The Energy Report: Is investing in agriculture like
investing in any other commodity, or do investors new to the space need to
get familiar with special considerations?
Tom Wallace: Agricultural investment is composed of a multitude of
subsectors, so when it comes to making an investment decision, investors need
to focus their efforts. Agricultural investment encompasses everything from a
sheep and beef farm in New Zealand to a phosphate mine in Brazil. We're
talking about very different operations that come under the same banner of
agriculture, but some cross into other sectors. Obviously, fertilizer is
directly related to agriculture, but a phosphate mine, for example, is part
of the mining sector as well. You have those considerations to take into
account.
The fundamentals that support growth in agricultural commodities are
different from those of other commodities for a number of reasons, the main
one being that people have to eat. You don't need gold bullion. It's great to
have some to protect yourself from the actions of central bankers, but you
don't need gold to live. Everybody needs agriculture, so agriculture tends
not to correlate with other assets like stocks or bonds. Those considerations
are important.
Source: The Agletter
TER: What risks are inherent in agriculture investing?
TW: After we first acknowledge that the two greatest risks to
investors are 1) their own herdlike actions and 2) the actions of government,
we have systemic risk. That incorporates wild cards like weather, and
disasters like a plague. Given that the majority of the world's agriculture
is conducted by small farmers, these risks have far-reaching consequences.
We also have market risk, especially in emerging countries. We have the
cyclical and seasonal price fluctuations of agricultural products, and
government meddling with import and export restrictions. A current example of
that would be the ludicrous sanctions that Western governments like
Australia's have imposed upon Russia.
We also have exchange controls and subsidies. A perfect example of the
failure of subsidies would be the current water situation in California.
Farmers have had access to essentially free water for quite some time, and as
a result, they developed ridiculous habits of growing crops like almonds,
which are extremely water-intensive, in a desert. Problems like that can be
solved very quickly if the government gets out of the way and lets the market
solve them.
You also have credit risk. Farmers and agricultural companies take on huge
amounts of debt, but agricultural capital revolves fairly slowly. We're
talking about one or two crops a year. So a disaster or some sort of weather
event can spell failure for farmers. In developing nations, land rights and
boundaries can be a problem, especially when it comes to pledging collateral
for a loan.
Finally, political risk is always inherent because government is
essentially violence and coercion. People only need to go and ask a
Zimbabwean farmer about political risk. It's definitely something investors
need to be mindful of.
TER: How do investors hedge these risks?
TW: The risks might make investing in agriculture sound like
holding an Easter egg hunt in a minefield. But you can protect yourself
relatively easily through diversification by location and by subsector. When
it comes to agriculture, definitely don't put all your eggs in one basket. If
you're buying farmland, for example, don't just buy in one location. Do some
research and find out where land is still reasonably priced, because many
markets have experienced dramatic valuation increases in agricultural land in
the recent past.
If you're buying equities—a potash or a phosphate mine, for example—get to
know the projects, the people, the financing, the location, the target
market; everything you'd normally research when it comes to securities
analysis. Find and follow the serially successful people within whatever
agricultural subsector interests you. For me, that's agro-mineral miners, so
I follow people like Simon Ridgway, the founder of Focus
Ventures Ltd. (FCV:TSX.V), and the guys from Sprott Global Resource
Investments Ltd. (a wholly owned subsidiary of Sprott Inc. [SII:TSX]), like Rick Rule and Jason Stevens. It's the easiest way not to
lose money. That should be your No. 1 investment goal, closely followed by making
money.
TER: Is there seasonal volatility or variability?
TW: There definitely is seasonal volatility and variability in many
agricultural subsectors. If you're directly exposed to agricultural
commodities like corn or canola, this is especially pertinent. Agro-mineral
miners, for example, can be affected if they operate within higher rainfall
areas. Some mining operations in Latin America have to be suspended during
the wet season because it gets too muddy.
TER: What commodities come under the heading of agricultural
investment? Is it just crops?
TW: I can't give you a complete answer, because there are so many
components. But obviously there are crops and commodities futures for things
like corn, soybeans, coffee, orange juice. You also have fertilizer, potash,
calcium and magnesium. But I also throw water into the mix. Water is
obviously a very important component of agriculture, but access to that
component is somewhat limited for retail investors. Very few publicly listed
companies operate purely in the water sector.
TER: What companies are particularly interesting to you right now?
TW: By far, my favorite company in the agricultural space is Focus
Ventures. That is closely followed by Clean Seed
Capital (CVE:CSX) and DuSolo Fertilizers Inc. (DSF:TSX.V). Focus Ventures and DuSolo
operate in the phosphate space. Clean Seed Capital is an agricultural
machinery manufacturer. Input Capital Corp. (INP:TSX.V) is high on my list of
companies to examine. I have a favorable outlook on the company so far, but I
still have to do a fair amount of due diligence before I'd give it any sort
of rating.
TER: What competitive edges do these companies have?
TW: Let's start with DuSolo Fertilizers, which is a beautiful
logistics play. It has a high-margin phosphate mine, the Bomfim project,
that's within one of Brazil's most productive agricultural regions. It is the
only direct-application natural fertilizer (DANF) producer within 500
kilometers. It already has sales contracts in place for 81,100 tons of DANF,
and that's worth $8.5 million ($8.5M). It just submitted an application to
increase its mining capacity from 100,000 tons per year (100 Ktpa) to 200
Ktpa. The beauty of being located so close to the farmers within Brazil's
agricultural region is that the company doesn't incur the transportation
costs that rival fertilizer companies do in terms of importing. DuSolo's edge
is its location and lack of local competitors.
TER: What near-term catalysts do you see for DuSolo?
TW: DuSolo is putting out an updated resource estimate later this
year. I don't think the market realizes what DuSolo is sitting on at Bomfim.
It has identified significant resources past the initial resource estimate
area. If the company comes out with a much larger estimate than what it
currently has, that could propel DuSolo much higher. Also, if the company
gets approval for an increase in its mining allocation permit so it can mine
200 Ktpa, that, along with additional sales contracts, will definitely get
noticed.
TER: Is DuSolo's management deeply invested in the company?
TW: Inside and institutional ownership is roughly 15%. Tembo
Capital Mining Fund L.P. is a big holder as well. As with all the companies
that I hold in The AgLetter, I like to see when management has put its
own money on the line.
TER: What about Focus Ventures?
TW: Focus Ventures has several big things going for it. First, it
was founded by Simon Ridgway, who is a serially successful mining
entrepreneur. He is the founder of Fortuna Silver Mines Inc. (FSM:NYSE;
FVI:TSX; FVI:BVL; F4S:FSE), and he's already put a mine into production
within Peru. He has country-related specific experience, and to go along with
that experience, a level of institutional ownership and backing by firms like
Sprott Global. Sprott has already done a significant amount of due diligence
that investors can leverage upon.
Second, Focus has, potentially, a world-class deposit. It's huge. It's
very close to The Mosaic Co.'s (MOS:NYSE) Bayóvar mine. The company has
infrastructure in place to start exporting its product. It has a port only 30
minutes away, which is owned by its partner in the project. The phosphate in
the mine is some of the best quality in the world: It's known as Sechura
rock. I won't go into specifics, but if this stuff weren't brown, it would be
called gold because it achieves such good results with crops.
Focus is not only a people play, but also a project play. If you do an
extremely conservative calculation on just the Indicated resources, that's
well over 100M tons of phosphate. The stuff has been selling within the
region for between $100–200/ton. The company is trading at $0.22/share, so
that's definitely a no-brainer for me.
TER: Focus Ventures has been criticized for slow development of its
Bayovar 12 project. Is that a valid complaint?
TW: Sure it is, but everybody wants things done instantly. The
reality is that the natural resource world is a tortoise. Things take time.
You have to pick your teams with a long-term viewing line. If they get
everything done quickly, that's a bonus and investors get some low-hanging
fruit. But don't count on things happening quickly when we're in a commodity
bear market.
TER: Are you anticipating a more rapid pace from Focus, or is this
about what we should expect?
TW: I think once the preliminary economic assessment on Bayovar 12
comes out, we'll start to see some movement. As I mentioned, Focus has an
absolutely huge deposit, and only heaven knows where things go from here. The
agro-mineral giants have openly said that they're looking to acquire these
sorts of projects, so we could see a buyout. Who knows? But $0.22 for a share
in well over 100M tons of a commodity that is both irreplaceable and utterly
essential to life on the planet, plus the backing of the most knowledgeable
natural resource investors in the world? I'll take that.
TER: What brings Clean Seed Capital to the top of your list?
TW: Clean Seed Capital has developed a revolutionary no-till
seeding machine. It has put together and patented a machine that I think will
have the same effect on the agricultural machinery market as the iPhone had
on the cell phone market.
Current seeding machines are using technology that is 30 years old. The
technology is way past its use-by date, and it's not very precise. The CX6
SMART Seeder that Clean Seed has developed is essentially a laser printer. It
sows seeds with amazing precision. It's the way of the future, because as we
lose more and more agricultural land, we have to make more efficient use of
the land base that is left. I would encourage everybody to get on YouTube and
have a look at the CX-6 seeder. It's amazing technology.
The company is going into production with the CX-6, and has distribution
and manufacturing agreements in place. It's my personal opinion that Clean
Seed Capital will be bought out by one of the giants or, at the bare minimum,
some sort of royalty deal will be done. But at around $0.47/share, it's money
for jam [an easy way to make money].
TER: What draws you to Input Capital?
TW: Input has an excellent streaming model for its canola business.
For investors who are unaware of how this works, Input Capital provides a
farmer with an upfront cash payment in return for a share of the farmer's
crop production. The farmer can use this money to buy inputs like fertilizer
during the off season and this can save him anywhere between 20–40% compared
to purchasing in season. The farmer also gets access to an agronomist who
helps him grow an excellent crop. The farm then delivers Input's share of the
crop and is paid a discounted contract price per tonne. If the crop yield has
improved, Input can buy additional tonnes at the same contracted price, so
both the farmer and the company benefit from an improved crop. Input then
sells the crops at the market rate and can invest the proceeds into new
streaming contracts.
Input deployed $49.1M in capital during the 2015 financial year and now
has 78 cash-producing streams in place, with 10 more being added in Q1 of the
2016 financial year. The company generated $11M in streaming revenue during
2015, which is a 258% increase over 2014. That's a beautiful business model.
In terms of the profit margin, Input Capital's total costs per tonne of
canola are around $310. It sells the stuff for around $500 a tonne. Not bad
for a hard day's work, is it? Input gets canola price upside, production
upside, compounding cash returns and diversification without the need for
heavy management.
TER: Canola prices have surged 17% since early May, but Input's share
price has remained in a fairly stable range. That would be a significant
statistic in crude oil or gas. How important is it for Input?
TW: It should be significant for Input, but it shows how
disconnected the market is at the moment when it comes to valuations. Less
than a month ago, the company was trading at around $3/share, now it's at
$2.50/share. These are the buying opportunities that investors should be
taking advantage of. When you go shopping, you look for quality clothing that
is on sale so you get the most bang for your buck. Buying stocks is no
different, and you'll know you're on the right investment track when you can
identify these buying opportunities.
TER: What advice would you give new investors to the agricultural
investing space?
TW: First, study the fundamentals that are driving the growth in
the market. Once you've got a good understanding of the "why," look
for the "how." The "how" is the agricultural subsector or
subindustry that you want to focus on. Second, identify the people operating
within that subsector who are serially successful and follow what they do.
Finally, when you identify projects that these people are involved in, do
your own due diligence, and if everything adds up, back these people.
Agricultural companies are like any other businesses—they're only as good
as the people that comprise them. The best deposit in the world can always be
screwed up by an incompetent management team. You'll only learn that
investment lesson once, trust me. Learn to read a financial statement; that's
an absolute must. The difference between solvency and insolvency is about 15
seconds on SEDAR. Contact company management and ask to speak to the CEO. If
you get through to the CEO, it's a bonus, but even if you get stuck with the
investor relations rep, pay specific attention to demeanor. Is the person
enthusiastic about the company he or she works for? Does it feel like the
person just wants to be left alone? People love talking about success, so if
the company has nothing to say for itself, it's probably best to move on to
the next one.
TER: Tom, thank you very much.
Tom
Wallace is the publisher and editor of The Agletter. He is a
successful natural resources investor who specializes in the agricultural
sphere. His research covers a plethora of agricultural subindustries ranging
from agri-mineral miners to farm machinery producers. He has spent
significant time in the Middle East, Australia and New Zealand, where he
currently resides. Wallace is a passionate anarcho-capitalist and free market
advocate. He publishes his research at www.agletter.com.
