The demand-supply imbalance in food articles provides an opportunity to invest in companies operating in the agriculture value chain.
There is a saying that if people in China and India put together start consuming a particular commodity, it could fast lead to an imbalance situation. This is not impossible given that the two countries account for almost 40 per cent of the world population wherein their per capita consumption is lower than the world average leave alone that of the developed world. Positively, the situation is not as daunting in the near-term. Investment gurus believe that though India and China are among the fastest growing economies, they are still small to make any major impact on the world’s consumption of food and agriculture output in the near-to-medium term. But, they believe that the impact will definitely be seen in the long run as the supply of food articles remains limited whereas demand is growing at a faster pace.
Demand & supply pressures
According to a study by Food and Agriculture Organisation (FAO) of United Nations (UN), the world population is expected to reach to 9.1 billion by 2050 as compared to about 6.8 billion currently. This would also lead to demand for food almost doubling led by higher consumption and rising incomes in developing countries, especially India and China.
In addition to this, many countries are turning towards alternative ways to meet their energy requirements wherein agriculture produce like grains are increasingly being used for producing bio-fuel leading to higher demand. Sugar and corn are perfect examples, which are increasingly being used for making bio-fuel despite the shortfall in production. Further, the problems will accentuate considering that the UN estimates suggest that about 25 per cent of the food production will be lost by 2050 due to the impact of climate change, land degradation, water scarcity and so on.
On one hand while demand is growing, arable land is also shrinking. Land, which is already scarce, will become scarcer even as the world will need to double food production in order to meet the increasing demand for food. Estimates indicate that the availability of arable land is reducing by 10 million hectare annually as more and more land is being used for the residential and industrial purposes.
There are other concerns as well. “The inventories of food are the lowest not in years but in decades. Supply is going to remain down since we have serious production problems. At the same time people are eating more and we are burning some of our foods as fuels,” says Jim Rogers, a global investor.
In India, there are other hindrances too. As property prices soar, farmers find it attractive to sell their agriculture land, which ultimately gets used for industrial and residential purposes. Many also observe that water resources are depleting on the back of economic growth and increasing population. Considering this, it is increasingly becoming difficult for the farmers to expand agriculture output even as they remain heavily dependent on rain water, which in turn leads to poor utilisation of land resources.
Globally, too, water consumption is doubling every 20 years, which is twice the growth in population. According to the estimates of Food and Agriculture Organisation (FAO) of UN, availability of the arable land will decline to 0.6 acres per person by 2030 from 1.1 acres in 1960. All this only indicates that food prices remaining firm, if not move up, in the long run.
The combined impact of these developments seem to be having significant influence on prices of agriculture produce, part of which we have already seen in the recent past in the form of rising food inflation. Going ahead, too, prices are expected to remain firm feel experts.
“We are going to see much higher prices of the food. If we do not see much higher prices of the food soon, we are going to have people starving. The price of the food articles has to go higher and much higher and I think they will. Most food prices are very depressed,” says Rogers.
It is very recently that the supply side issues have been highlighted as a major reason for the surge in food prices. Measures to improve agriculture production and crop yields are seen as the key answers to this problem. However, economists and industries participant believe that the problem may not be solved overnight and will require substantial investment and sustainable policies. In any case, not all is lost. Companies operating in the food value-chain could be major beneficiaries of the evolving scenario along with the advantage of higher agriculture output prices. This includes players directly engaged in the agriculture business, food processing industry or ones that provide agri-inputs.
While many companies will stand to gain from their presence in different segments of the food value chain, including Monsanto India (seeds), Tata Chemicals (fertilisers) and so on, we have picked up five that have a good track record, enjoy healthy market shares and operating profit margins in their respective businesses and have better growth prospects. These companies are expected to benefit substantially from the growth opportunities and changing dynamics of the global agriculture industry. Notably, in most cases, valuations are not expensive, which should help these companies deliver good returns in the coming years.
Jain Irrigation would benefit from its presence in micro irrigation systems (MIS), which helps in effective utilisation of water resources and agriculture inputs such as seeds and fertilisers as well as in improving the crop’s yield.
According to estimates, in India only about 3 per cent of the arable land is cultivated by way of using MIS. But, this will change as penetration levels improve on the back of increasing awareness of the benefits of MIS and the government’s support, by way of subsidies on equipments, to farmers. Estimates indicate that an additional 15 million hectares of agricultural land is to be covered under micro irrigation over the next seven years, as against only 3.68 million hectares currently covered. This translates into an opportunity of about Rs 45,000 crore over seven years.
Jain Irrigation is a MIS leader and generates about 42 per cent of its consolidated revenues from this segment. Notably, among the company’s different businesses, MIS enjoys the highest operating profit margins of over 20 per cent. Over the next two years, revenues from this business are expected to grow at about 30-35 per cent annually as penetration levels increase led by government subsidies for purchasing these systems. Besides, the company is also exploring new and untapped markets and developing new products suitable for different crops and topographies. The company is also present in the pipe manufacturing and food processing (contribute over 55 per cent of total revenues) businesses, which are expected to grow at about 12-15 per cent annually on the back of higher demand. Overall, analysts expect Jain Irrigation's revenues to grow at about 25 per cent over the next two years. Although its current PE appears high, considering its earnings growth prospects, the stock can be considered.
Karuturi Global is world's largest cut rose producer with an annual capacity of 555 million stems, which give it a market share of 8 per cent. The company exports its products to developed countries like the US, Europe, Japan, Russia and Australia whereas its operations are spread in some of the low-cost countries like Kenya, Ethiopia and India wherein the company has a total farm land of 239 hectares. The company is further expanding in Ethiopia, where it has been allotted 366 hectares of land. The cultivation on this new land is expected to start over the next two years. Considering the increasing acreage, its core business alone can grow at about 30 per cent annually for the next two years.
The company also has ambitious plans to garner substantial revenues through its recent agriculture-based venture. It has acquired on lease 311,700 hectares of land in Ethiopia, which analysts say is about seven times the size of Mumbai city, for cultivation of agriculture produce in a phased manner. In the first phase, 60,000 hectares of land will begin production starting 2010-11. The company plans to grow cereals, sugar and palm, which will be sold in the market. While this is seen as a good move to capitalise on the growing food demand, expect revenue contribution to start reflecting by around 2012-13. Also, the company will have to incur investments in the initial stage to bears the fruits.
Food processing companies would also have their share in this ever-expanding opportunity considering the growing need for food security and increasing consumption of processed food items. In India, the industry is still small, but is expected to grow at about 10 per cent annually over the next few years given the rising per capita income, rapid urbanisation and GDP growth of the country. Also, despite being one of the largest agri-producers today, India could not harness the export potential, which could change as the industry develops.
Although there are many companies that stand to gain, one such company is KRBL, which is an integrated basmati rice producer having the world’s largest milling capacity of 1.7 million tonnes per year. The company is world’s largest exporter of basmati rice, which it sells through its portfolio of well-known brands like “India Gate”, and enjoys a large share in the international markets. On the back of its strong brands and distribution network, the company earns better realisation and operating margins compared to some of its peers in the sector. The exports of basmati rice have been growing at about 20 per cent annually in value terms. In the future also, the demand for basmati rice and its price are expected to remain firm given that its demand continues to outstrip supply. The domestic industry, too, is expected to grow at about 15-20 per cent annually over the next few years on the back of rising demand and increasing share of organised players. Hence, expect KRBL to grow at about 25 per cent annually over the next two years.
Even as India is the fourth largest vegetable oil market globally and consumes about 12 millions tonne annually, it still ranks low on the basis of per capita consumption. About 35 per cent of India’s edible oil requirement is met through imports due to lower production and less yield in the country. Such a scenario will ensure that domestic companies in the edible oil space will continue to gain in the future. One such company is Ruchi Soya. The company is the largest and most integrated player in the domestic edible oil industry commanding about 17 per cent share of the palm oil market and 25 per cent of soya oil. The company will also benefit as it increases its focus on the branded products, which enjoy higher margins. (Click for table)
Besides, the company has also forayed into the overseas markets to secure low-cost supply of raw materials. It has signed an MOU with the Ethiopian government for 123,550 acres of land for cultivation of soybean. In palm oil as well, the company is looking for plantations in Indonesia and Malaysia. The company is further venturing into the mustered oil market and plans to increase its capacities by about 1 million tonnes by the end of 2012. Its diverse product mix, integrated operations, robust market shares and expansion of capacities along with the opportunities in the sector should mean good growth for the company in the years to come. For now, analysts expect the company to clock about 30 per cent growth in earnings over the next two years.
There are equally large growth opportunities in the agriculture input industry as well. Focus on increasing output and crop yields along with rising income of farmers would mean higher spending on seeds, especially high yielding seeds, fertilisers and other chemicals like pesticides. United Phosphorus (UPL), which is present across the value-chain from seeds to crop protection, is a good play from the domestic and international industry perspective. UPL is among the top five generic agro-chemicals companies in the world. The company is well diversified in terms of products and geographies, which is a result of several acquisitions it has made in the past. Its presence in almost 120 countries ensures that overseas operations accounts for almost 80 per cent of its revenue. Nevertheless, the company plans to further expand in other markets like Brazil. Notably, access to a low-cost manufacturing base in India gives the company an edge over other international players.
Considering the opportunities in the international markets, particularly in the generics crop protection products, analysts are expecting the overseas revenues to grow at about 12-15 per cent. In addition to this, the opportunities in the domestic agriculture market should benefit the company in the long run. The company also owns 49.88 per cent stake in Advanta India, which is a listed company with strong position in the domestic seeds market. Analysts expect Advanta’s sales turnover to grow by about 16 per cent to Rs 715 crore in CY09. Advanta India was also in news recently for its acquisition of US-based Crosbyton Seed Company. To sum up, UPL’s diversified portfolio, strong distribution network and presence in growing markets mean higher revenue visibility.