LET'S suppose you work in agriculture, broadly defined, and you think you know it fairly well.
Let’s also suppose you decide to use this knowledge to invest in firms listed on the stock exchange whose main business is in agriculture. You might even think of it as a legal version of insider trading.
Let’s further assume you have a friend who does not share your knowledge of agriculture. Your friend therefore decides to buy shares in an Exchange Traded Fund that tracks the All Ordinaries Index, so that movements in the Index are directly reflected in the value of his investment.
Over the last two or three years, which one of you would have made the most money?
The answer is not what you might expect. Unless you had limited your share buying to just six of the 21 agribusiness companies I found, your investment would have lost a substantial amount of your investment, whether you started in 2010 or 2011.
The poor performers cover the gamut from input suppliers to output marketers. Examples include AACo, AACL, Agricultural Land Trust, Conquest, Elders, Namoi Cotton, Ridley, Arrium and Shearer. A few managed to almost keep up with the All Ordinaries, while there is a very short list of those that outperformed it. One of them, GrainCorp, is only in that position because of the ADM offer.
And not one is substantially above it.
Your friend, on the other hand, would have enjoyed a handy increase in his investment.
This is a bit of a shock. The experts tell us that investing in a limited number of firms that we know something about, in an industry we understand, is the smart way to do it. Brokers employ analysts who specialise in particular industry sectors, and high performing investment funds often have a bias towards sectors with which they are familiar. And they all regard beating the All Ordinaries as the absolute minimum for performance.
It is unfortunately the case that most Australian public companies involved in agriculture do not perform well for their shareholders (although their management usually does a lot better).
Return on capital tends to be low, dividends are meagre if paid at all, and the share price struggles (and mostly fails) to keep up with the market.
This leads to reluctance to invest in agriculture. Those managing superannuation funds, for example, are well aware of the history of poor results from agriculture investments and tend to stay away. It’s not as if they don’t have plenty of alternative options.
Increased profitability and reduced volatility by listed agriculture firms would make a huge difference to their appeal as investments and have all sorts of flow-on benefits. But I can’t see it changing.
High profits are actually not uncommon in agriculture, albeit with some big ups and downs. In every sector of farming, from apples to zucchinis, grapes to goats, and of course wheat, dairy, wool and beef, the top 20 per cent or so are generating returns on capital that would make a fund manager blush. There are also input suppliers, rural merchandise retailers and machinery manufacturers which are doing handsomely.
What characterises these businesses is that they are strongly focused on what they know, and their owners are intimately involved in their operations. Public companies typically lack both these attributes.
But it is also true that the big international agribusiness firms such as Agrium, ADM, Glencore, Cargill, Louis Dreyfus, the big Japanese trading houses, plus the major international crop protection companies, manage to achieve respectable performance. Most of these are public companies.
The difference in their case is global scale. They have suppliers in a range of countries and customers in all corners of the world, allowing them to benefit from fluctuations in global supply and demand.
When there is a drought in Australia, it is usually a good season in the US or Russia and vice versa. Costs can be spread across huge volumes and volatility is substantially reduced.
Given my background, I was once among those who thought investing in Australian agribusiness firms made sense. These days I avoid them all.
While I understand the logic of investing in the growing demand for food, buying shares in Australian agribusiness companies is a good way of losing money. Investing in the All Ordinaries Index is more lucrative, and it is safer to buy shares in international companies.
David Leyonhjelm has been an agribusiness consultant for 25 years. He may be contacted at email@example.com