Australia | Sep 20 2007
By Chris Shaw
If asked to think of commodities most investors would likely think of gold, copper, nickel and oil off the top of their heads while forgetting agricultural commodities are just as significant in global terms, especially given strong demand from China and India and applications in the creation of energy.
Just as in the metal markets where producers are now struggling to invest in increasing output after years of neglect the same has occurred in the agricultural sector, with Austock Securities estimating there has been underinvestment in supply chains for as long as 30 years and market participants are now struggling to close this gap.
With the amount of available land for farming likely to remain relatively steady the broker suggests one almost certain outcome in the sector is further rationalisation and the Australian agricultural sector appears ripe for further consolidation.
This is on the back of the consolidation that has already occurred over the past 20 years, the broker noting in the agricultural supply sector the Australian marketplace has been reduced to just four players while over the same period Australian farmer numbers have halved and the top 10% in the sector now account for about 40% of profits.
Part of this change in farmer numbers reflects difficult conditions, as while the winter crop was something of a respite the lack of rainfall is again forcing down expectations for the upcoming wheat crop in particular.
As conditions remain difficult the rationale for mergers and acquisitions increases in the broker’s view as there is the potential for companies to gain supply chain improvements and other shortcuts, which it expects will mean opportunities for investors.
One sector where Austock expects continued strong performance is among the farm input companies, as the broker suggests the main players, Incitec Pivot (IPL) and Nufarm (NUF), already have solid platforms in place but will be looking for ways to lift productivity and here they are almost spoiled for choice.
For the former the broker has lifted its short-term profit forecasts by 17% and it is positive on the move to take a stake in Dyno Nobel (DXL) as this would be an example of the available consolidation gains the sector provides.
It also sees scope for the company to expand its operations either through additional acquisitions or via joint ventures in other markets, particularly in the Asian and Middle Eastern markets.
As a result Austock has recently upgraded its rating to Buy from Hold, in the process lifting its target price to $87.00. By way of comparison the FNArena database shows the stock as rated Buy and Hold three times each along with one Sell recommendation and an average target price of $75.81.
The broker has also upgraded Nufarm to a Buy given what it sees as a strong growth outlook, this despite making small cuts to its profit forecasts for FY08 and FY09. The diversified nature of the group’s operations stands it in good stead in the broker’s view, while it expects the recent merger with Agripec of Brazil will be a forerunner of other similar deals.
The FNArena database shows a more mixed opinion on the company’s outlook as it is rated as Buy twice, Accumulate once and Hold five times with an average price target of $14.90, which compares to the Austock valuation of $16.00 per share.
Grain companies are more exposed to the current tough conditions and so have had earnings estimates for FY08 revised lower, for Graincorp (GNC) by as much as 47% and for ABB Gain (ABB) by 31%.
Despite this ABB remains a Buy in the broker’s view given management is implementing some internal initiatives that will increase value over time, particularly given the global diversity of the group’s operations.
The greater clarity in the ownership structure following the conversion of shares into a single class type is also a positive, so the broker is happy to maintain its rating given its target price of $10.03 is more than 30% above the current share price.
The FNArena database offers a more mixed view as while the company is only covered by two brokers it scores one Buy and one Sell, with an average price target of $8.18.
In contrast to the simplification of share classes achieved by ABB the broker is less confident of the same being achieved at Graincorp given the board is not united on the issue. Offsetting this is the expectation the company will move towards storing a more diverse range of grains, which would help reduce earnings volatility somewhat.
While the uncertain outlook over the company’s structure remains the broker rates the stock as a Hold, pointing out it is currently trading near its DCF valuation of $11.03. The FNArena database again shows diversity of opinion with the stock garnering one Buy and one Sell rating and an average price target of $10.08.
Similarly to the input companies the broker expects the distribution companies will look for merger opportunities, possibly adding heavy assets in the process. It sees AWB (AWB) as a potential target here, as the company has scrapped its de-merger plans but would become a possible play if the Federal Government decided to take away the Single Desk rights it currently holds.
The recent sharp falls in the stock price (it is down around 40% in the past two months) has resulted in the broker upgrading its rating to Hold, as it points out the stock is now trading near its disaster valuation of $2.50. The FNArena database shows one Buy rating, two Holds and one Avoid, with an average price target of $2.84.
Futuris (FCL) is a far more diversified play but the broker has also trimmed its forecasts by 8% for both FY08 and FY09, while maintaining its Lighten recommendation. This makes the broker one of the more negative in the market, as the FNArena database shows one Buy and four Hold recommendations. The average price target on the stock is $2.52.
Austock has contrasting views on the livestock plays in the Australian market, rating AAco (AAC) as a Buy given its excellent land and cattle assets. In contrast it has downgraded Ridley (RIC) to Lighten from Hold as it sees scope for margins to be squeezed.
FNArena’s database shows AAC as rated Buy once and Hold once with an average target of $3.08.
