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Old 02-03-2011, 06:04 AM
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Default Longer term outlook of agri shares investors have always been wary of stocks

Don't blame the flooding in Queensland and Victoria for putting a dampener on the prices of Australia's agri shares. They dropped well before it and have been uninspiring for a couple of years, but perhaps not for much longer.

The chances are most of them are going to be snapped up by some of the world's biggest food producers, if not private equity funds.

Australia's farm and food stocks are in perfect proximity to a hungry, fast growing Asia.

We've already lost AWB and ABB Grain to Canada, the S for sugar in CSR has gone to Singapore and SunRice may soon become Spanish. The only Australian owned listed dairy company left, Warrnambool Cheese and Butter factory, is a key takeover target. Talk about selling the farm.

Besides, the longer term outlook of agri shares has been improved immeasurably by the flooding as the swollen dams will provide water security for several years. Even so, investors have always been wary of stocks that depend heavily on the weather, for good reason.

Food stocks have other problems as well. Unlike mining coal or iron ore, where shortages can last for years because of the time it takes to get a new mine up and running, a crop harvest can be turned around in a season. A shortage one year can be a surplus the next. That's why the prices of agri commodities bounce around so much, which is enough to put anybody off.

Only that's not the real story. Like coal, or even gold, it's how much is produced, rather than the price for it, that counts most.

One thing you can take for granted is that as the world's population grows, more food will have to be produced. The only issue is how it's going to happen. No wonder the big food giants want to corner the global market.

Even BHP Billiton had a go with its thwarted bid for the world's biggest potash fertiliser producer in Canada. It knows that with inevitably rising prices, the bottom of the food chain is a better place to invest than at the manufacturing top.

That would be water rights and fertiliser. There are three listed stocks involved in one or the other, making them potential takeover targets. Two smaller stocks that produce cotton but mainly trade water rights, an attractive prospect despite the floods if you think long term, are PrimeAg and Tandou.

There's also money in poo. BHP let the secret out of the bag when it bid for PotashCorp, giving four reasons: "increasing demand for food, decreasing arable land per capita, the shift to higher protein diets, and the need for more balanced fertilisation to maximise yields". If it had known the floods were coming it could have added that fertiliser producers are the first to recover from weather disasters. Farmers replanting crops need fertilisers and sprays.

Anyway, Australia has only one listed fertiliser producer, Incitec Pivot. Ridley Corporation, in a way, fits too as a feedstock and supplements producer, although it's further progressed along the food chain as it also produces salt. Incitec Pivot has more than half the Australian market, with an explosives business in the US, making it dependent on a US recovery and susceptible to a stronger dollar.

If you're wondering what bombs have to do with fertilisers, well, er, they're both made from chemicals. Its new ammonium nitrate plant at Moranbah has been delayed by the Queensland floods but when it's up and running it's forecast to lift earnings by 20 per cent. Luckily, it's also hedged itself against the dollar.

Ridley is 19 per cent owned by GrainCorp, which has the east coast wheat market virtually to itself, and because it is a fixed cost business, higher grain volumes go straight to profits. For that reason brokers consider it the most likely takeover target. That's despite its malt business not doing so well because of the sluggish economies of the US and Europe, not helped by the strong dollar.

Then there's the need for pesticides. The global insecticide company Nufarm, which has the Australian licence for Roundup, has its troubles. Its price almost halved last year and it's had a run in with the Australian Securities and Investments Commission over the quality of its financial disclosures and some of its own shareholders over its profit forecasts. But since then its share price has been on a roll, though analysts would like to see lower debt.

The other bottom feeders in the food chain are the fish hatcheries. While you wouldn't say the ocean is shrinking, it's certainly being overfarmed. The biggest is an Atlantic salmon breeder, Tassal, which isn't without a tussle or two either. It recently turned down a private equity takeover offer, to the horror of its biggest shareholders. And not even Atlantic salmon can escape the price of oil, thanks to rising feed prices and transport costs.

Other aquaculture stocks are Cell Aquaculture, which breeds barramundi and markets its hatch to dispatch technology, and Clean Seas Tuna, a hatchery for southern bluefin tuna, mulloway and kingfish.

Meanwhile, at the top of the food chain is Goodman Fielder, which has just lost its managing director. Its problem is that rising food prices are anathema since it supplies manufactured products, bread, milk, margarine and flour, to the supermarkets, where it's also up against cheaper house brands.

Still, it has to be said most Australian agri shares aren't world scale. To ride the food price boom you need to go global.

The managing director of Sirius Fund Management, Kieran Kelly, says: "Without doubt the best sector is food. There will be shortages due to the decline in agriculture but it is a difficult one to play on the Australian sharemarket. We like Colonial First State's Global Soft Commodity Share Fund."
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