AGRICULTURE |GLOBAL EMERGINGMARKETS Agriculture See the Important Disclosures and Analyst Certifications on Pages 311-314
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Agriculture AGRICULTURE | GLOBAL EMERGING MARKETS NOMURA INTERNATIONAL PLC Richard Ferguson +44 207 521 1623 [email protected] ANCHOR REPORT A revolution of sorts.. See the important disclosures and analyst certifications on pages 311-314. gl Contents Anchor themes 1 Countries section 41 Argentinean agriculture 41 Brazilian agriculture 65 Chinese agriculture 93 Kazakhstan agriculture 127 Russian agriculture 145 Ukrainian agriculture 173 Company pages - an introduction 201 Black Earth Farming 205 Razgulay 213 Astarta 227 Kernel 241 MCB 251 Brasilagro 263 Cosan 273 SLC Agricola 287 Cresud 299 Disclosures 311 Nomura 27 October 2008 blank Nomura 27 October 2008 Agriculture AGRICULTURE | GLOBAL EMERGING MARKETS NOMURA INTERNATIONAL PLC Richard Ferguson +44 (0) 20 7521 1623 [email protected] Our view We are witnessing the third great subcontracting wave of the modern era: twenty years ago, manufacturing headed to China. A decade back, IT services shifted to India. Now we are witnessing the shift of agriculture from high-cost, inefficient producers to low-cost producers such as Brazil, Argentina, Russia, Ukraine and Kazakhstan. The latest great industrialisation process is underway. Anchor themes The structure of the industry will change dramatically: farms will get much bigger and more industrial, the major trading houses will face considerable challenges from new companies, some of which don’t even exist yet. Economic distortions and political interference will remain at the root of the industry’s problems. A free market with transparent pricing, enforceable property rights and liberalised trade would solve just about very agricultural problem under the sun. Politicians will fight it but it will likely prevail. A major agricultural land bubble has emerged. It may burst in dramatic fashion. There is a surplus of farmland in the world, not a deficit. A richer China does not necessarily imply a need for more food; it might even consume less in the future. “Food security” is a misappropriated phrase which borders on the meaningless. A revolution of sorts Analyst Prepare for the unexpected Richard Ferguson Bad economics and foolish (but well meaning) politicians are a curse on agriculture. + 44 207 521 1623 [email protected] So, too, are the useless tools we use to value the companies in the sector. We are entering a great liberalising period, despite what you see and read in the media. Doha is not dead and has a future. Ukraine will eventually join the EU and Russia will likely create a couple of agricultural companies of note. Expect a currency crisis to engulf Ukraine but to have a positive long-term effect on its agriculture sector. The short-term consequences will be severe. Winners and losers The winners will be the countries which embrace the free market ideal to the greatest degree. Some will struggle. The companies which know that a major land bust is on the way and adopt a strategy to work through it, or have sufficient capital to take advantage of it, will emerge triumphant. Diversified enterprises with existing profitable businesses will provide a high degree of flexibility. The trading houses which currently dominate the market face significant strategic challenges. They may restructure but, given their histories and backgrounds, they will likely prevail. Farms are going to be big – very big – but small farms will remain the norm. Scotching some myths A number of dangerous myths have begun to appear and are now accepted as conventional wisdom. First, there is not a shortage of land as some vested interests would have us believe; there is, in fact, quite enough farmland in the world. Second, the rising Chinese consumption theme may be a fairy tale of staggering proportions. Third, land acquisition programmes by groups from the Middle East and China have less to do with food security and more to do with the sensible recycling of current account surpluses. Nomura 1 27 October 2008 Agriculture | ANCHOR THEMES Contents A revolution of sorts 3 The future of farming 4 The companies in the frame 5 Anchor 1: Russia will create an agricultural Gazprom. Perhaps two? 7 The Agency for the Regulation of Food Markets 7 Lack of access to capital 8 The state’s land bank 9 Anchor 2: Ukraine, the EU and the Hryvnia 11 Understanding Serbia 11 Economics trumps politics 12 Anchor 3: There is no shortage of farmland 13 The global scale 13 Anchor 4. Land prices will fall – there will be blood 15 Anchor 5: Doha is not dead but WTO membership is not a panacea 17 The heart of the matter 18 Anchor 6. The current valuation toolkit needs to be refined 21 The horror of EV/hectare 21 DCF captures long-term value 23 Anchor 7. Vertical and horizontal integration and investor fears 24 The farming model 24 The next wave of enterprises 25 Anchor 8. The myth of food security 26 The Middle East and Africa 27 The Chinese approach 28 Anchor 9. A new challenge for the middlemen? 29 Business strategies 29 Fundamental strategic advantages 31 Anchor 10. Farms are going to get bigger – a lot bigger 33 How do you define a “farm”? 34 Anchor 11: The myth of Chinese consumption 36 A model of rural-urban migration 37 Anchor 12. Leasing versus ownership and the case for both 39 Obsolescence of assets 39 Working capital availability 39 Land appreciation 39 Nomura 2 27 October 2008 Agriculture | ANCHOR THEMES A revolution of sorts We must not leave the vital issue of feeding people to the mercy of market laws and international speculation – Michel Barnier, French Minister of Agriculture, 14 April 2008 If you put the federal government in charge of the Sahara Desert, within five years there would be a shortage of sand – Milton Friedman Thankfully the laws of economics are immutable, in contrast to politicians – or, at least, in contrast to those in countries where free elections are permitted. In the face of the many uncertainties in the agriculture sector, we at least feel confident that if M. Barnier took charge of our interests the world would be placed on a crash diet of some severity and magnitude. Unfortunately, he is not alone and, as a consequence of some seriously slack thinking and bad economics, the world is currently making policies for the agriculture and food sectors on the basis of some poorly observed data and some appallingly bad economic rationales. As investment scribblers, we are prone to fits of hyperbole which would put the most It’s just like any other sector shameless of politicians to shame. In the case of the agriculture sector, however, we take the view that it is just like any other industrial or commercial sector. The one thing that distinguishes agriculture from many of its peers is that the former experiences a higher degree of volatility and a greater unpredictability of outcomes. In the next few years, however, we may bear witness to embellishment and exaggeration on a scale not seen since, well, the last frenzy. In our view, some of the structural changes taking place across the agriculture sector mirror the internet frenzy of the late-1990s. Both centre on industries which have been around for generations but which are being transformed into something quite different to what preceded them. Both attract (or did attract, in the case of the internet) considerable investment sums for mostly unproven start up enterprises; trading companies dominate agriculture markets in the same way that incumbents dominated the telecoms market; new technologies and processes are generating many new market participants and, just as the internet frenzy had many people wishing they had studied computer science at university, the agriculture sector is making some people wish they had headed off to agricultural college instead of doing a finance degree. Extending this analogy still further is the notion that the valuation tools for both the Questionable valuation tools internet sector and the agriculture sector are rudimentary, to say the least. We also believe that the agriculture sector will go through a bust similar to that of the internet sector and that at the end of this process of creative destruction the agricultural equivalents of Google, eBay, Yahoo! and Amazon will emerge. We would emphasise several points at the outset. The first is to dispel as many myths Dispelling myths about the sector as you possibly can at the earliest opportunity. The most obvious myth, and the one we look at in much greater detail in subsequent sections, is the myth that rising incomes, growing population and urbanisation are having an enormous impact on demand. It quite simply isn’t true. A second myth is that, somehow, there is a shortage of farmland. Again, this is a myth of considerable proportions. Although there are supply bottlenecks, illiberal markets and suffocating regulation that stifle market mechanisms, but there is fundamentally no shortage of farmland. A third myth is how we interpret “food security”. In some ways it doesn’t exist. If you believe that owning an equity stake in a Russian oil company somehow implies energy security, then you can believe in imported food security. In reality, state investment in overseas land is simply that: an investment. If dispelling myths takes some of the froth out of the sector, it is also important to Seeing truths recognise some other truths which may appear to strip the excitement levels back still further. The first truth is that commodity food prices will not rise in perpetuity. Wheat at US$13/bushel was a short-term phenomenon and we are just as likely to see the price back at US$5/bushel over the long term. However, within that framework there remains the scope for making huge profits.