Agricultural stocks riding commodity upturn
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Short-term factors such as a great harvest have pushed some ASX listed agricultural stocks higher, but will the great run continue?
The outlook for the agricultural sector is looking bright with commodity prices for food and livestock riding high, with a great season in 2016 lifting rural prices and profits, underpinned by strong demand for food from Asia.
Australia's proximity to major Asian markets will continue to drive strong demand for agricultural products, from livestock, cereals, grains, and seeds to value-added producers such as farm-equipment manufacturers, and crop protection chemical and fertiliser producers.
"Over the long term, agriculture can be considered a secular growth opportunity, due to both rising global population and per-capita income levels in the developing world," said David Bassanese, chief economist with BetaShares.
"According to the latest United Nations population projections, the global population will expand from 7.3 billion people in 2015 to 8.5 billion by 2030. In short, over the next 15 years, the world will have 1.2 billion more mouths to feed," he said.
Shorter-term factors such as a great harvest have pushed some agricultural stocks higher.
"Generally speaking, 2016 saw a terrific harvest for grains and cereals with record harvests across the board, from wheat and canola to chickpeas. Prices for some commodities have risen strongly and yields were robust," said Morningstar's head of equities research Peter Warnes.
"We've also seen livestock prices go up for beef, lamb and pork, though feed prices have also gone up. This helped to push up Australian GDP in the fourth quarter of 2016, with farm output up substantially."
Data from the Australian Bureau of Statistics reveals agricultural output jumped 23.7 per cent in the December quarter compared to a year earlier, compared to an overall rise of 2.4 per cent for GDP.
That was driven by rises in grains, cotton, and livestock production. The Australian Bureau of Agricultural and Resource Economics and Sciences (ABARES) has revised up their grain forecasts due to stronger-than-expected winter crop yields.
Agricultural chemical company Nufarm (ASX: NUF) is one of the companies that has rallied in recent times. Morningstar puts a fair value of $6.00 on Nufarm, which is currently trading around $9.20, up from just $3.77 in April 2014.
"They've done well and they will probably continue to do well. The stock has got a nine in front of it, and three years ago it had a three in front of it," said Warnes.
"People are going to have to eat and this will benefit companies like Nufarm with its business in crop protection."
Another stock rated by Morningstar is bulk grains handler Graincorp (ASX: GNC).
"It's mainly operating in infrastructure, such as the storage of grains and rail transportation, so it becomes an infrastructure play and they have generally have had a good year because tonnages are up," said Warnes.
Morningstar puts a fair value of $8.50 on the stock, which is currently trading around $9.00.
GrainCorp told shareholders at its annual general meeting in February it was expecting a full-year profit after tax of between $130 million and $160 million in 2016-17, 16, reflecting a bumper year.
Another company which has rallied is agribusiness service provider Elders (ASX: ELD), which in recent days has hit a year high level of $4.55.
Since bottoming at 47 cents in May 2013, it has gradually headed higher as its fortunes changed with a better outlook for agricultural stocks and better management.
But will the run of selected agricultural stocks continue?
"I don't want to put a dampener on it, but the chances of another fantastic season next year aren't high. History suggests that rarely do you get two to three good seasons in a row. And the biggest risk factor in the agricultural sector is the weather and it's still as unpredictable as ever," Warnes said.
Having said that, some food commodities are likely to do well. World dairy prices, for example, are expected to grow each year to 2019-20, as consumption grows faster than supply, with increasing demand for high-value dairy products such as infant milk formula from Asia, according to ABARES.
For investors seeking exposure to the food sector, the currency-hedged BetaShares Global Agriculture ETF (ASX: FOOD) provides exposure to the world's leading global food companies. By investing across a range of companies, this ETF allows investors to gain exposure to the "agricultural" theme, while reducing country and stock-specific risk, Bassanese said.
"Another advantage of investing in companies, rather than [commodity] prices per se--at least over the long-term--is that companies can still make profits in an environment of flat or falling prices, provided their costs are well contained and/or quantity produced is still rising," he said.
"The FOOD ETF, for example, has lifted by 11 per cent over the past six months to mid-March."
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Nicki Bourlioufas is a Morningstar contributor. This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind. Opinions expressed herein are subject to change without notice and may differ or be contrary to the opinions or recommendations of Morningstar as a result of using different assumptions and criteria.
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