PORTFOLIO POINT: Amidst all the gloom in some sectors, Australian agricultural stocks are likely to shine thanks to plentiful winter rains. Plus SMSFs can benefit from rising bank term deposit rates.
It was a week where bad news tended to seep up from under the carpet.
The market clearly doubts whether the Germans will actually give their wealth away and is realising that the world faces tough economic times, whether IT be in Europe, US or China. My guess is that in the next month or two we will see more stimulation, which will rally markets but will not remove the underlying problems.
But, for me, this week there were a few items of good news that I would like to share with you. The first was that self-managed funds have achieved a significant victory in the Australian banking term deposit market. And, the second, was that I think I have isolated a sector that is going to do well, but I had difficulty finding a company that would really benefit. And then I found one, but more of that later.
Here at Eureka we have been warning the Australian banks that if they lowered interest rates below 5% then term deposits would no longer be attractive to self-managed funds looking to make long-term interest bearing security investments.
While there was obviously no problems with lower interest rates for money that has been set aside for other purposes – such as later equity investment – 'sticky’ deposits require better returns. Australian banks are very nervous that the euro will split because, if it does, their wholesale deposits, which are obtained from overseas, will almost certainly dry up.
Nevertheless they have been punting and sending term deposit rates down sharply, which has affected the fortunes of a great many self-managed funds. Now, UBank, the internet banking arm of the National Australia Bank, suddenly raised its shorter-term deposit rates to around 5.3%. They had previously been a touch above 5%. It wasn’t a big rise, but it was a significant one because it showed that there was concern in the banking community that they would lose their prime pole position in attracting long-term self-managed fund term deposits.
I know in my own situation I am simply not prepared to invest longer-term securities in term deposits that yield less than 5%. I have taken out some 5.7% five-year Rabo deposits.
I have also been exploring the corporate bond market and I will tell you more about that next week. However, with safety there are securities around that yield around 6%. Increasingly that is where the money is going to go if the banks play hard ball with long-term depositors.
The second piece of good news comes is I looked around the Australian scene for non-mining areas that might have strong economic activity despite the problems we have got in manufacturing, construction and many service industries.
What hit me was the looming big returns from the agricultural sector, particularly the grain area. The Russian crop is not looking good. European producers are finding it hard to fund their operations given that so many European banks are bankrupt. It is early days but the US is looking very dry and this may very well affect crop yields.
Meanwhile, most wheat areas in Australia have had good rains. The ground is moist and ready to produce some fantastic crops. Naturally we may end up with too much rain and there may be other problems, but at this stage we are looking at a bumper harvest at a time when other countries are struggling. That means a cash bonanza in the rural sector is a real chance, but of course not a certainty.
But it is no longer easy to find stocks that will benefit from an upturn of that sort. The tragedy is that so many of our rural stocks, including AWB, have been taken over and Australians no longer get the benefit.
When you look at the rural sector your first inclination is to buy Elders shares but of course, as we all know, Elders is struggling and although CEO Malcolm Jackman has done a first-class job saving the company from what looked like certain death, he is not out of the woods yet.
Buried in my portfolio is a very small holding in Elders hybrid stock, which I foolishly purchased many years ago. In my own mind I have written it off, but for those who want to punt the rural sector it is not a bad option because the hybrids are selling at under $40 and they will have a very large yield if Elders can ever get itself back on dividends.
A solid stock is, of course, GrainCorp, which handles large portions of the Australian wheat crop. It is a smaller company amongst the majors but it specialises in high-grade and other specialty wheat and therefore has carved itself a really worthwhile niche in the market. It will be an important beneficiary.
But the stock that really caught my eye was a company called Ruralco. What surprised me about Ruralco was that revenue in the past four years has been growing at above 9% annually. Moreover, underlining EBIT has grown by 40% over the same period, which directors say demonstrates the successful way Ruralco has been able to grow the margins of the business and attempt to find the most effective way to generate returns on capital employed.
The group paid dividends last year of 18 cents a share fully-franked, which provides a yield above 6% on the current share price of $3.05. Earnings per share last year were 27.2 cents, which gives the company a P/E of just over 11 times. In the first half of the current financial year earnings were actually down fractionally, but any boom in grain trading will obviously benefit 2013 returns more than 2012 returns.
The wonderful thing about Ruralco is that it has been reducing its debt, which is now at very modest levels, so that it is very well placed to benefit from an upturn but doesn’t have the baggage of an Elders.
The key to investing in the coming years is going to be finding companies that can transverse economic fluctuations and really know their business. And, of course, Ruralco has taken a rather aggressive step and bought 10% of Elders. The two companies are in very similar base businesses and clearly the Tasmanian-based Ruralco is pondering whether to buy control of the struggling giant or simply to have a seat at the table if there is a raid on Elders. My guess is that Ruralco or any Elders raider would want to sell Elders’ automotive parts business and other areas of its operation that might be distractions.
The difficulty anyone has in trying to buy Elders is the $150 million in hybrids. Elders hybrids have a nominal value of $100, compared with a market price of $35.
Anyone who buys control of Elders equity has to take into account the hybrids. Ruralco’s dabble in Elders adds a greater degree of risk to the stock, but the Ruralco management looks unlikely to allow size to go to their heads.