Agribusiness short-changed by a well fed sharemarket
GrainCorp holds a near monopoly of grain handling along the eastern seaboard. Photo: Steve Hynes
FOLLOWING news that US agribusiness behemoth Archer Daniels Midland had acquired a 14.9 per cent stake in GrainCorp and put an indicative bid of $11.75 a share to the board, investors decided that GrainCorp was actually worth well north of $12 a share rather than the $8.85 they were willing to accept prior to the approach.
GrainCorp's board has now lent its considerable weight to that position, having advised ADM that its offer materially undervalues the company.
In fact, the ADM offer is 50¢ a share higher than GrainCorp's previous adjusted all-time high of $11.25, set in 2005.
Why does the Australian market consistently undervalue agribusinesses, many of which trade well below net asset values, relative to our international peers? Perhaps Australian investors have been among the food ''haves'' for so long that we do not appreciate the intrinsic value of food security or the value of controlling the food chain.
Perhaps we've been jaded by a drought-afflicted decade in which Australian agribusinesses have delivered total shareholder returns of less than 5 per cent a year.
While we expect each of these reasons has some bearing on valuations we believe that valuation models used by Australian investors still look at agribusinesses relative to a broad ''industrials'' investment basket and not as a unique investment class.
When domestic investors are estimating their required rate of return they would typically take into account the 10-year government bond yield, which averaged 4.8 per cent over the past three years and currently sits at 3.1 per cent, and add a risk premium.
In the US, 10-year Treasuries have offered just 2 per cent over the past three years and currently offer a yield of 1.6 per cent. Thus the base risk-free rate on which a risk premium is added in the US is about half ours. And required returns for US companies are further advantaged by lower borrowing costs. Monsanto, another US agribusiness titan, offered its 10-year debt to investors at just 2.2 per cent in July.
Assuming a US corporate does not place a significantly higher risk premium on Australian assets than domestic investors, it would clearly have the capacity to place a higher valuation on Australian agricultural businesses.
An agri-banker I spoke to recently noted that prices achieved in some recent foreign purchases of Australian agribusiness assets were indicative of annual returns on investment of just 3-4 per cent, though cheap finance should result in higher returns on equity.
The relatively high required rates of return applied by Australian investors rarely reflect the underlying value of land, infrastructure and stock, let alone intangible agricultural assets (water permits, export licences), the arguably perpetual nature of many of these assets and the intangible value of control of the food chain.
This disconnect is most striking among listed agribusinesses with direct exposure to primary production. Shares in listed agribusinesses including Australian Agricultural Co (beef), PrimeAg (cotton/grains), Tassal (salmon), Select Harvests (almonds) and Tandou (cotton/grains) trade at an average 27 per cent discount to net assets less goodwill.
So does the ADM offer send a signal that it is time to start valuing Australia's listed agribusinesses in a manner that more closely reflects the global market in which they operate?
I believe so. We are living in a region that the Asian Development Bank estimates will create a million middle-income earners every week for the next 20 years. Australian producers won't be able to feed all of these new consumers, but have been adept at focusing their operations on high-value produce of very high quality.
In the context of 1 billion new middle-income earners seeking higher-quality produce, we need to better balance the benefit of a short-term, one-off windfall against the long-term loss of the value of controlling the food chain.
A week after ADM's approach to GrainCorp, Elders Rural Services went on the market. This week Elders said it had received calls from 30 interested parties to date, split evenly between local and international suitors.
Australian investors are competing in a global market for finite assets.
Chris Gibson is an analyst at Investorfirst Securities.