Is the dining boom overcooked?

Despite talk of Australia moving from a mining boom to a dining boom, PE ratios look high and investors know how booms end.

Summary: Despite the talk of Australia switching from a mining boom to a dining boom, everyone knows how booms end – badly. Some food stocks are trading on boom-time share prices, with price-earnings ratios substantially higher than the market average.

Key take-out: There is an excellent opportunity for Australia to sell more food and fibre to Asia. But the story can become embellished and some companies will do better than others, so take care.

Key beneficiaries: General investors. Category: Commodities.

An overcooked meal can be quite disappointing, but it’s unlikely to damage your investment portfolio in the same way as buying into the flavour of the month, stock-exchange listed food producers, some with share prices that look severely overcooked.

Talk of Australia flipping from “a mining boom to a dining boom” is everywhere in the media these days, even attracting the attention of international visitors such as the former Indonesian president, Susilo Bambang Yudhoyono (or SBY as he is commonly known).

Speaking at the University of WA yesterday, where he received an honorary doctorate, SBY said Australia was well placed to supply essential food to fast-growing Asian countries, nominating grain and meat which are not typically grown in his homeland.

Publicists at UWA seized on SBY’s words, using virtually the same headline announcing his comments as that from a story in yesterday’s edition of The Australian newspaper about Australia shifting focus from mining to dining.

The snappy headlines are partially correct: exports of food and fibre to Asia are on the rise. But the headlines can also mislead which is why investors should consider these four important points:

  • Everyone knows how booms end – badly.

  • Companies exposed to agriculture carry the risks of seasonal fluctuation (drought and floods, to mention two).

  • Barriers to entering most forms of food production are lower – as seen in previous agricultural busts such as when Australia produced too much wool, grapes and trees, gluts which cost investors (and farmers) dearly.

  • Some food stocks already have boom-time share prices, as shown by looking at one of the most important measures of a company’s financial performance, its price-to-earnings (PE) ratio.

A starting point for a PE analysis is the average for companies listed on the Australian stock market which is currently about 14.8 times – with that number derived from dividing the share price by the most recent earnings per share.

Commonwealth Bank, for example, has a PE slightly below the average at 14.2, and a forward PE (based on forecast profits for the next 12 months) of 14.08, still close to the average. Woolworths, a leading retailer, has an historic and a forward PE of 12.5.

Bega Cheese, however, has an historic PE of 56, and a forward PE of 43, according to an analysis of the company’s fundamentals by the stockbroking firm, JBWere.

There are a number of reasons for Bega having a PE which is 200 per cent higher than the stock-exchange average, such as booming cheese sales. But it’s also hard to avoid the conclusion that Bega’s share price has moved ahead of its earnings – not that this story contains investment advice; that’s a matter for you and your professional adviser.

However, a forward PE of 43 indicates that the market believes Bega’s earnings will rise strongly, or it could indicate that the company’s share price is already too high, a view shared by at least one stockbroking firm, Morgans, which has a hold on the cheese maker and a 12-month price tip of $4.30, 5 per cent below where it is today.

High PE ratios can be found across the spectrum of listed agricultural stocks, just as low PE ratios can be found among mining and oil stocks as the resource sector investor-sentiment pendulum has swung from boom to bust.

Examples of modest PE ratios in the mining sector include Rio Tinto’s historic 8.3 and a forward PE of 12.1.

Among the food stocks the numbers tell the story of an expected boom in future earnings, or a share-price bust in the making, with ratios such as:

  • Australian Agricultural Company, a big beef producer, with an historic (and forward) PE of 70.

  • Bellamy’s Australia, a maker of organic baby food, with an historic PE of 79 and forward PE of 64.

  • Treasury Wine, historic PE of 48 and forward PE of 40.

  • Webster, a walnut producer, historic PE of 20 and forward PE of 23.

  • Capilano Honey, historic and forward PE of 24.

A number of food stocks have PE ratios closer to the ASX average, or are below the average.

  • Huon Aquaculture, a fish farmer, historic and forward PE of 17.

  • Warrnambool Cheese, historic and forward PE of 10.

  • Elders, largely exposed to wool, historic PE of 14 and forward PE of 9.5, and

What this exercise in PE comparisons shows is that some high profile food companies which are seen to be at the cutting edge of a boom in Australian agricultural exports to Asia have share prices which might have run ahead of reality.

Capilano Honey, for example, has a fabulous story to tell about honey sales to China which could rise substantially when/if Australia ratifies a free trade agreement with that country.

However, Capilano’s share price has rocketed ahead of the FTA ratification, rising by 300 per cent over the past 12 months from a low of $5.75 to recent sales at $23.05, a price which values the stock at $200 million, and which is $4.20 above the price tip of $18.85 put on the stock by Morgans five weeks ago.

There is unquestionably an excellent opportunity for Australia to sell more food and fibre to Asia. Demand is strong. Incomes in Asia are rising. Appetites are adapting to western food. Australian farmers have the capacity and a cheaper dollar is providing a currency boost.

But as always happens in every boom, the story can become embellished. Some companies will do better than others. Some share prices get ahead of the earnings required to support them. All of those points are reasons to take care when thinking about entering the dining boom.