Everyone has certain expressions they particularly dislike. One of mine is “they’re not making it any more”. It is used by egregiously dim City sales people when promoting various asset classes, including commodities, property and especially land. For making it or not, all asset classes are cyclical.
Yet it is in farmland that the irritating saying is most alluring. How do you feed a global population that has risen from 2.5 billion in 1950 to 7.9 billion today and is projected to reach ten billion in 2050? Especially given that, as incomes and living standards have risen steadily in most countries, the result has always been that people eat more (usually more than they need) and better, switching from staples to dairy products and expensive meat.
Moreover, farmland has been one of the best and least cyclical investments for decades, beating most other investments with the current exception of gold. In the UK, for example, bare land prices over the last 20 and 50 years have risen by a factor of four and 25 respectively. Similar or even greater increases have occurred in other countries.
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An unsustainable business model
There has been much pontificating about the enormous changes that must result from the pandemic. But my guess is that the trends in place beforehand will simply accelerate and perhaps nowhere more so than in farming, where the business model is utterly hopeless and unsustainable. The hopeless part is that in every developed country farming is a marginally profitable and low value-added business, kept afloat by subsidies and owned and managed by old men (the average age of farmers in the UK is now 61). Much of what is grown is not essential or can be produced more efficiently elsewhere, but the lure of subsidies dictates land use.
As for sustainability, land degradation is a major problem; the United Nations Food and Agriculture Organisation estimates that a third of global farmland has suffered meaningful degradation. Many farm chemicals and pesticides are both hazardous to health and environmentally damaging. Then there is waste. Between a quarter and a third of all food production is thrown away or rots. Finally, consider simple economics. There has been a surplus of food every year since 1980. Any famine since then has been a function of poor distribution, incompetence or corruption – usually all three.
The level of subsidies is eye-watering. No one knows the total globally, but a World Bank estimate suggests a figure of $700bn a year, or just under $2bn every day. That is four times the aid rich countries give to the poorer nations who often need support because they are barred by tariffs from exporting food.
While the EU has rightly been criticised for its farming subsidies – they comprise a third of its annual budget and a basic payment of €260 per hectare (2.5 acres) – it is not the worst offender. Countries such as Norway, Switzerland and Korea pay farmers far more. In Japan subsidies can be as high as the equivalent of $800 per 0.1 of a single acre. America last year decided to bail out its soya bean farmers because China had briefly halted soya imports from the US during the trade war. That cost more than the rescue of the entire US car industry in 2008/2009: the respective figures are around $28bn and $17bn.
The consequences of these subsidies have been universally bad. They include tariffs to prevent food imports from cheaper, more efficient producers, leading to higher domestic food prices; land prices soaring to uneconomic levels; corruption, and the suppression of development and food production in third world countries. Estimates vary, but the approximate cost of subsidies in the UK for a family of four is about £500 per annum.
Even with subsidies, farming is barely profitable. In England, subsidies account for over half of farm income across all sectors (the figure is higher in the other parts of the UK), with livestock and cereals being the most dependent, horticulture the least. The median farmer earns slightly less than the national average for longer working hours and sometimes awful conditions.
So why do they do it? Lifestyle and conservatism play a part, but there are hidden benefits: generous VAT rules, other subsidies (costs such as a car can be put on the farm account) and exemption from inheritance tax. What’s more, even poor farmers are sitting on a valuable asset where the tax rate on a sale is not onerous.
New Zealand blazes a trail
New Zealand is often cited as an alternative to those developed countries addicted to farm subsidies. In 1985 it was effectively bust because of widespread subsidies across many industries. Farm subsidies were abolished. Until then the sector had been unproductive and inefficient. Land prices tumbled and then the recovery began. Better pasture management and improved animal breeding turned New Zealand into the world’s largest exporter of powdered milk. Meanwhile, the 70-million-strong sheep flock was slashed to less than 30 million – yet exports have not changed. Productivity, in other words, has more than doubled.
Great leaps forward in productivity
There has been impressive progress on the global scale too. From the 1950s, farming made huge leaps to meet the demands of population growth and rising wealth. Since 1960 the world’s population has increased by about 150%, but cereal yields have increased by 200% and overall production by 250%. All this was achieved with only a tiny increase in the amount of land farmed.
Moreover, there is still scope for another surge in productivity. In 1945 UK farmers were producing what was then seen as a dizzying 2.5 tonnes of wheat per hectare (tph). At the local pub today you’re a loser below 7.5tph. Major potential agricultural producers such as Russia are still stuck at the 2.5 level. Rice is another important staple. China has increased its output per hectare fivefold since 1960 to 5.5 tonnes, but other rice growers in Asia, such as Thailand, have seen their output rise to a mere 2.2 tonnes. Large gains can therefore be made even before we consider better seed dressings against disease and new seed strains.
I have said I think the pandemic will accelerate pre-existing trends. For farming two of these matter: the level of subsidies and environmental concerns. The latter has gone mainstream. Before the last general election the three UK nationwide parties developed competitive tree planting fever (Labour one billion by 2030, Conservative 30,000 and Liberal 40,000 per year to 2025). All developed countries have slowly woken up to increasing public concern about pollution (from nuclear to sewage), poisons in the food chain, waste disposal and climate change – all lumped together under the term “environmentalism”.
EU leads the green charge
The champion in this context is the EU, driven by the ever-greater success of “green” parties in elections. The EU has banned a range of pesticides, including one that has many organophosphate compounds – a useful herbicide and pesticide, but very harmful to humans and the environment. This lead is slowly being followed by other major food producers, including Brazil and China. Because the EU is such a large food importer its rules run beyond its borders. The US is fighting such changes (the farm lobby is very powerful), but will lose.
Modern farming practices also look increasingly old-fashioned with their reliance on a single crop or a lack of sensible diversity. Around 90% of the world’s banana crop is under threat because of a lack of genetic diversity and a rapidly spreading fungus. The paucity of pig strains (swine fever is rampant in China) or varieties of apple leaves them open to the same risk.
Dabbling in farming
Although by trade a city type, I also own a farm in the UK (we were young and land was then cheap) and a much larger one in the Baltics (where land and drink were cheaper still). More recently I acquired a small share in an operation in Uruguay (nice warm winters). I am definitely not a professional farmer, but after 30 years you get an idea of what works.
Here in the UK until recently we followed the standard model of heavy machinery compressing the fields, ploughing and levelling until they look like bowling greens. It is a very expensive process.
The clay soil is gradually breaking into sand and has a nasty smell. Lots of nitrogen and dubious chemical sprays are applied yet most years there is only a tiny profit, even after subsidies. In the Baltics we plant nearly half the seed numbers per hectare compared with the UK. Our fertiliser is mostly chicken muck. We spray rarely and selectively. We rotate crops. Our yields are better than in Britain, profits are peachy and soil improvement dramatic. In Uruguay we are mostly renting and do even less, but I expect the profits to be higher still. Yet in the UK we get the full fat subsidies, in the Baltics a third of that level and in Uruguay, none. All subsidies are on the block following the pandemic, not least because government deficits and debt levels are rocketing. Farm lobby groups still mutter about food security, but given the continuous global surplus and that during the pandemic the supply chain worked remarkably well, their case is weak.
What happens next in the UK and Europe is easy to forecast from the mood music. Big farmers and giant agribusinesses are bad. But small mixed farms with grass-fed animals and operating in the sensible, but unfashionable way (such as crop rotation), will be the winners from a smaller subsidy pot.
Step away from that steak
There is one other change that will transform farming even more than environmental concerns and subsidy cuts: the trend towards lower meat consumption. As someone who needs at least two steaks a week to function I am not keen, but the vegetarians are largely on the money. Around 70% of the world’s land is habitable. Of this, half is used for agriculture; forests comprise a third and the rest scrub. Built-up land and freshwater lakes and rivers make up only 1% each.
Of the agricultural land, three quarters is used for animals – beef dominating, followed by dairy, with only a fraction for sheep, pigs and poultry. Eating less beef would free up enormous quantities of land twice: there would be less cattle and lower demand for grains. It takes seven pounds of grain to produce one pound of beef. Most other animals are far more efficient converters: pigs 3:1, chickens 2:1 and salmon 1:1.
Expect bargains next year
So is there any money to be made by investing in farming? Yes, but selectively. Overall UK land prices started to slip immediately after the Brexit vote and continue to weaken. The peak for good arable land was around £11,000 per acre in England. Now the price is around £8,500. It gets into value territory below £7,000. Outside England there are two areas where land prices are already low: much of France and central Scotland, where some large parcels are a snip.
One area where I want to buy is woodland, which in no particular order will be a big beneficiary of changing grants, is likely to maintain its highly favourable tax treatment and will be a winner from environmental awareness. One day the government will wake up and notice that wood (including pulp, paper and furniture) is the UK’s sixth-largest import, yet we could be almost self-sufficient. Woodland is also relatively easy to manage, while professional sub-contractors are plentiful. There are also potential sidelines in camping and eco-tourism. Depending on the age (the closer to felling, the higher the price) valuations look appealing and one can expect a yield of around 3%. England looks fine, while Scotland and France offer better value.
The next two years will give us a better idea of the government’s plans, but even the most optimistic outcome will compress land prices further. Many farmers will sell up and leave and one weak harvest would force out more. The bargains should appear as soon as late next year. Buy small (less than 80 hectares), buy mixed and chase the eco-money, including organic. However, don’t buy a listed farm fund; historic returns were bad even in the good times because management charges ate the profits. And don’t buy unlisted agri-funds, you will be shark food. In the box below I look at listed investments in agriculture.
What to buy now
I can find no suitable fund providing broad exposure to agriculture, forestry and environmental improvement. All are either too small, suffer from lacklustre performance, or are too widely diversified. Thus the only option is to invest in listed companies directly. I recommend mostly larger companies that are the best in their class.
In agricultural machinery two stand out. The first is New York-listed Deere & Co (NYSE: DE), which with a market capitalisation of $56bn is the largest listed manufacturer. Offerings range from combine harvesters to forestry equipment. Extra profits stem from machinery add-ons and financing for buyers.
Many farmers tend to be repeat buyers of a trusted brand such as Deere. Its share price has easily beaten the leading US S&P 500 index over the last three and five years.
I prefer (and own) the much smaller ($5bn) competitor AGCO (NYSE: AGCO), even though it has underperformed Deere recently. It is also headquartered in America, but most of its sales (combines, tractors and grain-storage equipment) and production are based in Latin America, eastern Europe and East Asia. Economic problems in some countries (such as Argentina) have held back sales and profits. In most of its markets it’s number one or two.
Local manufacture can be risky, but it means AGCO is also much closer to clients and local governments. Last year earnings per share reached $4.40, giving a historic price/earnings (p/e) ratio of 15 – cheap for the sector. This year profits will be about a fifth lower, but 2021 should see a strong recovery.
In nitrogen fertiliser – it will never be “green”, but many crops won’t grow without it – the standout is America’s CF Industries Holdings (NYSE: CF). This is based both on performance and better management than its competitors. When cereal prices enjoy a cyclical upturn (currently they’re flat), fertiliser firms boom. The stock is at a three-year low, on a trailing p/e of 19 and yields 3.5%.
Viniculture is often ignored, yet is a huge industry. The three largest companies in this subsector are all based in North America, but the fourth – which also produces far better wines – is Australia’s Treasury Wine Estates (Sydney: TWE). A star performer for five years to 2019, it has since fallen dramatically from A$18.50 to A$10.90 because of reduced demand from China, two profit warnings (one Covid-19-related) and some seemingly tendentious legal actions. These will pass; demergers and sales of non-core divisions should herald a recovery.
The UK has few listed agriculture-related companies, but in forestry one stands out: Gresham House (LSE: GHE). Small, with a market cap of only £220m, it was until early last year an “alternative asset manager”, but made a transformational acquisition when it bought Forestry Investment Management. It manages funds in the forestry sector, which now accounts for half of assets under management. In the half year to 30 June these increased by 17%. It’s not cheap, but seems to have the growth mojo.
Jonathan Compton was MD at Bedlam Asset Management and has spent 30 years in fund management, stockbroking and corporate finance.
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