The Energy Report: Do you rely on the stock-to-use ratio to
predict grain prices and, if so, what is it telling you right now?
Spencer Churchill: Yes, we do. Stock-to-use is a good way of
assessing the degree of tightness in any crop market and hence how much
underlying support there could be for prices. The lower the amount of
"buffer" there is—the amount of stocks or inventory relative to the
total usage or demand—the tighter this market could become and the greater
the likelihood of higher prices. In North America, by ranking of lowest to
highest stock-to-use ratio expected for 2015–2016, we would expect price
support/appreciation for 1) canola, 2) soybeans, 3) corn, and 4) wheat.
TER: How is the drought in the Western U.S. impacting projections
for ag prices in the coming years?
SC: The states most affected by the drought are generally not large
producers of the key crops we follow with regard to fertilizer usage—corn,
soy, wheat—so we wouldn't expect much of an impact here. The potential impact
would be more on fruit and vegetable prices of which these states are large
producers.
TER: Asia's population has quadrupled in the last century according
to World Population Review. Do you expect to see continued population growth
and urbanization in China and India, and what impact would that have on
demand for food?
SC: This continues to be one of the most commonly cited macro
trends for agriculture. Larger and wealthier developing world populations
generally consume greater amounts of food, and dietary changes like eating
more meat also put upward pressure on demand. We agree; however, as
experiences in the past several years have shown, other macro variables, such
as greenfield/brownfield projects, planted acres, government policies, crop
prices and farm income, have a much more influential effect on the demand and
prices of fertilizer and other ag products.
TER: You have talked about leveraging demand for food by investing
in agricultural input companies. What criteria do you look for in a company
that can be successful in this area, and what are some examples?
SC: From a high level, we look for companies with strong track
records of profitable growth, solid management teams, good oversight and
defensible business models. Ag Growth
International Inc. (AFN:TSX) is one of our favorites on the equipment
side. The company has remained profitable through several cycles, even during
the 2012 drought year, with a very stable, experienced management team and
strong board. Near term there could be some pressure on fundamentals, such as
less corn planted in the U.S. and the drought in western Canada; however, we
view any weakness as a buying opportunity for long-term investors. The
company recently completed the acquisition of one of its key Canadian
competitors, Westeel, giving it a combined 60% market share of the grain
storage market in Canada, while the company continues to have ~60% share of
the U.S. grain handling equipment market.
In the larger-cap Canadian space, we currently prefer Agrium Inc.
(AGU:NYSE; AGU:TSX) over PotashCorp (POT:TSX; POT:NYSE) for its large,
stable retail operations and lower exposure to potash on the wholesale side.
Potash prices have been in decline this year, with certain producers lacking
discipline.
TER: In your last interview you discussed a unique approach to
investing in agriculture through streaming. Can you explain this and give us
an update on the company exploiting this opportunity?
SC: Streaming as a business model has been around for several years
in the precious metals market. Streaming is where a company makes an upfront
payment to a producer/development project in return for a multiyear stream of
production, such as a number of gold or silver ounces, etc. It is viewed as a
less-risky way to get exposure to any given commodity, with a highly leverageable
business model.
Input
Capital Corp. (INP:TSX.V) is a public company in Canada that has taken
this model and adapted it to become the first-ever agricultural streaming
company, using canola as the underlying crop initially. The business is off
to a great start and is proving that farmers are demanding alternative forms
of financing such as streaming. In FY/15, which ended in March, Input
deployed ~$49million (~$49M) into new streaming deals, up ~100% year over
year; generated $19.3M in revenue, up ~280% year over year, and $9M in cash
flow (before changes in working capital), up from $1.5M in FY/14.
The stock has been a little weak recently on concerns regarding the health
of its farmer clients in western Canada; however, Input's exposure is
predominantly in the eastern prairies where conditions are much better. This
does bring a key issue to light—the benefit of diversification, both by
geography and product. The company's recent announcement about exploring the
addition of soybean streaming is an example of how Input can add further
diversification to the model, by adding a different crop and gaining more
exposure to eastern Canada.
TER: What words of wisdom do you have for investors looking to get
into investing in agriculture today?
SC: Be selective and do your homework. The agriculture space is
very complex, with numerous macro and micro drivers that impact the various
companies and subsectors differently. It can be a very lucrative area to
invest in, but due diligence is required to make smart decisions.
TER: Thank you for your time, Spencer.
Spencer Churchill has been working in the
investment industry for 15 years. Prior to joining Paradigm, Churchill worked
as a sellside research analyst at CIBC and Clarus Securities, with coverage
areas including agriculture, clean technology, special situations, software
and wireless technology. Churchill also spent two years working as an
associate portfolio manager at a hedge fund in Toronto.
