Yields key when it comes to agriculture sector

IT'S one thing to be sure that rising food insecurity will push up farm and food prices. It's another to identify compelling food plays on our stock exchange.

IT'S one thing to be sure that rising food insecurity will push up farm and food prices. It's another to identify compelling food plays on our stock exchange.

Australia's farm sector is highly fragmented with many small or family operators, while larger enterprises are often either privately or foreign-owned after a wave of consolidation.

Listed agriculture stocks such as AACo and Elders are just recovering from the legacy of the millennium drought, when cash flow slumped and borrowings accumulated, compounded by the financial crisis, which hit anyone with high debt levels especially hard.

Branded food makers such as Goodman Fielder are suffering from the supermarket wars, as discounting and house brands eat away at sales and profitability. Food retailers such as Collins Foods are battling soft consumer sentiment.

The macro view, says Brisbane-based analyst at RBS Morgans, Belinda Moore, "is very supportive of soft commodity prices over the next decade-plus, driven by demand for the four Fs: food, feed, fibre and fuel".

A key question, according to Wilson HTM's James Ferrier, is whether supply can keep up with growth in demand. "Yields need to increase, through improved or increased use of fertiliser, agricultural chemicals, seed technology, or farming practices." Hence his pick for the agriculture and food sector is Nufarm, maker and distributor of pesticides, herbicides and fungicides, including Roundup.

For decades Nufarm was a high-growth stock and darling of the local sharemarket, says Mr Ferrier, "a small company that grew rapidly, expanded globally and had huge success".

It fell out of favour from 2008 after Chinese competition burst the bubble in glyphosate and earnings downgrades put it at risk of breaching debt covenants, resulting in a collapsing share price. A shareholder class action was run jointly by lawyers Maurice Blackburn Cashman and Slater & Gordon, with preliminary hearings set for March.

Managing director Doug Rathbone, who joined Nufarm in 1973 and has been at the helm since 1999, sparked controversy in 2010 when he sold down his stake. Between 2008 and 2010 Nufarm shares fell from above $16 to below $4.

Mr Ferrier is standing by Nufarm and Mr Rathbone: "I think they suffered from some very tough industry conditions, but we're backing them to continue what has now been more than 12 months of very attractive earnings recovery."

Mr Ferrier is not alone: brokers including Macquarie and Credit Suisse also have buys on the stock, but Ms Moore downgraded Nufarm to a hold after the annual meeting in November, when profit guidance for 2011-12 was a little softer than she expected. "We continue to see Nufarm as a turnaround story," she wrote in December, noting the company had successfully refinanced $625 million in debts and endorsing the $US55 million purchase of American sunflower seed producer Seeds 2000.

But she noted Nufarm's share price had recovered, and was trading in line with its historical price-earnings ratio of 13 times. "We think they're doing a good job in terms of turning the company around and making necessary changes," Ms Moore says this week, "but they've had a decent ride."

Among the producers, Mr Ferrier likes Tandou (for its water entitlements in the Murray-Darling Basin) while Ms Moore likes Graincorp (she is tipping a surprise on guidance for 2011-12 when the company reports this month). Of the service providers, both favour Ruralco, which has grabbed substantial market share from larger rival Elders.

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