China's Agriculture Sector Is Ripe for Investment

by: Howard Sun April 08, 2008 | about stocks: CNOA.OB / FEED / GRO / SEED    

Howard Sun

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Agriculture has been one of the hottest industries for an investor to be in. However, a majority of the market has already had significant gains. And although I do have positions in the large agriculture companies; as a value investor, I feel somewhat uncomfortable buying into companies that have already had tremendous returns.

I’m still very bullish on agriculture, and I’ve been trying to find value plays, particularly in China’s emerging market. In this article, I will introduce a few of the companies that I’m interested in and high-level rationale behind why they might be good investments in the coming months. But first, let us explore the agricultural landscape in China.

The Chinese Agricultural Landscape

China has 1.3 billion people with over 900 million living in rural areas, contributing to tremendous amount of consumption. The agricultural sector accounts for approximately 13% of China’s GDP growing approximately 8% annually. Arable land in China is less than 1ha per household versus 100ha in the US. The Chinese agricultural technology is slowly improving, but the production efficiency continues to lag behind western countries. With decreasing supply of soybeans, corn and wheat and increasing demand, China has changed from being a net exporter to being a net importer of major agricultural crops. The government heavily supports the agriculture sector with year on year increases in financial support.

Why Invest In Chinese Agriculture?

  • Chinese agricultural companies are protected by the government and foreign competition is heavily regulated
  • Recent droughts have made have contributed supply shortage which has driven prices upward
  • Emerging markets can be thought of as a hedge against domestic agricultural markets, particularly when the domestic markets weak
  • Consumption has increased across the board for all commodities; this will continue as more Chinese people move out of rural areas into urban settings

Top Pick #1: AgFeed Industries (FEED) – High-Level Overview

  • Based out of Nan Chang City, AgFeed sells premixed food for livestock, particularly hogs
  • China is the largest pig and pork production country in the world as pork makes up almost two thirds of meat consumed in China
  • 98% of pork produced in China is consumed domestically and 80% of Chinese people consume pork as their primary meat
  • China raised over 530 million hogs in 2006, compared with 100 million in the US for the same year.
  • The increasing supply of Pork is not offsetting the outrageous growth in pork prices, as the price of pork has gone up by 29% over the past year, and the price of live pigs gone up by 71%
  • AgFeed’s total output amounted to 53,000 metric tones, with pre-mix sales accounting for approximately 85% of revenues. Premix is important because it accelerates the growth of hogs from over two years to as little as several months
  • The company sells its feed products through 550 wholesale distributors and 630 retail stores across the country
  • In addition to feed revenue, AgFeed also raises its own hogs and is benefiting from the current TAX-FREE environment due to the blue ear disease
  • The company recently gained license for export to the Hong Kong market
  • Revenues increased by 321% in 2007 versus 2006
  • Net income increased by 467% in 2007 versus 2006
  • Total feed in metric tones increased by 225% in 2007 versus 2006

Top Pick #2: Agria Corp (GRO) – High-Level Overview

  • Agria is involved in the research & development, production and sale of corn seeds (50%), sheep breeding products (40%) and seedling products (10%)
  • Agria sells its products to local and regional distributors
  • Agria has access to 27,000 acres of farmland, of which 23,000 acres are used for producing corn seeds
  • Besides producing seeds and seedlings, Agria also owns 17,000 sheep
  • Revenues likely to increase by 5-10% in 2007 versus 2006
  • Gross margin of 58% versus industry gross margin of 31%
  • P/E of 14.8 versus industry P/E of 20

Although I will not discuss further in detail, other potential plays in the Chinese agriculture sector may include Origin Agritech Ltd. (SEED), and China Organic Agriculture (CNOA.OB).

Throughout this article, I have offered my high-level thoughts on China’s agriculture sector in and a general overview of some of the companies that I’m interested in.

Based on what I’ve seen so far, agriculture, like many commodities, is here to stay. The high prices are well justified by economic fundamentals, unlike other price bubbles we’ve seen in the past. This sector will continue to benefit from the increasing global demand. Prices will continue to rise, and I think every investor needs to attribute a good percentage of their portfolio to this sector.

Disclosure: Author has a long position in FEED.

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This article has 14 comments:

  •  
    Apr 08 11:58 AM
    I agree with the theme, but I like the fundamentals of CAGC and HOGS better than the ones you mentioned. CAGC is current OTCBB, but working on moving to a major index.
    Reply | Link to Comment
  •  
    Apr 08 12:37 PM
    GRO is down some 30% today....
    Reply | Link to Comment
  •  
    Apr 08 01:57 PM
    Yeah, we've just purchased a position in HOGS over the last couple months. I think the valuation is very good at these levels. Agree with Josh.
    Reply | Link to Comment
  •  
    Apr 08 02:45 PM
    Just to follow up...the biggest valuation differences show up when one looks at price to sales ratios. Of course it all depends on what one expects for future profit margins, but I'm a lot more comfortable with P/S near 1 than P/S in the 6-9 range.
    Reply | Link to Comment
  •  
    Apr 08 05:28 PM
    GRO may be dead money for awhile, even though I like their business and overall focus.
    CNOA.OB is interesting and a direct player in rice...a good place to be
    CYXI.OB is another Chinese firm involved with rice, and garners quite a bit of their revenues from diabetic-friendly rice products. Fundamentals are excellent with CYXI.
    I'll put one out there that nobody knows about...CHBU.OB. Trading near cash despite nice EPS, CHBU is on the fertilizer side of Chinese agriculture...worth a peek.
    Reply | Link to Comment
  •  
    Apr 09 12:19 PM
    In re the five comments above: Confucious said that collective wisdom advances the cause. Thanks, guys!
    Reply | Link to Comment
  •  
    Apr 11 12:08 PM
    This article serves to reinforce my opinion about FEED. This stock has been on my short list (not to be confused with my list of short stocks), with a big green check mark next to it, for awhile. It
    's been getting a lot of "air play" in the chat rooms and on the radio here in Denver lately, too. The more talk, the better, as participation in the stock seems to be increasing.
    Reply | Link to Comment
  •  
    Apr 14 12:16 AM
    A question-I would appreciate a comment on Migao(MGO) in any future articles. Thank you.
    Reply | Link to Comment
  •  
    Apr 16 12:19 AM
    China Organic Agriculture CNOA.OB is a great value right now - I think it should double my year end. They recently announced acquisition of a Northeast China food processing and transportation company (distribution). This will open doors to more channels and customers. Contrary to press reports I view this as a great strategic decision. FYI Here's an excerpt from their 10-k. It seems that Huiming Trading may be a good diversification strategy for CNOA esp if price controls stay in for rice. Diversifying into wheat and soybeans is not a bad idea and having more control over distribution alleviates some potential pressure from higher transportation costs. Also, of the major provinces Huiming and CNOA operate in, it seems ony 1 (Sichuan) was a primary victim of the winter storms. Northeast China largely escaped the bad weather. I'm leaning towards giving CNOA until mid summer before I judge their acquisitions. Operating in China is largely based on relationships - so acquisitions tend to be based on what relationships you get along with the assets. I've advised US companies in CHina for 5 years so I'm ok with this acquisition. Revenues are about equal for the two companies. Let's see what the next steps are. I think CNOA is a good buy here at under 2 and should go to 3 soon - multiples are just too low. Northeast China incl. Dalian are targeted as a primary area of growth for the next 5 years - a govt priority to grow their region!

    Excerpt
    On December 12 2007, the Company announced that it had entered into a letter of intent to acquire the Dalian Baoshui District Huiming Trading Limited ("Dalian"). The acquisition is pending due diligence which is not likely to be completed until late Aprill. Dalian is engaged in grain procurement, international and domestic trading, wholesale sales and food delivery logistic services. Its main products include including soybeans, corn, and cereal crops, which are major products from the Northeast part of China. Sales to consumers are made in national regions including Liaoning Province, Jiling Province, Heilongjiang Province, Sichuan Province, Fujian Province, Beijing, and Shanghai.
    Reply | Link to Comment
  •  
    Apr 16 07:09 PM
    I think HOGS is definatly one not to be left out, excellent growth, still under the radar here, probably not for long
    Reply | Link to Comment
  •  
    May 05 12:32 PM
    CNOA's CEO just announced a major buyback. Jump in if you can, it's already going up, still a little under the radar. Great company.
    Reply | Link to Comment
  •  
    May 14 12:46 PM
    CNOA now trading at 4x its EPS. It just signed a multi-million dollar sales contract. Its ratios are high, and has no debt. It's insane that this stock is so low for a company so solid and profitable.
    Reply | Link to Comment
  •  
    May 15 09:15 PM
    It is true that the time is ripe to invest in Chinese agricultural sectors. I had worked for many years in China and I know it is great time. I set up the Canada-China agriculture and Food Development Exchange Centre to help people to invest in China.
    Reply | Link to Comment
  •  
    Jun 04 07:27 PM
    ALL EXCELLANT REVIEWS, HOPING 'FEED''..WILL BE GOOD OVER LONG HAUL..!
    Reply | Link to Comment
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