Expensive Food, Cheap Stock
By Chris Mayer
China's last emperor, Pu Yi, loved his soybeans. They were a staple of the Manchurian diet in Northern China. In the 1930s, a forward-thinking Brazilian friend asked Pu Yi if he could take some soybeans back to Brazil. Pu Yi agreed. The beans eventually made their way to bustling Rio de Janeiro.
In Brazil's fertile soils, soybeans found a welcome new home. Over the ensuing decades, they would become one of Brazil's most important crops. Today, soybeans are Brazil's largest export.
So there are historical roots for the boom in trade between China and South America. Trade between the countries has really surged in recent years. For example, China gets about one-third of its food supply from South America - with a good chunk of that from Brazil's vast farmlands. It's a natural, too. Not just for China, but for the world.
In Brazil and Argentina, you have one of the few places left in the world where you can acquire large tracts of land in temperate climates with plenty of rainfall to support large-scale agriculture. Already, the two countries produce about one-third of the world's agricultural commodities. As China is the world's workshop and India its back office, so has South America become its breadbasket.
Brazil is already the world's largest producer of coffee, sugar cane, ethanol and fruit juice. It is also near the top in soybeans, beef, poultry and tobacco. Brazil's agricultural sector alone has grown at a 5%-plus clip since 1999. That's pretty good for such a big sector. Agriculture represents about 8% of the economy, employs one-quarter of its work force and supports some 8 million enterprises. Likewise, Argentina is also a leader in beef and grains - it is the largest consumer of beef on a per capita basis in the world. In beef production, Argentina is behind only Brazil and Australia. Argentina is big on soybeans, wheat, sorghum, rice and barley. Argentina also produces an abundance of fruits - lemons, apples, peaches, pears and more.
But - as hard as this may be to fathom - there is the potential for so much more. The rise in the living standards of hundreds of millions of people in China and India, the resulting shift in dietary habits and the global push for alternative fuels derived from agricultural products put South America in the catbird seat.
The agricultural markets are abuzz these days. The prices of corn, barley, soybeans, coffee and cocoa are all well above their averages over the past five years. Meat and poultry prices are also on the upswing. You can see it, too, in the behavior of the companies involved. Dannon recently announced it would boost prices for its dairy products. That follows on the heels of similar announcements by Nestlé, Unilever and Cadbury Schweppes, Kellogg's, General Mills and others.
As an investor, I think I'd like to own companies that make the stuff that everybody else wants to pay more for. So it's not hard to see why I should gaze at those lush farmlands in South America.
Historically, the productive capacity of this region is underdeveloped - despite its chart-topping production. Some 90% of Brazil's fertile and productive land has not yet been cultivated. Similarly, the United Nations' Food and Agriculture Organization estimates that farmers have cultivated only 3% of Argentina's fertile land. So there is lots of land to accumulate and turn into a top-notch farming operation.
Only in the last decade or so have producers in these countries applied cutting-edge technologies in managing their farms. The result has been a great expansion in crop yields. In today's markets, farmers in Argentina and Brazil are highly competitive in the global market for corn, wheat, soybean, sugar and other products. In fact, some of the success in Argentina and Brazil has come at the expense of American farmers - especially in the area of soybeans, for example.
Brazil and Argentina have something else of great value: water. Take a look at the chart, which shows that South America has about 26% of the world's water supply, but only 6% of the world's population. Asia, by contrast, has many more people to support with its water supply. Then again, this chart makes things look better than they are. Most of China's water supply is in the south, while most of its people live in the north.
In any case, Brazil alone holds 14% of the world's supply of fresh water. I remember, too, visiting a ranch in Argentina and having the owner proudly show me how water generously bubbles out of the ground from underground streams and then waters acres of crops. Quite a natural advantage.
Perhaps it goes without saying that the biggest risk down here is the populist and interventionist policies of governments. That is a risk one takes everywhere these days -even in America, and even in Canada (remember the income trust fiasco?). Political risk seems to be on the rise the globe over, something we should expect after a long period of fat years. People get complacent and take economic growth for granted.
While the political risks of South America bear watching, I believe the investment merits of owning farmland down here outweigh the political risks.
The best way to own South American farmland, short of hopping on a plane and bringing a bag full of money to a settlement table, is to buy shares of Cresud (CRESY:nasdaq).
Cresud is a big agricultural concern in Argentina. It has operations in beef cattle, grain and milk. It also has a large stake in the Argentine developer IRSA. And the real kicker - the thing that could make a mint for shareholders over the next few years - is its investment in BrasilAgro. BrasilAgro is what prompts me to write this update, as I believe that Cresud's investment in BrasilAgro could eventually exceed the size of Cresud's existing Argentine operations.
Cresud and some local investors started BrasilAgro in May 2006. The idea was to use Cresud's expertise and replicate its successful business model in Brazil. Since BrasilAgro's initial public offering, it has been busy acquiring farmland throughout Brazil. By April of this year, it had gone through about 40% of its IPO proceeds. Cresud owns about 10% of BrasilAgro.
When I was in Argentina earlier this year, I met with the management team at Cresud. I remember the team's excitement about the long-term prospects of BrasilAgro. It is easy in Brazil to acquire vast tracts of farmland. It is also relatively cheap. Finally, the business environment in Brazil is generally thought somewhat friendlier than in Argentina.
I expect the value of BrasilAgro to increase significantly in the years ahead. In the meantime, Cresud itself still looks cheap and has great trends behind it. Even the investment banking firms that are neutral on the shares still come up with a net asset value of $25 per share – 25% above the current quote. The downside on Cresud looks low here. I think the worst case is that a year from now, this stock still lingers around $20 per share. Basically, we ought to get our money back. But in the best case, you've got lots of potential catalysts for a move higher.
Cresud remains a buy.
China's last emperor, Pu Yi, loved his soybeans. They were a staple of the Manchurian diet in Northern China. In the 1930s, a forward-thinking Brazilian friend asked Pu Yi if he could take some soybeans back to Brazil. Pu Yi agreed. The beans eventually made their way to bustling Rio de Janeiro.
In Brazil's fertile soils, soybeans found a welcome new home. Over the ensuing decades, they would become one of Brazil's most important crops. Today, soybeans are Brazil's largest export.
So there are historical roots for the boom in trade between China and South America. Trade between the countries has really surged in recent years. For example, China gets about one-third of its food supply from South America - with a good chunk of that from Brazil's vast farmlands. It's a natural, too. Not just for China, but for the world.
In Brazil and Argentina, you have one of the few places left in the world where you can acquire large tracts of land in temperate climates with plenty of rainfall to support large-scale agriculture. Already, the two countries produce about one-third of the world's agricultural commodities. As China is the world's workshop and India its back office, so has South America become its breadbasket.
Brazil is already the world's largest producer of coffee, sugar cane, ethanol and fruit juice. It is also near the top in soybeans, beef, poultry and tobacco. Brazil's agricultural sector alone has grown at a 5%-plus clip since 1999. That's pretty good for such a big sector. Agriculture represents about 8% of the economy, employs one-quarter of its work force and supports some 8 million enterprises. Likewise, Argentina is also a leader in beef and grains - it is the largest consumer of beef on a per capita basis in the world. In beef production, Argentina is behind only Brazil and Australia. Argentina is big on soybeans, wheat, sorghum, rice and barley. Argentina also produces an abundance of fruits - lemons, apples, peaches, pears and more.
But - as hard as this may be to fathom - there is the potential for so much more. The rise in the living standards of hundreds of millions of people in China and India, the resulting shift in dietary habits and the global push for alternative fuels derived from agricultural products put South America in the catbird seat.
The agricultural markets are abuzz these days. The prices of corn, barley, soybeans, coffee and cocoa are all well above their averages over the past five years. Meat and poultry prices are also on the upswing. You can see it, too, in the behavior of the companies involved. Dannon recently announced it would boost prices for its dairy products. That follows on the heels of similar announcements by Nestlé, Unilever and Cadbury Schweppes, Kellogg's, General Mills and others.
As an investor, I think I'd like to own companies that make the stuff that everybody else wants to pay more for. So it's not hard to see why I should gaze at those lush farmlands in South America.
Historically, the productive capacity of this region is underdeveloped - despite its chart-topping production. Some 90% of Brazil's fertile and productive land has not yet been cultivated. Similarly, the United Nations' Food and Agriculture Organization estimates that farmers have cultivated only 3% of Argentina's fertile land. So there is lots of land to accumulate and turn into a top-notch farming operation.
Only in the last decade or so have producers in these countries applied cutting-edge technologies in managing their farms. The result has been a great expansion in crop yields. In today's markets, farmers in Argentina and Brazil are highly competitive in the global market for corn, wheat, soybean, sugar and other products. In fact, some of the success in Argentina and Brazil has come at the expense of American farmers - especially in the area of soybeans, for example.
Brazil and Argentina have something else of great value: water. Take a look at the chart, which shows that South America has about 26% of the world's water supply, but only 6% of the world's population. Asia, by contrast, has many more people to support with its water supply. Then again, this chart makes things look better than they are. Most of China's water supply is in the south, while most of its people live in the north.
In any case, Brazil alone holds 14% of the world's supply of fresh water. I remember, too, visiting a ranch in Argentina and having the owner proudly show me how water generously bubbles out of the ground from underground streams and then waters acres of crops. Quite a natural advantage.
Perhaps it goes without saying that the biggest risk down here is the populist and interventionist policies of governments. That is a risk one takes everywhere these days -even in America, and even in Canada (remember the income trust fiasco?). Political risk seems to be on the rise the globe over, something we should expect after a long period of fat years. People get complacent and take economic growth for granted.
While the political risks of South America bear watching, I believe the investment merits of owning farmland down here outweigh the political risks.
The best way to own South American farmland, short of hopping on a plane and bringing a bag full of money to a settlement table, is to buy shares of Cresud (CRESY:nasdaq).
Cresud is a big agricultural concern in Argentina. It has operations in beef cattle, grain and milk. It also has a large stake in the Argentine developer IRSA. And the real kicker - the thing that could make a mint for shareholders over the next few years - is its investment in BrasilAgro. BrasilAgro is what prompts me to write this update, as I believe that Cresud's investment in BrasilAgro could eventually exceed the size of Cresud's existing Argentine operations.
Cresud and some local investors started BrasilAgro in May 2006. The idea was to use Cresud's expertise and replicate its successful business model in Brazil. Since BrasilAgro's initial public offering, it has been busy acquiring farmland throughout Brazil. By April of this year, it had gone through about 40% of its IPO proceeds. Cresud owns about 10% of BrasilAgro.
When I was in Argentina earlier this year, I met with the management team at Cresud. I remember the team's excitement about the long-term prospects of BrasilAgro. It is easy in Brazil to acquire vast tracts of farmland. It is also relatively cheap. Finally, the business environment in Brazil is generally thought somewhat friendlier than in Argentina.
I expect the value of BrasilAgro to increase significantly in the years ahead. In the meantime, Cresud itself still looks cheap and has great trends behind it. Even the investment banking firms that are neutral on the shares still come up with a net asset value of $25 per share – 25% above the current quote. The downside on Cresud looks low here. I think the worst case is that a year from now, this stock still lingers around $20 per share. Basically, we ought to get our money back. But in the best case, you've got lots of potential catalysts for a move higher.
Cresud remains a buy.
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