Many corporate and institutional investments into Australian agriculture have not performed well compared to the returns achieved by the family farm, argues David Cornish, principal at Cornish Consultancy, an independent advisory firm. Here, he offers investors some answers.
Corporate investment in Australian agriculture has been going on since the 18th century. Founded in 1824 through an Act of the British Parliament, with the right to select 1 million acres (4,047 km2) in New South Wales for agricultural development, the Australian Agricultural Company (AACo) is one of Australia’s oldest still-operating companies. The amount of corporate investment in agriculture has ebbed and flowed in line with the fortunes of the sector and once again agriculture is in the spotlight of the corporate investor. Yet the financial performance of corporate agriculture across the globe has been patchy at best and downright appalling at worst. So why, given the hype, has investment performance by institutions been so poor compared to the performance being achieved by the family farm?
The following is a list of common reasons why this sector doesn’t always meet expectations and some hints to help investors make better decisions. If you can avoid a few of the common potholes you may actually be able to make money in this sector – good luck!
- The world will run out of food! – believing the hype
‘There will be a desperate arable land shortage before the year 2000’ – The Limits to Growth, Club of Rome 1973.
Since Thomas Malthus in the 1700s, man has been predicting the end of man due to the shortage of food production compared to the rise in population levels. This view of the world has once again re-established itself as the new norm with reports stating that the world will run out of food by 2050. Based on this, and the increase demand for animal protein, prices for foodstuffs will rise, ipso facto good times for the corporate to enter the world of farming as rising prices are guaranteed! However, the facts might suggest this may not be the case and rising prices aren’t quite as rosey as the person flogging the investment prospectus would have you believe.
So when looking for an agricultural investment the first thing is to look at are the financial assumptions. If the analysis spends most of the time focusing on the ‘big picture’ of food demand and little, if any, on the likely financial performance of the project under offer, I suggest you put the prospectus down and avoid any further waste of time. Also if you think that investing in farmland to secure your food supply back home makes sense think again. You might own the land but that doesn’t mean you can export the product. Governments still own the harbours and make the laws.
- Numbers, what numbers? – lacking financial track record and data
The hardest thing about investing in agriculture is the lack of solid financial analysis to interrogate the value of the investment. Unlike the share market where every figure is analysed to death this is not the case in the ag market. In fact the lack of a systematic information sharing system has been a continued bugbear of mine as many of the unlisted agri funds and managed investment schemes (MIS) have avoided public scrutiny due to the fact that they don’t publicly disclose their actual performance. This has led to the practice of borrowing from publicly-available benchmarking studies such as the Australian Bureau of Agricultural and Resource Economics and Sciences (ABARES) annual survey to justify an investment in agriculture.
Funds will take this information to identify a top 25 percent and then use this figure to compare against an investment in another class of investment such as Australian shares. The problem is that this can be very misleading. The ag top 25 percent index is a hypothetical index and is based on sample data from farmers across Australia. You cannot actually invest in these farmers. It is therefore very questionable that we are comparing apples with apples. What’s more the top 25 percent of farmers is not held constant. This means the number will look substantially better than it really is as farmers jump in and out of the index based simply on if it has rained or not in that part of Australia. Therefore, this will always skew the performance of the top 25 percent upwards.
Justifying an investment in agriculture purely on this index is misleading. Yet tens of millions of investor dollars have been invested based on this misconception about agricultural investment performance. So avoid agricultural investments which are either new or have no track record. Or invest in these realising that you have just as much chance of picking the winner of the Melbourne Cup than achieve the financial returns promised in the prospectus!
- Project-specific investments rather than portfolio-designed investments
Most opportunities to invest in agriculture are based around a specific project or industry exposure. This ensures that you are locked in to the performance of that one business without the ability to diversify your risk by geographic location or commodity. Australia is the land of droughts and flooding rains; you are asking for trouble to focus on one region or one industry as your agriculture investment. Spreading your risk is essential in this market.
- Over-burdensome and expensive administration systems
A critical success factor in this industry is a lean administration and managerial structure. Many agricultural investment opportunities have excessive promotional or administration costs making them uncompetitive, except for their possible tax advantage. (I myself do this but hopefully I am honest enough to outline the limitation of this information.)
- Focusing solely on high risk, high return agri investments only
It would seem to attract the attention of the investment community – managed investment scheme-style funds have focused on high risk, high return investment opportunities. So far very few of these have achieved the financial performance set out by the promoter. Investment in agriculture should be dead boring. Look at what has worked well in that country. In Australia the wheat-sheep belt has continued to deliver reasonable returns for risk. Yet we seem infatuated with the next best thing delivering returns never before achieved.
- How hard is it to drive a tractor? – Poor operational management
Farmers manage a business which requires them to integrate biological, financial and marketing competences in a way that no other business requires. Contrary to the popular stereotype of the farmer being some poorly-educated hillbilly to farm in today’s business environment requires a balance of skills not often seen. Therefore, ensure you know that the person that is managing the investment actually knows a thing or two about managing a farm. By that I don’t mean some agri consultant or agri banker, I mean someone who has actually done the hard yards and knows what it is like when you spend each day of the week feeding sheep in the middle of a drought. I would also recommend that you will get more out of the investment where the operator also has some skin in the game as they are more likely to do the hard yards when required. Running an agricultural business and ensuring optimal financial performance requires significant management skills as you are managing a biological system in a risky environment. Too often a lack of farming savvy, by city-based investment groups, has led to under-performance of the operation.
- Ignoring the fundamentals of an agricultural investment
Agriculture is fundamentally a commodity business where product differentiation is not impossible but very difficult and unlikely to generate long term profit. Success in a commodity industry is about cost leadership. The critical issue is that profitable operations can be identified by their cost structure – cost-efficient producers will make sustainable long-term profits while cost inefficient producers will not. Avoid investments that think they can beat the market or talk about supply chain relationships as their main selling points. Farming history is littered with failed supply chain investments. The main reason being that they over-estimate the value that a closed loop will bring to the business and under-estimate the increased costs and risks that a closed loop brings to an operation.
- Investing in agriculture for non-profit imperatives
A true story – a large superannuation fund decided to make an investment in agriculture. When I asked why, expecting them to reply for the benefit of their members they stated, “we believe we can make a positive contribution to the required structural adjustment in the farming practices in the region. This will therefore make a positive contribution to the community and therefore our members”. Makes you feel good don’t it! Several years later I caught up with the same fund to find that their investments in agriculture had become a black hole for members’ funds and the operation was not even delivering on the feel-good factors it set out to do. Losing sight of the need to make a quid can have a two-fold effect. Firstly you get sucked into speculative investments that are high risk. Secondly it often results in the managers getting away with poor performance as often these types of investment are long=term and hard to financially benchmark.
- Tax imperatives outweighing profit imperatives
Enter the MIS projects. I think the performance of these schemes speak for themselves. The fact that both sides of politics still support these schemes is a tragedy for rural Australia. However, the simple fact is that it is an exception to the rule that you will find a project that even returns your investment let alone makes a reasonable return even after tax.
I believe that the sector can be a good investment, bu it needs to be structured in a way that manages the unique risk profile of the sector. This requires the fund manager to enter into some novel investment structures with good operators within the industry to which they want exposure. The other two vital ingredients are patience and timing. Too often I have seen poor investments made due to the need to meet some arbitrary deadline to spend the capital by. This thinking does nothing to support the best interests of the investor.