May 25, 2018
“The agriculture sector has been a disaster for 35 years. Things are so bad. The average age of an American farmer is 58, the average age in Japan is 68. And do you know that the highest suicide rate in the UK is in the agricultural sector?” – Jim Rogers
Jim Rogers oft recited spiel on agriculture may be slightly dispiriting, but the crux of his argument for investment in this sector is compelling.
Three key fundamentals underpin his optimism for this unloved and underinvested industry:
- Aging farmers – and farm workers
- Agricultural resources are finite – soil and water in particular
- Increasing food demand – driven primarily by Asian consumers
As Jim Rogers knows, nothing stays the same forever. Although some investment commentators forecast better days ahead for the agricultural sector, why has agriculture struggled to attract substantial investment from non-farming finance sources to date?
(In the context of SAS’s business objective to make bovine agriculture investable, we are primarily referring to attracting investment capital into midstream agriculture – the production of crops and livestock – i.e. the actual farming bit!)
There are four key barriers preventing widespread investment into agriculture:
- Capital intensity
- Weather risk
- Price fluctuations
- Poor profitability
Conventional Agriculture Investment
The capital intensity of agriculture is driven primarily by high farmland values. Although productive agricultural land is considered a good investment, it does tie-up a lot of capital. Often, this limits the ability of a farming operation to invest in technology, equipment and systems that can improve business profitability.
Although many investors expect farmland values to appreciate, servicing any debt and generating consistent income from farming can be challenging.
Despite the sound fundamentals supporting an investment into agricultural land, any capital gains resulting from asset appreciation are not realised until the land is sold. Some investors may be content with this approach, but it is a significant barrier to others who require consistent annual returns.
Furthermore, investing in conventional farming is not straightforward, or without substantial weather and disease risk. Droughts, floods, or an animal disease outbreak can quickly put even the most well-run farming operations in financial difficulty.
Food production needs to be a viable business delivering decent annual cash returns, not just a speculative investment based on appreciating farmland values.
Unique Investment Opportunity
The SAS System offers an attractive investment opportunity for several reasons:
- There is no requirement to own productive agricultural land
- Weather risk is eliminated
- Diverse income streams minimise exposure to price fluctuations
- Healthy margins support consistent and respectable annual cash returns
The SAS System has no requirement to own productive agricultural land, only a “production site” on which the cattle operation is built. Most of the investment capital required to develop the SAS System is deployed into technology, efficient infrastructure, high genetic merit breeding stock and cost-saving equipment.
The poultry sector has demonstrated the economic viability and efficiencies of “production site” agriculture. There is no reason why this cannot be replicated in the cattle sector.
Eliminating Weather Risk
The SAS System outsources primary feed production (grain and fibre). The risk and cost associated with growing crops for livestock feed is not directly borne by the SAS System. I will explain SAS’s feed procurement model in next week’s post on making bovine agriculture manageable.
But in the context of making bovine agriculture investable, the controlled environment feed production model utilised by the SAS System eliminates the weather risk associated with conventional livestock agriculture.
Come rain, hail, or drought – the SAS System can produce cattle feed rations to the exact same consistency day in, day out.
Moreover, the housed dairy system protects cattle from the vagaries of the weather – be that heat stress or inclement weather.
The protected production environment afforded by the SAS System also prevents disease carrying wildlife from encountering 100% disease free livestock. The strict bio-security status of the SAS System will be explained further under a future post on making bovine agriculture scalable.
Reducing the impact of commodity price fluctuations is another key aspect of the SAS System. This is achieved by developing multiple streams of revenue.
The SAS System generates income from the sale of:
- Surplus breeding stock
- Humus compost
These diverse revenue streams reduce exposure to the price fluctuations of the international dairy market. The SAS System generates 52% of net farm income from the sale of milk; 22% from surplus breeding stock; 22% from beef; and 4% from humus compost.
Water Tradeable Commodities
The SAS System is investable at current food prices. Although no one can predict the future with complete certainty, the evidence would suggest that food is set to become a more valuable commodity.
Annual population growth is running at 80 million people – the population equivalent of a new Beijing, a new Shanghai, a new Tianjin, a new New Delhi, and a new Lagos being added to the world every year.
Not all these 80 million people will automatically go on to consume a diet rich in animal protein; however, the models predict that 40% of the global population increase by 2050 will be in Asia – an increasingly wealthy and consumption driven continent.
Perhaps one of the most compelling arguments for higher food prices is the tie-up between fresh water and food.
The idea of investing in “water tradeable commodities” (aka food) has been explained succinctly by Michael Burry, the Californian fund manager played by Christian Bale in the 2015 movie – The Big Short:
“I started looking at investments in water about 15 years ago. Fresh, clean water cannot be taken for granted.
Transporting water is impractical for both political and physical reasons, so buying up water rights did not make a lot of sense to me.
What became clear to me is that food is the way to invest in water. That is, grow food in water-rich areas and transport it for sale in water-poor areas. This is the method for redistributing water that is least contentious, and ultimately it can be profitable, which will ensure that this redistribution is sustainable.
The water embedded in food is what I found interesting.”
By investing in a SAS System, investors are gaining exposure to water in two ways – the sale of water tradeable commodities (milk 87% water, carcass beef 73% water); and through the ownership of a water-efficient agricultural production facility – the SAS System itself.
The SAS System improves business profitability by growing the net margin, rather than output.
One of the key financial performance indicators of the SAS System is the net margin per cow. There is no correlation between the number of litres produced and profitability. It is how those litres are produced that matters, as well as the value of the product.
Historically, farming has been a commodity industry with multiple producers of homogeneous goods. Therefore, buyers purchase on price, and producers profit by producing commodities below market prices.
The SAS System deviates from this slightly. Maintaining competitive farm working expenses remains crucial, however more focus is placed on product quality attributes and sustainability parameters. This leads to the production of differentiated goods deserving of market premiums.
Many food processors and retailers are beginning to pay commodity premiums for milk and beef with points of difference.
In 2016, Nestlé introduced a new milk payment mechanism for UK dairy farmers supplying the company. A sustainability bonus is paid for carrying out work on-farm around biodiversity, soil or water. Additionally, the new mechanism incentivises milk fat and protein. As stated by Nestlé milk buyer Robin Sundaram, “the higher the level of protein and fat, the better our factories run.”
McDonald’s has announced that starting in 2016, the corporation will endeavour to purchase verified sustainable beef as a step forward in its mission to purchase sustainable beef for all its restaurants worldwide.
Using a recognised life cycle analysis approach, McDonald’s calculated 70% of the company’s greenhouse gas emission impacts are in its supply chain with 40% related to beef.
Hydroponic barley feed has been approved by the American Grass-fed Association (AGA). It is thought that hydroponic sprouts may produce more nutrient dense animal products than conventional pasture. Thompson Rivers University (Canada) is conducting research to determine the quality of hydroponic fodder fed dairy products and beef.
Milk produced by mammals contains several different types of proteins. Of interest is beta casein.
There are two variants of beta casein – either A1 or A2. Most European cattle breeds produce milk containing both the A1 and A2 beta casein. However, some consumers find that milk containing the A1 protein causes digestive upset.
The milk produced by the SAS System will be 100% A2 milk. Producing A2 milk attracts a price bonus, and most importantly, allows many people who thought they were lactose intolerant to enjoy the goodness of dairy again.
In aggregate, the bonuses paid for product quality and points of difference significantly improves the profitability of milk and beef production.
Reconfigured Business Structures
The two most important developments agriculture needs are new agricultural systems and new business structures.
Traditionally, farming has been an owner occupier family business. Therefore, most farm gates have remained closed to investors.
However, as the SAS System operates on a “production site” there is no need to own agricultural land. Therefore, so long as suitable a ten-hectare building site can be located, a SAS System can be constructed.
The design of the demonstration unit Open Farm facility will enable office attired business people to observe the SAS System in operation whatever the weather. The demonstration unit provides the showpiece and blueprint for subsequent SAS System developments.
Developing a new agricultural system fit for the 21st century; and implementing a business structure capable of facilitating investment into agriculture, is an incredibly exciting opportunity.
In my next two posts I will introduce SAS's objectives to make bovine agriculture manageable and scalable – two very important aspects given the need to recruit more food producers and increase global food output.