Agribusiness: Climbing up the investment food chain

While we are undoubtedly experiencing the worst financial downturn since The Great Depression, this hasn’t stopped industry participants from searching out the few winners to emerge from the crisis.

A sector rising above the doom and gloom need not produce stellar returns. In such an unstable period, any sort of positive performance is notable, and even then, success can be short-lived, as evidenced by the mercurial nature of performance results released on a monthly basis.

As the finance industry wearily ushered in the New Year, the agribusiness sector — managed investment schemes (MISs), agri stocks and agribusiness owners all included — was emerging as one such frontrunner in the crisis, faring comparatively better than other sectors.

A diverse sector

The agribusiness sector is worth an estimated US$5 trillion globally, comprising half of the world’s labour force, 40 per cent of consumer purchases and half of the world’s assets, according to Timbercorp, formerly an MIS specialist.

In the Australian industry alone, the agribusiness value chain was last year estimated to be worth $227 billion, $98 billion of this belonging to the processing arm of agribusiness.

Arguably, the relationships between investors, lenders and producers in the sector are slightly incestuous, with the performance of one segment potentially impacting another.

“There can be different risk exposures in the agribusiness value chain so that different players in agribusiness are affected in different ways,” noted Westpac’s chief executive, agribusiness, Graham Jennings. “They [stocks, MISs and businesses] all have exposure to agribusiness, but their exposure is different.”

Jennings illustrated his point with an example of the price of inputs: high fertiliser prices last season were a challenge for on-farm production.

“Now some of the agri stocks on the Australian Stock Exchange (ASX) are being impacted by the lower fertiliser prices.”

Westpac is one of the major mainstream financiers to agribusiness, predominantly in debt finance for investment and seasonal carry-on finance.

A recent report put together by the bank and Charles Sturt University (CSU) told a relatively positive story for the producers of an industry subject to nature’s whims and a crippled economy.

According to the results, based on a survey of 1,200 agribusinesses, the sector has experienced a boost in economic performance, reporting a substantial improvement in the December 2008 quarter following two quarters of negative economic performance.

The results, reported in a quarterly survey of the sector, also showed increased levels of business performance and confidence. A significant improvement in the Westpac/CSU agribusiness index — the economic performance index (EPI), which measures the average of results for business performance, employment and investment (capital expenditure) indicators rose five basis points to 0.03 in September 2008 — was attributed primarily to generally positive business performance and an increase in capital expenditure during the last quarter.

MISsing in action

There are strong indicators that despite potential for long-term growth, the MISs of the sector are experiencing their share of bumps along the way, with project numbers hovering below the levels previously seen in the industry.

Timbercorp announced in December last year that it would move away from its investment management business to transform itself into a fully integrated agribusiness. While maintaining its existing MISs, the company is no longer offering any new agribusiness MISs.

“The focus at the moment is simplifying and deleveraging the business,” said Sol Rabinowicz, Timbercorp’s chief executive.

“A key focus at the moment is to complete our asset sale program to reduce corporate debt and to finance the remaining capital expenditure works on our horticultural properties.”

Rabinowicz said that once this process is complete, Timbercorp will be focusing on “the process of transforming the company into an agribusiness for the future”.

Timbercorp is at the core of Australia’s fresh food supply chain, managing investments in such produce as olive oil, almonds, and mangoes, and with strategic investment in agricultural producers, processors and marketing companies.

“We will undertake a full re-examination of this agri supply chain and look for new opportunities in the corporate farming context,”Rabinowicz said.

For its competitors, however, Timbercorp’s departure from the MIS scene seems to have provided opportunities for growth.

“No-one is predicting a ‘boom’ year for the agri MIS industry as it’s obviously a tough economic environment for anyone in the investment sector right now,” said David Ikin, a spokesperson for Great Southern, which reported a $34 million net loss in December last year.

“That being said, our major competitor (Timbercorp) has indicated theywill not be offering MIS products this year, so we do see opportunitiesto retain or even grow our market share.”

Ikin said advisers they were dealing with were looking for “opportunities to build real diversity into their clients’ portfolios through the use of forestry and agricultural projects, while at the same time providing a way to manage their tax position more effectively”.

His sentiments towards the sector seemed to reflect the general consensus.

“We are great believers in Australian agriculture as an asset class. The fundamentals remain strong — Australia is well positioned geographically to provide the growing markets of Asia with agricultural commodities, we have abundant land and strong agricultural expertise in this country,” he said.

The taxman comes knocking

Even so, a troubled financial landscape and changes to the taxation laws relating to agribusiness have delivered their share of challenges for MIS operators.

In October 2007, the Australian Taxation Office (ATO) ruled that investments in agribusiness MISs offered after July 1, 2008, were not tax deductible, a decision that caused waves but was aimed squarely at those taking advantage of the generous tax break.

In the end, forestry MISs weren’t impacted by the decision, with legislation introduced to deal specifically with this type of agribusiness MIS.

However, for the tax deductibility of non-forestry MIS contributions, things were a bit more complicated. A test case was carried out, in agreement between industry body Agricultural Investment Managers Australia and the Commissioner of Taxation, to determine the rules.

The final outcome, settled in December last year by the Federal Court of Australia, made contributions to non-forestry MISs tax deductible, albeit less broadly than previously allowed.

“The direct and indirect consequences of the tough financial environment and the late decision on the test case for non-forestry MIS are the primary reasons [why the number of projects on offer in 2008/09 won’t reach previous levels],” said Tim Lee, director, Australian Agribusiness Group (AAG) in a newsletter earlier this month.

Despite this, AAG has said it intends to release up to 15 MIS projects in the 2009 financial year, including those from most of the listed agribusiness MIS operators.

Anthony Abraham, executive director, Macquarie Funds Group, is optimistic about the longer-term potential for the sector and believes there are still benefits to investing in agribusiness.

“Agribusiness is not correlated to traditional asset classes like shares and bonds, which can provide diversification and reduce risk in an investment portfolio,” he said. “Further, it provides potential for long-term returns.”

Macquarie Agribusiness, which offers two investment options — closed-ended and unlisted products — deals in forestry and almonds. In December, Macquarie announced it was merging two agriculture businesses into one, a move Macquarie said was part of a strategy to expand its overseas operations and develop its wholesale fund offering.

This change would see the forestry and almond MISs merge with the Pastoral Fund business to form a new division — Macquarie Agricultural Funds Management — a transition expected to be completed this month.

The move was anticipated to increase the new division’s funds under management to $1 billion, which would facilitate development of its retail offerings in other markets.

At the time, Abraham told Money Management that the new business division underlined Macquarie’s “view of agriculture as an area of opportunity, notwithstanding the current state of the market”.

Now, as we make headway into 2009, Abraham said the current market volatility was not directly impacting the Macquarie investments because they are unlisted.

“Macquarie is well funded and well positioned in terms of liquidity,” he said.

In the agri stocks arena

Data relating to agri stocks released from the Commonwealth Bank of Australia (CBA) in its January Agri Indicators report boasted agenerally positive outlook for the agribusiness sector, recording an increase of 7.8 per cent compared to the S&P/ASX 200, which delivered an increase of 4.4 per cent.

The bank’s index measures the performance of a CBA-defined‘agribusiness’ sector, which currently comprises 16 rural-dependent publicly listed companies — among them AWB, Futuris, Great Southern, GrainCorp and Timbercorp — which would include MIS operators.

These initial results marked an auspicious start to the year in agristocks, despite argument the sector is significantly underpriced and that it would take time for a full recovery. Agribusiness was hardly immune from turbulent market conditions, although the risk exposure for the various segments within the sector differed. CBA noted the potential for agri stocks but said it remained “a cautionary tale”.

And with good reason: last week’s February agri report from CBA turned these initial gains on their head, with the sector falling 20.8 percent, compared to the S&P/ASX 200’s significantly more modest drop of 6.5 per cent.

As companies reported their interim and full year results, CBA noted there were downgrades to forecast dividends and earnings by a number of key companies in its index, which significantly impacted the sector’s performance. Profit forecasts in agricultural organisations were downgraded considerably and investment analysts were looking to future earnings prospects and devaluing stocks accordingly.

While CBA was expecting a rocky road ahead for agribusiness, the bank said it estimated a “reasonable” total return for the next 12 months of 11 per cent.

“In general terms, the bank retains an optimistic view for the industry based around fundamental principles,” said Dale Champion, acting executive general manager, CBA Agribusiness.

“The medium term should see continued and growing demand for basic commodities, which, despite the current global issues, to a large degree will be led by the evolving middle class economies of our close trading neighbours in Asia.”

Champion said China and India in particular would prove integral.

Champion also said they expect to see the international investment focus return to Australian agriculture in the medium term, “which had been consistently rising prior to the current global credit turmoil”.

“This interest is based around Australia’s ‘clean, green’ reputation, together with the stable political environment.”

The business side of agribusiness

Westpac’s Jennings said with lending becoming tighter all around, the finance industry is taking a closer look at the risks it carries in general.

He believes agribusiness is resilient, however. “We’re talking about food and everyday staples,” he said, and despite the ravages of drought and flooding on the other side of the natural disaster spectrum, “global demand remains strong and there is an appetite for Australia’shigh quality food”.

He noted the benefit of a relatively lower Australian dollar, an advantage also acknowledged by Bill Cordingly, general manager, Rabobank Food and Agribusiness Research. Rabobank is another major food and agribusiness lender.

Cordingly said reductions in credit availability and consumption are having a noticeable impact on the agricultural sector.

“The exodus from futures markets, a shortage of credit for companies trading in agricultural commodities and the damage to consumer wealth have all added to the downward pressure on commodity prices.”

Cordingly identified three key benefits for the sector and farmers in particular, following the release of the group’s annual Australian Agriculture in Focus Report to clients in early February, beginning with the drop in the Australian dollar, which experienced a greater fall than many major economies.

“The Australian dollar was driven down by 30 per cent against the US dollar in the second half of 2008 helping to offset the falling US dollar commodity prices in export markets and the softening of pricesat the farm gate,” he said.

Cordingly added that the collapse in input costs, fuel, energy, fertilisers and agri chemicals was a further benefit, noting that they “have all fallen well below the highs of early 2008” and showing no signs of changing in this regard for the first half of 2009 given the global market uncertainty.

He argued there was a third benefit to farmers in the “aggressive cutting” of interest rates by the Reserve Bank.

These factors combined “mean that the full effects of the crisis, that are severe globally, will be somewhat softer in Australia in 2009, giving the industry the opportunity to manage through what will be a difficult year better than many competitors overseas”, he said.

Westpac’s Jennings is also looking at the positives.

“Overall, we see agriculture as a robust sector through these times. I’m cautiously optimistic.”