First State Global Agribusiness Fund
Market review
- The Global Agribusiness Index was broadly flat in August, outperforming global equity markets.
-August is always a pivotal month for many soft commodity prices as the world’s largest producer and exporter of grain, the United States, enters a critical time for the development of its summer crops. This year, large acreage and benign conditions had the market anticipating record production, however hot and dry conditions through August dented expectations.
- Corn and soybean had a volatile month, falling during the first half before rallying strongly as weather conditions changed.
-The Global Timber and Forestry sector weakened (3.0%). Having outperformed for over 12 months, forestry related companies experienced some profit taking as investors became nervous about the impact of rising mortgage rates on the US housing recovery.
-Corn prices crept 0.6% higher as poor late-season weather in the US posed a growing risk to production forecasts. Heat and dryness across the corn-belt accentuated water stress, posing downside risk to yields.
-Weather expectations also played their part in the soybean market where prices went up 12.5% over the month. Concerns over hot, dry weather across the US Midwest pulled back output expectations. This occurred against a backdrop of strong Chinese purchases, which reinforced the positive soybean price trend.
-Palm oil prices moved up by 7.8% as a weaker ringgit boosted export prospects from Malaysia, the second-biggest palm oil producer, and on speculation that dry weather in the US may cut soybean output.
-By contrast, wheat prices weakened -3.4% on the back of expectations for a bumper crop in the northern hemisphere. Production numbers were discouraging for short term prices with European Union yield potentially up from 138 million tonnes to 141, Kazakhstan up from 14.5 to potentially 17 million tonnes and Ukraine up from 19.5 to 21.5 million tonnes.
-Sugar prices fell -3.7% as strong production from top producer Brazil helped global supplies exceed demand for a fourth consecutive year. The depreciation of the Real against the USD has reduced the impact of lower sugar prices on producers. Sugar producers in South America and Asia are bolstering their dollar-denominated exports to take advantage of falling emerging market currencies yet the move risks weighing on already low global sugar prices.
Fund activity
-We initiated a position in Concha y Toro, Chile’s largest wine exporter and the world’s sixth largest winery. A combination of falling grape costs in Chile and a stable (or depreciating) currency should lead to earnings expansion and margin recovery.
-We purchased Brazil’s JBS SA, the world’s largest meat processing company, which derives almost two-thirds of its revenue from foreign operations. Falling feed costs should help maintain profits from its US poultry division while margins from its Brazilian beef business are likely to improve with falling cattle prices and strong export demand.
-We added to our holdings in London Sumatra, Malindo Feedmill and Plum Creek Timber. London Sumatra is a large plantation company with palm oil, rubber, tea and cocoa plantations across Indonesia. Indonesian plantation companies have become compellingly valued as investors have been downbeat about their earnings prospects. We believe that even a modest earnings improvement could cause investors to rethink their attitudes and expand London Sumatra’s valuation.
-Indonesia’s Malindo Feedmill produces animal feeds and is a chicken breeder. Disproportionately low meat consumption in Indonesia provides immense room for Malindo to grow. Its attractive valuation, trading at a significant discount to peers, and projected earnings growth above the sector prompted us to increase our weighting to the stock.
-Plum Creek is the largest and most geographically diverse private land owner in the US. It has a solid timberland base and is well-managed. It will benefit from a recovery in sawlog prices in the southern US and exposure to the improving housing and construction cycle.
-We reduced the position in agricultural equipment manufacturer Deere & Co, selling into strength as the company reported an impressive third-quarter profit attributable to a strong farm sector in North and South America. We also sold down plantation company Kuala Lumpur Kep, due to its expensive valuation, with the proceeds redeployed into the attractively valued London Sumatra.
-There were no exits from the portfolio over the month.
Market outlook and fund positioning
-It can be easy to be distracted by month-by-month market and price fluctuations. As long-term investors, however, we maintain our focus on secular trends that support an optimistic outlook for agricultural companies. According to the United Nations, the world’s population is set to grow 40% by 2050. That would mean 9 billion people compared to 7 billion today, an additional 77 million people each year. Clearly agricultural volume will need to lift appreciably to feed many more people.
-Food demand is more than a story of absolute numbers, though. Higher living standards are also accompanying population growth. One consequence of many more millions moving up the income ladder is a desire for more calorie-rich, protein-packed food. More people than ever want chicken, meat and dairy products. Increased protein demand has a knock-on effect on grain demand. Pent-up demand for more calories and protein will require far higher agricultural productivity than is currently being achieved.
-This imbalance between demand and supply will be a boon for companies that can help to feed the world and produce more food in better and safer ways. We are positioned to benefit from this dynamic by focusing on the upstream and mid-stream portion of the agricultural value chain. We believe companies in these parts of the value chain will benefit from demand for greater volumes of their products ranging from fertiliser producers and seed makers to traders, grain handlers and food producers. Our focus remains on investing in agricultural companies that will benefit from this increased demand for food as well as companies that are helping to improve agricultural productivity.
-The volatility experienced in underlying commodity prices in August reiterates the case for being diversified by geography, commodity and across the agricultural value chain. The fund is positioned with a significant underweight position in fertilisers and machinery companies which is offset by large overweights in seeds/crop protection, food processing and supply chain companies. Despite recent downgrades in production forecasts, a large crop will benefit handlers and traders as well as protein and food ingredient companies.
