Play the agri theme with the right stocks
The shorter-term risks of the agri cycle are mitigated by companies through their ability to add value to the end product.
Naval Bir Kumar
The global trend of investing in commodities is here to stay and the challenge of investing in them has been simplified with the advent of the futures market. However, within the asset class of commodities, it is agriculture that offers several opportunities for investing. Agriculture is hugely cyclical. And unlike an industrial cycle that can last over a period ranging from five-eight years, agriculture cycles are usually dependent on the yearly crop patterns and good weather. However, crops are perishable in nature and storage losses can be high, especially in developing countries where infrastructure is in its infancy. Therefore, the vagaries of investing in agri-commodities are reasonably high, even though demand is steadily on an uptick. Do note that volatility in the shorter term can be the undoing of a trade that started off successfully. Companies engaged in processing agri commodities or trading them have shown their ability to manage these cycles reasonably well and thus, may be good vehicles for investors to play the agri theme. Companies act as efficient asset managers for particular crops.
Playing the agri value chain
The shorter-term risks of the agri cycle are mitigated by companies through their ability to add value to the end product. They also depend on scale to arbitrage cross-border differences, wherever available. But what's most important is their availability of organised finance to hold inventory and ride out a down cycle. Simply put, there are three main components of the agri business chain — ones that make agriculture inputs, enablers and then processors, which put together would involve companies that make agrochemicals, soft commodities, micronutrients, fertilisers, or ones that have agri land banks and livestock and help in farm mechanisation. Seeds and irrigation too would fall in this segment. But how can you make the best of this investing opportunity? By knowing how the profits pools in the value chain shift at different points in the price cycle. Companies that are ‘enablers' generally tend to benefit at both extremes; therefore, they would necessarily need to be a constant feature in any portfolio playing this chain. As for processors, high profitability and higher prices of end products helps create cash flows. This in turn finds its way down to creating the demand for agricultural inputs for the next season or two.
Bright prospects
The demand picture for agricultural products is pretty well documented. Between India and China in the next 10 years we would have 50 per cent of the world population to feed. This remains a challenge, though both these countries have a rising per capita income. Agriculture as a percentage to total GDP in India is about 16 per cent. Any further decline would destabilise the food security for the nation. However, if this number rises, that it would attract a lot of capital to the sector. The demands on the existing land under cultivation can only step up from hereon. Besides, there is no alternative to productivity and technology enhancements that are finding their way into the business. All these lead to higher capital intensity of the business, which could mean a dramatic shift towards corporatisation. Rapidly changing technologies, from fuel efficient farm equipment to higher yielding and pest-resistant seeds are making way for a new generation of companies. These are developments, we haven't seen before. The sum and substance is that agri business offers a large universe of traded stocks. While food inflation is working in favour of the already profitable industry, over time it will work in favour of every company in the agri-business value chain. And that's a bigger opportunity probably, than just commodity futures.
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