Simple: Unloved, Undervalued and Underowned and of course enormous potential. Not only China Agri-Business but also more companies involved in agri.
Agricultural commodities are going to surge the coming years. The prices are largely driven by supply and demand factors. A growing population, coupled with limited agricultural land, means that long term demand for agricultural commodities will increase in the long run, while supply continues to be limited. Therefore there tends to be an upward bias on prices.
The above effect is exacerbated since demand for soft commodities is inelastic. This means that the majority of these commodities are required as food (consumer staples) consumed by humans to stay alive. This dependence means that any decline in demand tends to only be marginal when there is a significant increase in price. Unfortunately, the only substitutes for most soft commodities are other soft commodities.
There are a number of reasons why prices in soft commodities are going to surge the coming years. One of the most important reasons is:
*Booming levels of consumption in emerging economies such as China and India.
Industrialisation of these countries has increased the wealth of their consumers leading to larger disposable incomes, a higher standard of living and greater demand for food.
The rise in income coupled with western influences has also lead to a change of diet in these countries. In line with most developed countries, the meat constituent of their diet has increased proportionately. An increase for the demand for meat leads to significant increases in the demand for soft commodities. To give us some perspective on this, one kilogram of beef requires about seven kilograms of grain.
The supply of soft commodities is limited by the availability of agricultural land. Although additional land can be devoted to the production of soft commodities, often the added benefits are marginal as they are often not the most suitable for farming and do not contribute significantly to global productive capacity. Modern society is trying to improve the technology surrounding optimisation of this limited land space.
Global warming and weather inconsistencies across the globe have resulted in increased environmental awareness from the general public, but there are many that argue that it has had a significant impact on the supply of soft commodities. As these commodities are grown they are susceptible to temperature and weather conditions, events such as droughts can have a massive impact in the price of commodities such as grain.
An important factor that must be considered when viewing the current strength in soft commodity prices is the weak US dollar. The softening of the US dollar the last years against most foreign currencies has seen $USD quoted soft commodity prices rise as purchasing power increases. Therefore despite the fundamental reasons driving the soft commodity boom, there is an opinion that the nominal price increases witnessed are overstated and will come back should the US dollar strengthen sometime in the future.
Speculative activity in soft commodity futures has also contributed to current prices. Investors have been flocking to “defensive” commodities to get away from volatile equity markets. This is also evidence of financial institutions seeking to recover from their “sub-prime” losses. becoming more involved in the sector. Unfortunately, since speculative money is often highly leveraged, it distorts the expected prices for soft commodities and increases short term price volatility. Notably, futures for the soft commodity market indicate that prices are expected to continue rising for the foreseeable future.
Consumers have been directly impacted by the rises in soft commodity prices. Consumers are starting to find that a larger proportion of their income is being spent on food. Given food is a necessity, increased expenditure in this area means that the remaining disposable income available to households reduces. This leads to a reduction in consumer spending and reduces economic activity.
Companies operating within the food industry have also been affected as these commodities are required for production. The increased prices will directly affect the profit margin and hence overall profitability of this industry. There has also been a direct impact on inflation as many of the consumer basket of goods used for calculation of the CPI (headline inflation) are derived from soft commodities (such as bread and rice). High inflation will place pressure on interest rates and on sustainable earnings and disposable income. This in turn could lead to an economic downturn. Some weeks ago China planned to take price interventions to battle inflation. The measures contemplated by the State Council, ranging from a crackdown on speculation in agriculture goods to the imposition of price caps on “daily necessities” if needed.
Dealing with the prices
Although the rising prices have an unfavourable impact on the economy as a whole, steps can be taken in our share portfolio composition to mitigate or benefit from the rising prices. The key to benefiting from the price surge of soft commodities is to recognise quality companies in this booming sector with sound financial health. This will ensure that the company will still perform well even if soft commodity prices remain stable or fall.
Secondly, diversification of exposure to the sector will also reduce the risk of exposure to a specific soft commodity price. An example of this would be China Agri-Business (CHBU) which has benefited from the overall price rise of soft commodities and will be benefit more and more because of their store expansion.
Another stock worthly to look at is Man Shing Agricultural Holdings (MSAH).
Man Shing Agricultural Holdings Inc. (Man Shing) through its operating subsidiary, Weifang Xinsheng Food Co., Ltd. (Xinsheng) is engaged in the production and processing of fresh vegetables, including ginger, and others, such as onion and, garlic. Xinsheng leases 5.3 million square meters of farm land for the planting and growing of ginger in Anqiu of Shandong Province in China. It produces ginger with a focus on customers located in countries, such as Japan and European Union and are the largest ginger exporter in China.
As of June 30, 2010, the company’s product portfolio comprised: fresh vegetables and frozen vegetables.
This company is expected to earn around $0.20 and trades at $0.67, which gives us a P/E below 4. If the market is ready for it, like in the case of China Agri-Business a P/E of 10 is possible. So is Santa ready to take the price of Man Shing Agricultural Holdings (MSAH) to $2.00?
For more research about this company, visit Trading China or Geoinvesting.
POSITION: LONG CHBU and MSAH