Investments in the Agricultural & FMCG sector should be considered high risk and come with volatility. For this reason we tend to focus on stocks where we see either: a structural uplift in ROIC through the cycle (cyclical growth stories) or counter-seasonal crop exposures.
Our key commodity call for 2020 is the unwinding of the drought induced dislocation between domestic cattle prices and export meat prices on a normalisation in weather patterns. Our three stocks carry varying degrees of exposure to this dynamic.
AUSTRALIAN AGRICULTURAL COMPANY (AAC)
AAC is a vertically integrated cattle and beef producer with operations that span the entire supply chain across genetics, nutrition, pastoral operations, feedlots and processing.
The issues that have faced AAC in FY19-20 (attrition, high feed costs and weaker cattle prices) are cyclical rather than structural in nature. Over the past 18 months, direct drought related costs have resulted in a cost structure ~30% higher than what would be achieved in normal conditions. In our view, this additional cost is masking a 12% YOY uplift in meat supply chain returns (ex-Livingstone). When more normal weather patterns return we expect a to see a material improvement in the underlying returns per kilogram that AAC is delivering. In addition we would expect any material pick-up in the cattle price would be beneficial for AAC’s NAV.
ELD is a leading supplier of fertiliser, agricultural chemicals and animal health products to rural and regional Australia, with strong agency positions in livestock, wool and real estate.
The share price of ELD has been impacted by ongoing dry conditions across Eastern Australia and subdued cattle prices. Our FY20 forecasts assume a normal winter cropping season, a 10 month contribution of AIRR and continued transition of the ag-chem business to Titan. Rain is the ultimate catalyst for ELD, with the benefits that naturally flow through to the rural merchandise, livestock agency and StockCo businesses. We estimate EBITDA in a range of $130-140m under more normalised seasonal conditions and a stronger livestock pricing environment once Titan and AIRR are fully integrated. It is this view of operational leverage in ELD which forms the basis of our Buy rating.
RURAL FUNDS GROUP (RFF)
Rural Funds Group (RFF) is a listed agricultural REIT with a portfolio covering 50 properties, focused on almond orchards, vineyards, cattle, cotton and macadamias. Assets in the portfolio are some of the most productive in the industry and leased to high quality tenants including Treasury Wine Estates, Olam, Select Harvests, AACo and Stone Axe Pastoral, with a WALE of 11.3 years. RFF is externally managed by Rural Funds Management (RFM), who have been managing agricultural investments since 1997.
The RFF portfolio continues to transition to natural resources (from 46% to 59% of FY20e revenues), which are appreciating rather than depreciating assets, and towards assets with market linked rental reviews (from 37% to 43% of FY20e revenues). Over time as capex is deployed we expect favourable asset revaluations and growth in rental incomes from newly acquired assets. In addition as the investment in the cattle sector has lifted so too has the exposure the business has to cattle prices, through EYCI rent linkages on some leases.