3 per cent a year.

The land is in south-east Australia and is intensively used for almonds, wine grapes and meat chickens. Demand for the produce is climbing, alongside increasing population and wealth in Asia.

But the key to the value of the trust is not the scarcity of the land it owns, but increasing horticultural productivity, says Rural Funds managing director, David Bryant. “Commodity prices have declined in real terms over the past 100 years, but land values have gone up 4.5 per cent a year over that time, driven by productivity gains.” He says the productivity catalysts were Henry Ford’s tractor, synthetic fertilisers in the 1950s, and now genetically modified plants.

3. Ruralco
In the tough and unforgiving world of agriculture, Ruralco is a standout when it comes to building a business that can withstand anything the sector can throw at it, in theory. It was formed in May 2006 through the merger of the Tasmania-based pastoral company Roberts and its own CRT business, which was essentially a buying co-operative for families in the bush.

Since then, management, led by John Maher (who left the company earlier this year) has successfully diversified its operations both by geography and product, to the point where it is now one of the big three national rural suppliers, competing against Elders and Landmark.

The theory will be tested in the coming months, because indications suggest an El Niño weather event, although perhaps not to the degree of 1997/98. This event delivers droughts and floods.
Of the rural merchandise operators, Ruralco’s earnings are most leveraged to the east coast of Australia, where just over half its outlets are located (NSW and Queensland). This is the area usually hit by droughts.

Ruralco showed in its half-year results that it is improving and dividends are climbing, but there is a lot of weather uncertainty.

4. Freedom Foods
The food company has proved itself as a producer and packager of non-genetically modified, allergen-free foods and it has key relationships in the US. After considerable expansion it has the capacity to meet potential customer demand. As well, it now has the capacity to be one of Australia’s leading producers of long-life milk and non-dairy UHT food and beverage.

There is a great deal of expectation in the share price and its FY15 profit result could best be described as a year of consolidation, with operating earnings flat. The fact that the shares have pretty much held steady shows that investors are still largely believers.

The company spent almost $50 million last year on property, plant and equipment, which shows it is geared for growth. This was more than double the $20 million it spent the previous year and well above the $25 million or so it should spend in the current year.

About the author

Richard Hemming is editor of www.undertheradarreport.com.au
To find out more about the big growth opportunities in the world of small caps, get a 30-day free trial with Under the Radar Report. Click here.

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