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Soumik Kar

Interview

"Indian agri firm's return is poor"
Bill Barbour of Deutsche Asset Management on his big agri bets and why the best is over for the Indian stock market  

V Keshavdev

You run the biggest agri commodity fund in the world today with assets under management of $4.5 billion. What makes you so bullish about this sector when the whole world seems to be in a state of turmoil? 

Yes, what you are seeing now is quite a sizeable corpus globally in our agribusiness strategy. While post the 2008 crisis, our AUMs did take a battering, like all other managers, we have since recovered quite significantly. We first started looking at global agribusinesses in 2004, when the world was worrying about oil prices. We spent the whole of 2005 looking at what was investable as part of the agri theme and then launched the fund in 2006.

Food prices are rising as is evidenced by the FAO Food Price Index, which is up over 140% since 2000. The OECD and FAO released a joint paper last year which suggests that globally food prices are going to rise by 20% after inflation in real terms for grains and 30% for meat over the next decade. The reasons are very obvious. Rapid population growth is one of the factors. In about a decade we will be 8 billion people, that is, roughly a hundred million mouths to feed each year. We are living longer and urbanising, which adds fuels to the fire. The second important trigger is improving incomes.

The change in income in the developing world is crucial. In India, as incomes move from below $1,000 a year, people eat more. The third factor is limited agricultural land. In 1950, we had 2.5 billion people and around 1.3 billion hectares, which is half a hectare per person. Today, the world’s population has almost tripled and the number is down to 0.2 hectare. The fourth factor is biofuels. If you have a limited amount of land and devote more tracts to biofuels there is less land for food, which will fuel prices. The final factor is climate change – global warming. Droughts, storms, floods are all affecting supply. The global agri business is supported by these factors, regardless of whether you are part of the developed economy or developing economy. 

So how are you playing the theme?

Our universe covers everything right from the farm and farm inputs (known as upstream) to retail players such as Tesco and Metro (downstream). It also includes warehousing, logistics, processing, marketing and distribution. 

Can you give a glimpse of what variable you track and what goes into your decision making process while picking agri stocks? 

The internet is our salvation as we aggregate data from various meteorological sites and look out for rain and temperature anomalies. If we see one standard deviation either side of normal we go and do more work. That has allowed us to find droughts and supply disruptions earlier than our competitors. It’s surprising, but it appears few traders and managers are actually doing this. In 2009, data showed us that something was going wrong in China. We have a Chinese national in our 10-member analyst team and he was able to contact local farmers and media and confirm that a drought was developing. Traders in Chicago didn’t work this out for another two to three weeks, but we were able to position our portfolio and look at companies from which we were able to benefit. That is one example. 

Eating green, seeing red

Declining farmland is translating into demand for higher yields 

Right now corn inventories are at a record low in the US — they are down to below 6% of total demand. These are precariously low levels. The OECD says that we should have inventories of grains of 17-18% of demand to prevent problems. Right now we are just skimming around these levels. But the demand for corn in US is huge. It is coming from three areas: around 40% of the US corn crop goes into ethanol; there are large inventories of livestock in the US that have to be fed rough corn; and China is importing large amounts of corn to feed animals in feedlots as demand for meat in China rises relentlessly.

So, according to the US Department of Agriculture, corn exports from the US will rise four-fold in the next three years and US corn inventories are not forecast to rise this year despite record corn planting. So although corn price has fallen, it should rise. 

Now take the case of Brazil, where a drought has impacted soyabean production and which, in turn, has created a rub-off effect on India, where soyabean prices have risen by 50%. All I mean to say is that weather anomalies are important sources of data for future price movements and that’s what we follow closely.

Right now what is the positioning of the fund?

Fertilisers, agri chemicals and seed companies constitute nearly 42% of the portfolio. Agri products and retail companies make up the next largest components. The other sectors are smaller and are extremely stock specific. 

Would it be correct to say that you are betting on agri commodity prices going up?

In the long term commodity prices are likely to rise but they might not go up in the short term. However, these agri companies are still quite cheap. It is a play on the value of a company. Take the case of US fertiliser company, CF Industries, which is in the top ten holdings at the end of April. In September 2011, we saw a massive sell off in agribusinesses as global markets fell. If we are having a recession it may make sense selling base metals and oil stocks, but it makes no sense to sell food-related stocks.

Wall Street analysts don’t realise that recession or no recession, people will continue to eat! There is no correlation between food demand and GDP growth and food consumption has continued to rise throughout the crisis period. In September, CF Industries fell 37% to a P/E of 5.7. Since then, it has risen about 28% but it still remains cheap, as, according to Bloomberg (31 May 2012), the P/E is still only 6.95 times next year’s earnings. Right now we can find similar pricing anomalies across the whole agribusiness universe.

So your choice of fertiliser stocks is purely based on the low valuation for these stocks…

Let me explain. As you would appreciate, fertiliser demand is impacted by crop prices as well as the actual fertiliser price. The situation in the US helps to explain why we are currently optimistic about fertiliser prices and companies. High corn prices have led to farmers in the US planting the largest amount of corn since 1937. As a consequence, corn prices have fallen, which may seem sensible, but so has the price of fertiliser companies. We have earlier discussed why the corn price is likely to remain high. So, does it make sense for fertiliser companies to fall? This would be the case if farmers could not pay for the fertiliser.

Fertile times

DWS’ allocation to agricultural chemicals is the highest 

However, farm incomes are the highest in a decade and farm balance sheets in the US are exhibiting record strength. If farmers can afford to pay, as is the case, record amounts of fertiliser are likely to be used on this record corn crop. This has been confirmed in our discussions with fertiliser companies and should reflect in their next quarterly results. As a consequence, at the end of April, we had six fertiliser companies in our top 10 holdings. Of the remaining four, two are biotech seed companies and the other two are supply chain managers, Bunge and Archer Daniels Midland, which are very much undervalued.

We believe they are trading at a 20% discount to book value and similar instances exist among supply chain managers. Take the case of Viterra, a Canadian company which is the world’s biggest shipper of wheat and was part of our top 10 stocks in March. The company received a takeover offer from UK commodity trader, Glencore International, which saw the shares jump 46% to the offer price. Somebody recognised this as a valuable asset and we do expect to see more takeovers of companies which are part of our holding.

There are several agri companies in India, but one does not see them in your portfolio… 

We currently have only one small holding in India. We would love to have more exposure to India but it is difficult to gain listed company exposure as most of the Indian agri industry is privately owned or held by the government. Some are owned by the cooperatives, such as Amul. You can’t own them. So, there are very few good listed opportunities for us to participate in. The only way Indians can get exposure to this global megatrend is to invest in an offshore fund such as ours.

One drawback for India is that it is also a highly regulated market where the government interferes with the pricing mechanism, squeezing the margins of many of these companies. The truth is that most listed agri business companies in India have not produced great returns for investors, partly because of price controls. We have at times had portfolio positions in Mahindra & Mahindra which is the biggest producer of tractors in the world. But we booked profits by selling the stock last year. 

So your visit to India is all about taking out money rather than investing in the country?

Today, the P/E multiple of the Indian market is still one of the highest at 11.1 times next year’s earnings based on Bloomberg consensus data as of May 31. The P/E for Russia is 4.8 times, for Brazil it is about 7.8 times and for China it is 9.4 times. For much of Europe, it is below 8 times. In fact, the 30 biggest companies in America comprising the Dow Jones are cheaper than the Indian market.

I can find companies in Europe or other regions with a 100% upside but it is difficult to find one like that in India. We need to be clear about one thing: what worked till 2008 need not be the case going forward as that outperformance of Indian market is too much to ask for. Let me give an example. Back in 2000, Cisco was the third -biggest company in the world and everybody wanted to own it. It was going up at 40% an annum at that stage but not any more.

I give the example of Elvis Presley, who died in 1977. When he died there were probably about 15 Elvis Presley impersonators making a living. In 1992, this number was calculated at around 2,350 globally, a huge growth industry with about a 40% annual growth rate. If you keep compounding at that rate, it means that one in ten people on the planet will be an Elvis Presley impersonator by 2030! Clearly, that is impossible. Similarly, if you keep compounding 40% returns from the Indian market you will get to very stupid numbers. 

Are you saying the best is over?

It is just not possible. Long-term returns for share markets should be a combination of inflation plus GDP growth plus productivity. Right now inflation is at 7.3%, GDP growth is at 6.1%. Besides, productivity is really high at 3%. Let’s assume inflation can fall to around 3%, so the longer-term growth for the Indian market could be 12% per annum, which is pretty good. 

But then isn’t Euro crisis a bigger threat to the fund?

If global markets go down, this fund will go down as well, but not as much. That is just the way it works, unfortunate as that may be. But agri companies by nature are defensive. I am absolutely convinced that this strategy will outperform the broader global stock market over the next few years.

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