Each week, a professional investor tells MoneyWeek where he’d put his money now. This week: George Lee, partner of Eclectica Asset Management and manager of the CF Eclectica Agriculture Fund.
Despite recent share-price falls, we feel that the underlying case for long-term investment in agricultural equities is still compelling. Our fund was launched in June 2007 to take advantage of a once-in-a-generation opportunity to invest in agriculture. This opportunity has been created by a lack of investment in supply; increased demand driven by population growth; high demand for protein in the emerging markets and rising demand for fuel. Inventory levels remain extremely low, despite an improvement in the prospects for this year’s harvest.
Demand for soft commodities is relatively inelastic – no matter how deep a recession, a growing population still needs to eat. It is simply not possible for supply to be increased to meet demand without further investment in the industry. However, stock prices for many companies are now factoring in a depression in the agricultural sector.
For example, shares in Monsanto (US:MON), a food biotechnology company and producer of genetically-modified (GM) seeds, can be bought for only 15 times earnings. This is extremely cheap, given expected compound earnings growth of 20% over the next three years. In recent years, the stock has typically traded on closer to 30 times forward earnings – a better reflection of its exciting growth prospects.
Furthermore, earnings growth is being driven by the increased penetration of GM seeds, not short-term movements in crop prices. Indeed, corn prices would have to fall as low as $2 a bushel for the economics of Monsanto’s seeds to stop working.
We have taken advantage of this extreme sell-off to increase our Monsanto holding to 8% of the fund. The process of developing GM seeds is long and expensive: it takes over ten years to research, develop and commercialise a GM trait. Success is not a given, but profitability can be astronomic.
Syngenta (US:SYT), another player in the GM market, has grown its earnings at approximately 45% a year for the last five years. The firm is also on the verge of developing a “triple stack” seed – with three favourable traits built in. Bringing this product to market will trigger further revenue growth and margin expansion, which is not reflected in the current low valuation.
Finally, one of the biggest holdings in the fund is Canada’s Potash Corp (US:POT), a commercial producer of nitrogen, phosphate and potash. As with crops, the supply and demand balance for fertilisers is extremely tight. Although in geological terms potash is not a scarce resource, its price is supported by the fact that in the short term, supply is highly inelastic due to the time it takes to build a new mine. New supply will eventually enter the market, but we are unlikely to see any major developments before 2012/2013.
As things stand, potash companies have a five-year window to exploit underinvestment in the industry. We believe that the price falls we have seen for this company and other potash sellers have been excessive, considering that no new mines are scheduled to open and existing global stocks of potash are limited. Potash Corp is trading at a 25% free cash-flow yield, making the company’s shares pretty safe and potentially highly rewarding.