Everyone knows by now about the booming demand for hard commodities due to the rise of China. But as the country gets richer, its 1.3 billion people will need something else too - food. Dan Denning and Annunziata Rees-Mogg report.
You'd have to have been living in a cave not to have seen what has happened to China over the last few years.The country's economy has been growing at a good 9%-10% a year (or maybe more - statistics are even less of a science and more of an art in China than elsewhere) and is set to continue to do so for the foreseeable future. According to Chinese officials, the next five years will be a "golden time" for the economy, with annual growth averaging 8%.
This economic awakening of China has had now well-known, but still quite extraordinary, effects on the world economy, and in particular on demand for - and hence the prices of - hard commodities. As China urbanises, building factories, infrastructure and housing, its consumption of steel is soaring: even in 2003 China used 258 million tons of steel. America used less than half that. Then there is oil. The US still consumes three times as much oil as China, but Chinese demand has doubled in the last decade and is credited for the fact that the oil price has now settled in the $40-$50 a barrel range - a good $20 above where analysts forecast it to be only two years ago. Then look at coal. Who would ever have thought there would be a supply-and-demand mismatch for something so filthy and old fashioned? Well there is. In 2002, China definitively overtook the United States in terms of coal consumption, and now uses 800 million tons of oil equivalent annually to the US's 574 million. The result? Last year prices doubled. Today, the prices of pretty much every metal or energy-related commodity you can think of is trading at, or near, 20-year highs.
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China's newly voracious consumers are also going after retail goods with a vengeance. Luxury goods firm LVMH is making a killing selling overpriced handbags to the 25 million strong middle class, and there are more mobile phones in China than in the US (269 million to 159 million). The same goes for TV sets (374 million to 243 million). None of this should come as a surprise: as societies get wealthier, they obviously upgrade their consumption of this kind of thing. But it isn't just home entertainment systems the newly rich upgrade. There's something else the Chinese want, which you might not have heard so much about: food.
Everyone wants more to eat
As a country's wealth grows, so too does its demand for more, and for better, food. "When people have more money to spend, they add more variety and more expensive and high-end foods to their diets," says the United Nations Food and Agriculture Organisation. "These changes are reflected in both the volume and the composition of world trade in agricultural commodities." This in turn affects the worldwide markets for soft commodities. To produce one kilogram of beef takes seven kilograms of grain. So as an economy shifts up the food scale, increasing its per-capita consumption of protein, the amounts of raw materials required to satisfy demand increase exponentially. Today, China is the world's largest consumer of both meat and grain. It also used up twice as much fertiliser as the US in 2004.
And rising demand for food is not just about China. According to the Population Reference Bureau (PRB), the populations of the world's poorest countries are set to grow by 55% in the next 50 years. India will pass China as the world's most populous country and the end result will be that around the world there will be an extra three billion mouths to feed. That's a lot of additional demand, and more demand means higher prices, unless supply increases at the same rate, or at lower cost - something that really doesn't look very likely.
Farming is a tough business
China may be demanding more food, but the unfortunate truth is that it is producing less and less: its grain production has fallen 10% in the last decade. This is the result of a number of factors, not least the very urbanisation that is fuelling the demand. As workers move away from the fields, there are fewer workers to grow crops, and while the mechanisation of agriculture is increasing, it is not moving fast enough. So far it has managed to increase productivity per head significantly, but the food produced per acre is still lower than it was pre-mechanisation.
At the same time, peasants are migrating and turning what was once farming land into sprawling urban areas. Less acreage that is less efficient means less food production. Land is also being lost to the Gobi Desert and bad organisation in the north of the country - the main wheat growing area - has meant that the irrigation plans in place are not sufficient to keep the land fertile. Last-minute plans for dams have come too late to prevent the creep of desert into what was once lush pastures.
A final factor affecting the national supply of crops is the opening up of international trade. A large number of Chinese farmers have realised that more expensive crops, such as apples, which are exported, generate better profits than cheap crops, such as wheat, which are sold internally. In the 1980s, the US was the world's largest producer of apples. Not any more: China now grows four times as many as the US.
Depressingly, it isn't only China that has recently been experiencing falling food supply. Environmental factors have meant that Vietnam, Pakistan and most of the Pacific Rim have witnessed lower-than-expected crops recently.
Prices are already on the move
Like hard commodities, soft commodities have spent much of the last 20 years in a nasty bear market. But the recent shift in the supply-and-demand situation appears finally to have kicked some of them out of it. Sugar prices have risen 50% in the last year, live cattle prices 10% since March 2004, and this week coffee prices reached four-and-a-half-year highs in New York, and two-year peaks in London. However, not all prices have made their move yet. Wheat is down 25% on this time last year; corn, having soared in mid-2004, has now fallen back to 10% below last year's levels; and soybean prices have fallen by a third from last March's highs (thanks to overplanting in Brazil), with a slight recovery this month.
The good news here is that soft-commodities are still cheap. Take wheat. Last year's crop of 609 million was the second largest on record. But wheat stocks - the surplus amount of wheat in storage - are actually at 30-year lows. A recent US Department of Agriculture report suggested that price pressures will soon start building, because wheat stocks have not been dramatically rebuilt. Grain consumption is exceeding production: in all of the last four years, world grain production has fallen short of consumption, forcing a draw down of stocks not only in wheat, but also in corn and rice. And even at prices 50% above last year's levels, sugar is still cheap - or so says commodities guru Jim Rogers, in his new book Hot Commodities. World sugar consumption has been rising steadily for a decade - China imported more than a million tonnes in 2004, and that's sure to keep rising. Why would the Chinese middle class turn out to be less susceptible to "soda pop, iced tea, candy cakes and other pastries" than any other, asks Rogers. Note too that you can turn sugar into ethanol, a perfectly good fuel - so as long as oil prices stay high, sugar prices will keep rising.
Rogers is also a great fan of coffee. Its price has been "in the cellar" for years and production has fallen in response. That means that as demand rises, which it surely will (there are already over 100 Starbucks outlets in China), the supply won't be there to meet it. That's a recipe for a classic bull market.
Making money out of food
None of this is to suggest that we are headed for a Malthusian famine, with rising populations and starvation. Technology will provide, as it usually does. But it does suggest rising prices and tremendous opportunities for food producers and businesses that feed into food production. So how can we invest? The first answer is by looking to the food producers, both in terms of countries and individual firms. Australia is already a substantial exporter of commodities of all kinds, and increasingly of food to China, and it's likely a free trade agreement will be signed between the two countries later this year. New Zealand, along with Brazil and Argentina, has already signed such an agreement, opening the Chinese market. Brazil (the world's largest producer of sugar) and Argentina are places to watch - both have extensive and extraordinarily fertile farmland.
Another area for investors to consider is fertiliser, a product directly affected by world-food demand. In order to maximise land productivity, fertiliser must be applied, and because there is a fixed amount of arable land and increasing demand for food, each acre is going to have to produce higher yields - hence the basic need for fertilisers. One-third of global grain production is directly attributable to fertiliser already, but that can easily go higher: note that in 2003 China used double the amount of fertiliser used by the USA in an effort to get grain yields up.
A third option might be to get in at the manufacturing end of the food chain.To cultivate land, heavy machinery is required. Most of the large agricultural areas of the world are rapidly upgrading their technology in order to increase productivity and reduce costs. The South American and Asian markets are buying tractors and other machinery associated with food production and refining, creating new markets for companies that manufacture these goods, and boosting their long-term share-price prospects.
Next, take a look at the likes of KFC and Pizza Hut: they have caught the imagination of the aspirational middle classes and now share the number-one slot for "casual dining brand" in China. This has been achieved by exactly tailoring their product to the local market. For example, KFC, China's biggest chain, has expanded on its fried-chicken staple and converted 40% of its menu items to Chinese flavours. Favourite menu options include Sichuan diced chicken, complete with tiny bits of bone. Both Pizza Hut and KFC are owned by New York-listed Yum! Brands (YUM).
Overall, there are many ways to take advantage of the coming boom in food prices, but below we've taken a look at the eight best ways to get in via the equity market. They should all be reasonable long-term bets.
How to play the boom in food prices
Bunge
If you want to invest in the China food story, there is no easier way than to buy shares in New York-listed Bunge (BG), says Dan Denning in Strategic Investment. "Bunge is engaged in an easy-to-understand business: it helps feed the world, and makes a profit at doing it." It is a global agribusiness and food firm with integrated operations (divided into three divisions - agribusiness, fertiliser, and food products) that "stretch from the farm field to the retail shelf and circle the globe", capturing, in the firm's own words, "value wherever it appears on the food production chain."
Bunge is the world's largest oilseed-processing company, the largest producer and supplier of fertilisers to farmers in South America, and the world's leading seller of bottled vegetable oil to consumers. It has a strong position in every market it operates in and cannot fail to benefit from rising demand for food.
Sipef
Another way to buy into the food market is to do so via companies that own plantations and other agricultural land, says Sven Lorenz in The Sovereign Society. Sipef (SIFB.BR), listed on the Brussels stock exchange, is a fine example. Its full name is Societe Internationale de Plantations et de Finance, and it was set up with the principal aim of promoting and managing plantation companies that would operate in both tropical and sub-tropical areas. Since then, the company has developed into a small agro-conglomerate with plantations in Africa, Asia, Oceania, and South America. Up to the 1970s, it had mostly been harvesting rubber. Since then, the firm has diversified into oil palm, tea, bananas, pineapples, ornamental plants, guava, palm hearts, and pepper. The company's estates currently stand at 62,000 hectares. It also owns some real estate in the US and it operates a small insurance company, but basically the firm is a play on the rising price of food commodities, and a good one at that.
Between 2001 and 2003, Sipef grew its revenues from e91.6m to e127m, cash flow went from -e7.04m to e6.91m, while profits rose from -e0.5m to e8.15m. Earnings per share rose from -e0.70 to a healthy-sounding e11.51. Prices for palm oil have risen substantially, and Sipef reported strong demand from China, as well as from India and Pakistan. When prices were running high, the company made advance sales of a good portion of the harvest expected up to mid-2004, and it is therefore likely that 2004 will prove to have been another bumper year for the company. With a p/e of just over ten, the shares look cheap.
Cresud
Cresud (CRESY) is "the very best investment on the planet right now," says Steve Sjuggerud in Stansberry & Associates' True Wealth. The firm is an Argentine real-estate conglomerate, publicly traded on Nasdaq, which holds "incredible real-estate assets at very cheap prices, with what amounts to zero debt, trading for a small fraction of what it will likely be worth soon": it is the largest rural landowner in Argentina, and well placed to benefit from the China story. There is a word of caution though: the stock is hard to buy as it is only valued at $150m - and it doesn't trade much. Sjuggerud says that, "when you buy, use a limit order. Do not use a market order - who knows what price you'll get. Buy up to $15 per share." But then don't be greedy. When the price gets to $25, sell.
Agrium
The more protein people eat, the more fertiliser the world is going to need, says the US edition of the Fleet Street Letter. According to the United States Department of Agriculture (USDA), "every $1 spent on fertilisers returns almost $3 in crops". That makes Agrium (NYSE: AGU) a good buy. The firm is a global producer of fertilisers, operating 14 production facilities in North America and one in Argentina (via a joint venture). About 70% of its production is for use in the North American market and the remainder is produced for international markets, in particular Asia, Australia, South America and South Africa.
In addition to its fertiliser business, Agrium is the only company of its kind that also runs a retail operation. It is one of the largest in the US, with 206 farm centres there and another 18 in Argentina. The bulk of the company's business is based on fertilisers, but the retail sectors make up about 40% of both sales and profits. Agrium's current p/e is 11-12, which is right at the bottom end of its historic range, and makes the company look unusually cheap.Pilgrim's Pride and TysonTwo straight food plays that could make gains from rising global demand for food are Pilgrim's Pride (NYSE: PPC) and Tyson (NYSE: TSN). Last year, Pilgrim's Pride grappled with a loss-making acquisition, but now appears to have sorted things out. Shares in this poultry processor have risen 39% in the last nine months and "have further to climb", says Smart Money magazine. Another food stock listed in the US is Tyson, which, in its own words, "offers a delicious variety of quality chicken, beef and pork products that are packed with the protein you need to keep you going strong". Both trade on p/es of 15.
Deere & Company and Caterpillar
To take advantage of the Chinese-food phenomenon from its earliest stages, consider investing in the machinery that farms the land. Two possible stocks are Deere & Company (NYSE: DE) and Caterpillar (NYSE: CAT). Earlier this month, Dailyreckoning.co.uk argued that, "while stocks for most companies go down during a commodity bull market, companies connected to the commodities business - such as manufacturers of heavy machinery used in agriculture, such as John Deere and Caterpillar - are likely to do well". John Deere has already seen a 30% increase in earnings, with an 18% increase in revenue in the first quarter. Its share price has seen fluctuations over the last year, but as demand for food increases and efficiency comes into play, more machinery will be required, and Deere are in a position to provide it.
Funds and spread betFinally, those who want direct exposure to soft commodities - and are prepared to take more risk than they would with the equities mentioned above - can spread bet on the prices of everything from sugar to pork bellies with firms such as IG Index (www.igindex.co.uk) and Finspreads (www.finspreads.com). Those looking to diversify across a range of commodities could consider a fund.
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