“The ‘Holy Grail’ of Agriculture Investing”

Deciphering a teaser from International Living Investor

By Travis Johnson, Stock Gumshoe, July 20, 2011

I don’t think I’ve ever written about one of the teasers from International Living Investor before, but a recent ad from editor Chris Hunter caught my eye … he’s pitching an idea that he thinks might be the “holy grail” of agriculture investing.

And agriculture investing is probably too hot as an idea right now, but it’s certainly got something going for it — I’ve invested in many farm-owning and agriculture commodity stocks over the years and still hold several and consider it an important investment “theme.” Many, many investors are worried about inflation and even hyperinflation, and the impact that might have on our quality of life, and food and water are the two bedrock consumption items that we can’t do without — prices of all hard assets ought to rise as the value of paper currency falls, but agricultural commodities have a special spot in investors’ minds as a growing world tries to feed itself.

Just scanning through my potential teasers to write up today I also saw agriculture and farmland come up as key “tease” points in ads from Matt Badiali for his S&A Resource Report, and from the hucksters at the National Inflation “Association” (NIA) who are prepping readers for their next promo campaign with a thinly-veiled ag stock hint. But partly because I’ve written many times about the stock Badiali is teasing, and I don’t trust the NIA guys (too many rumors of pump and dump around their picks and the rumored connection to pump-and-dump innovator Jonathan Lebed, and I don’t like the fact that they’re clearly a profit-making enterprise but use the “association” name), I thought this new one, from a newsletter I haven’t covered before, would be a better one to cover.

The basic pitch in the ad is similar to most — it’s a story of declining paper assets over the last decade, and about this intrepid editor’s trip to the commodities powerhouse of South America, Brazil. Here’s how he introduces the idea:

“… it’s one of the few places in the world where massive areas of land can be brought under cultivation to feed the world’s rising population.

“In fact, my first port of call in Brazil was the southwestern state of Mato Grosso do Sul – which makes up part of Brazil’s ‘bread basket.’

“I spent three days there with top Brazil soil engineer Renato Roscoe investigating the best ways to invest in Brazil’s fast-growing agriculture sector.

“What I was looking for was a way ordinary investors could take part in the big boom in agricultural boom…and the shift in paper assets to real assets…without having to travel to Brazil or buy land directly (which is complicated for legal reasons).

“While on the road with Renato I found exactly that…”

So how does he think we should invest in this “breadbasket” of Brazil? Don’t worry, he throws out some tasty clues for us:

“Follow George Soros to Brazilian Agriculture Gains

“There’s one small Luxembourg-listed agricultural company that operates in this part of the world.

“It produces grains, rice, oilseed, dairy products, sugar, ethanol, coffee and cotton. And as the end of last year, it owned a total of 282,798 hectares in Brazil, Argentina and Uruguay.

“This company may be small. But it has the backing of one of the world’s wealthiest investors, George Soros.

“Soros owns shares worth $360 million though his hedge fund, according to the latest SEC filing. And it makes up the billionaire’s largest equity position.”

So that ought to be a relatively easy job for the Thinkolator, right? (Hey, we all have to take it easy sometimes — it’s Summer, after all). And indeed, no worries, this is Adecoagro (AGRO)

Which is indeed a Luxembourg company, though it IPO’d on the NYSE back in February at about $12 a share (it has bounced around a bit but is still near that price, $11.35 as I type). And George Soros’ funds are large holders, Soros Fund Management currently owns about a third of the company per the SEC info on Yahoo Finance — but he didn’t just buy it, he invested in the company before the IPO and was planning to lighten his holdings post-IPO (I don’t think he has — yet, at least — but I’m not sure, we won’t get his second quarter 13F updating his portfolio holdings until mid-August).

Adecoagro is a South American farm owner and agribusiness company — they started out as a buyer of Argentinean farmland about ten years ago, and gradually added more farms and processing/industrial facilities as well as one farm in Uruguay. They then expanded into Brazil about five years ago, and at the same time continued to step up their vertical integration efforts — buying dairy processing and coffee processing plants, for example, in addition to buying the productive farmland to feed those plants. It was only last year, however, that they got involved with the Soros fund and incorporated in Luxembourg, and only this year that they got their NY listing and started to get the attention of other ag-hungry investors.

And yes, the match for the teaser is spot-on: they do produce grains, rice, oilseed, dairy products, sugar, ethanol, coffee and cotton — the biggest ones, in terms of acreage planted, are soybeans and sugarcane; they do own 282,798 hectares of farmland in Argentina, Brazil and Uruguay. Uruguay is still a tiny portion, with two farms, and the rest was split close to even between Argentina (21 farms) and Brazil (15 farms) as of the end of last year.

Still, the attention has clearly not been overwhelmingly positive as of yet — most people have still not heard of the company, and it looks like they were fairly lucky to price the IPO as well as they did given the lack of historically positive earnings. Analysts are speculating that they will earn 27 cents per share this year and 23 cents next year, so that’s not exactly what one wants to hear when investing in a fairly pricey company (that means the current year PE ratio would be well above 40, a lot to pay if they’re not going to grow earnings).

So certainly the expectation, if you’re positive about Adecoagro, is that they will grow earnings eventually — and that they will continue to grow their land holdings. They don’t have a lot of flexibility to buy up land right now unless they want to become pretty heavily indebted — the IPO means they have about $400 million in cash that nicely offsets their roughly $400 million in debt, but the cash is spoken for as part of their investment in a massive sugarcane/ethanol refinery that will be one of the biggest in Brazil and will help them to build up a huge sugar and ethanol (and electricity cogeneration) capacity in Mato Grasso, where they already have one plant and are also planting sugarcane to prepare for this new plant.

Articles at the time of the IPO filing indicated that
completing the mill would cost $690 million, so they’re still going to carry quite a bit of debt. That’s not unusual for a farming company with capital-intensive industrial capacity and lots of land, but it can limit flexibility when growing and mean that they might have to issue more shares.

Are you getting our free Daily Update
"reveal" emails? If not,
just click here...

Analysts haven’t published quarterly estimates for AGRO, and there’s no particular reason to expect that their annual estimates will be very accurate for such a new company (and a company that is so seasonal and so dependent on commodity pricing and hedging), but the second quarter is generally expected to be their best one in terms of seasonality of earnings, so we might see some positivity come out if a good quarter catches investor attention.

On the other hand, the Soros fund is a big part of the Adecoagro story at this point too, so if they do lighten up their holdings that could pressure the stock — we’re likely to get the next Soros 13F and the next AGRO quarterly report at roughly the same time, in mid-August, when Wall Street moves to the Hamptons (your favorite Gumshoe, however, will be toiling away).

Risks? Aside from the big risks that impact all farmers, that the weather hurts you or crops won’t grow as expected, or the commodity prices won’t go your way, the risk that I imagine investors are focused on is politics — there is still a lot of attention on Argentina in terms of export limitations and farmer revolts, though the most easily comparable Argentina-focused farming company, Cresud (CRESY), has done surprisingly well through that turmoil so far. The fear over Brazilian and Argentinean farmland isn’t nearly as high as the fear over Peruvian and Bolivian mines being nationalized or shut down, to be sure, but there is certainly some cautious commentary from investing pundits.

So … does the current lack of earnings and earnings visibility worry you? Or are you excited about being in pretty early with a company that might become a South American agriculture powerhouse? They are making investments that ought to pay off if we see sugar, ethanol and soybean prices climb dramatically in the years ahead, but I’m finding it difficult to get mu