Saturday, April 5, 2008

Professional Investor: Food producers could provide a rich diet

There is an old saying on Savile Row that fashion celebrates the successful. Whichever industry finds itself in the limelight today tends to have an undue influence on setting the trends of high street fashion. The shoulder pad marked the march of the yuppie in the late 1980s; the Hoxton fin chronicled the internet entrepreneur; and today's smart-cut Mayfair chic celebrates the rise and fall of the private equity brigade. In searching for next year's muse, both sartorial and financial, it would perhaps be best to dust off your Barbour jacket, for farmers have started making some serious hay.

Earning money from food has been a tough task in Britain since the mid-1980s. The rise of big supermarkets such as Tesco and Asda has eaten into the lunch of the butcher or baker who supply them. However, food inflation is fast changing all of that. Rising food prices are leading to bumper profits for anything agrarian. The price of corn is up 44 per cent since last year. A pint of milk has risen 20 per cent. The smartest investment banker I know has traded his pitch book for a pitchfork and his Porsche Boxster for a tractor. The countryside idyll is back in vogue. And the story of rising food prices is the same across Europe – even the French are paying 10 per cent more for their fromage.

So why are prices rising so rapidly? Inventories of soft commodities such as corn or wheat are at 100-year lows. After years of underinvestment, the larder is bare. Even the EU's famous butter mountain has been depleted. As ever, political interference is also a factor. Elections are won and lost on the availability of bread. The Argentineans, for example, have imposed stringent fines on farmers who export their crop abroad. In America, the emergence of bio-ethanol production as a substitute for oil has further crimped global supply. These bottlenecks in the food chain are now forcing prices to rise.

Of course, one way to play this theme is to buy farmland directly. Real estate investors should take note: there aren't many property assets that have actually risen in value this year. Indeed, the Swedish-run Black Earth Farming Ltd has been quick to spot this trend and has quietly amassed 280,000 hectares of arable land in the most fertile part of Russia around the black earth region, so called due to the colour of its nutrient-rich soil.

But in my Continental European fund I have found several other ways to play food price inflation, through companies such as Yara, the Norwegian fertiliser specialist. Demand for fertiliser is booming. With crop prices high, farmers want to maximise the yield from their fields. Generous applications of mineral salts such as potassium and nitrogen can improve the output by a factor of four. German potash producer K+S is also a name to watch in this context.

In the UK, the menu is smaller but there are still some golden nuggets among Britain's food producers. Names include Northern Foods or Robert Wiseman, the milk supplier that keeps Britain's supermarket shelves stocked with milk. As a general rule, food producers initially struggle to pass on higher input costs. However, once the paradigm of food inflation becomes better understood, food producers become beneficiaries of this inflationary trend through higher prices. As a result, profitability enters a period of gentle recovery. This was confirmed last week by the trading statement of Northern Foods, Britain's largest food manufacturer and home to such brands as Goodfellas pizzas, Fox's biscuits and M&S salads.

In 1896, Northern Foods made Britain's first official Christmas pudding. By 2006, after years of indiscipline, the same company was in danger of not making it through another Christmas. A bloated balance sheet and souring profits threatened the company's very survival. A new management team was brought in to chop out the fat and tidy up the kitchen. Eighteen months later, this diet of financial asceticism seems to be bearing fruit. The 5 per cent dividend was confirmed at last week's results and margins are improving across the board. Importantly, they are now able to pass on the cost of rising food prices as inflation starts to work in their favour. And how much do you pay for this tasty morsel? Barely 11 x earnings, or 85p. Now that's what I call good value.




Food Producers



Food Chain

Food Price Inflation

Mineral Salts



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