Appetisers from the agri stocks field

Food stocks are suddenly hot and Ridley is underestimated … ALSO good news for Wide Bay Australia.

Listed food and agricultural companies are in vogue, with the sector recording some of the best gains over the past year. But it’s not strong fundamentals and bright outlooks that are driving buying interest in the sector. It’s merger and acquisition activity.

The question now is: who’s next? It feels like every member of the sector would make an appetising target to a foreign predator.

In fact, local food producers attract the most offshore interest of any sector as our industry lacks a listed global leader of any real significance.

But don’t be fooled into thinking that you can make easy money from the sector, as its recent strong performance belies the truth about investing in this part of the market.

The reality is that it’s hard to make any decent returns from this group of stocks, even though they have managed to generate a total return of 56% in the last 12-months.

While few sectors can match that, the 52-week share price volatility of food producers is extreme at 35%. This is even worse than mining stocks on the ASX All Ordinaries Index, as their volatility reading is 27.5%. The irony is that the food industry is supposed to be defensive.

I wouldn’t normally recommend this as investment strategy, but if you are trying to cash in on the sector you should pick stocks for their takeover appeal as much as for their fundamental value.

Don’t get me wrong. Fundamentals should always be the linchpin of any investment decision, but valuations are particularly difficult to work out for this sector because there are just too many moving parts.

Weather, global soft commodity prices and exchange rates are just some of the factors outside management’s control that can bring a food producer to its knees. Trying to forecast these externalities six months in advance is a challenge, and trying to predict beyond a year with any confidence is near impossible.

This is why, to be a successful player in this field and to mitigate risks, a company needs scale and diversification – and this is the key rational for the recent increase in corporate activity in the sector.

The agriculture industry is the third most active over the past year. The sector has attracted $4.8 billion in pending and completed bids, according to data sourced on Bloomberg. The biggest deal over the period is the Archer Daniels Midland $3 billion bid for GrainCorp (GNC) and TPG Capital’s $880 million play for chicken farmer Inghams Enterprises.

The most recent example is the bidding war for Warrnambool Cheese & Butter Factory Company (WCB), with Uncapped 100 member Bega Cheese and Canadian dairy company Saputo slugging it out to win over the target’s shareholders.

There are seven food and agriculture companies on the Uncapped 100, but their investment appeal is clouded by the lack of bargains as they are trading close to or above fair value.

Ridley Corporation (RIC)

If I had to pick one stock on fundamentals and corporate appeal, it would be Ridley Corporation. The animal feed supplier is in the midst of a turnaround and is expected to return to profit in the current financial year after posting a net loss of $21.7 million in 2012-13.

The stock may not be deep in value territory after bouncing 12% since July to around 84 cents, but there is still upside if management can meet consensus estimates of $18.9 million in adjusted net profit for 2013-14.

This would put the stock on a price-earnings multiple of 13.5 times, or a 10% discount to the sector, and the stock would be the second-highest dividend payer of its peers on the Uncapped 100 with a forecast yield of over 5%.

Further, Ridley has been touted as one of the more likely takeover targets in this space, and plans by the Indonesian government to set up cattle farming operations in this country (assuming it gets the necessary approvals) will likely give it more growth options.

I have an “outperform” recommendation on the stock.

Note: Since recommending the stock, Ridley announced that a new case of avian flu is likely to impact on exports of its products, but it cannot quantify the impact as yet.

Tandou Ltd (TAN)

Cotton farming and water rights trading group Tandou (TAN) is another that could see corporate action, as the stock is trading below its net tangible asset value of 56 cents a share.

New Zealand farming investment firm H&G and its related companies (Rural Equities and Ashfield Farm) own close to 18% of Tandou and may eventually make a play for the group.

However, the trigger for corporate action could come from a correction in global cotton prices as that is likely to send the stock falling. Cotton prices are at risk from further import restrictions from China – the world’s largest consumer of the material.

“In general, there is consensus that China’s cotton imports will fall significantly – 65% year-on-year in our view in 2013-14,” Rabobank London-based analyst Tracey Allen writes in an email to Eureka Report.

“Cotton futures [prices] are due for a downward correction if import demand fails to gather pace during [the December quarter] 2013.”

If the drop in futures prices does not stimulate demand, cotton prices may slip much lower than her current forecast, which predicts around a 5% slide in the cotton price to US80 cents a pound by mid next year.

Tandou can offset the earnings volatility through water trading, which helped the company deliver a 34% increase in revenue to $65.7 million and a 16% uplift in net profit to $6 million in 2012-13.

Management has not given guidance for the current financial year, but I believe they will give an update at its annual general meeting (AGM) on October 31.

I like the stock for the good reputation of its management team, under chief executive Guy Kingwill, and its undemanding valuation. Those with a stronger stomach for risk can buy the stock, but I think it is prudent to wait to hear what guidance Kingwill will give at the company’s AGM before urging investors to buy. I have a “neutral” recommendation on Tandou for now.


Wide Bay Australia

It’s time to get more bullish on Wide Bay Australia (WBB). There are more signs that the Queensland housing market is on the mend since I wrote about the company on September 11 with a “neutral” recommendation.

The Bank of Queensland results and comments from GWA’s chief executive Peter Crowley at the RBS Morgans Queensland conference is giving me greater confidence that the mortgage lender is close to getting re-rated by the market.

Crowley had described the Queensland housing market as being “dead as a Dodo” a year ago, according to RBS Morgans, but this week he was the most upbeat the broker had seen him in a decade.

As I mentioned in my earlier article, the share price catalyst will come from the release of bad debt provisioning in 2013-14. I think the $5.4 million the company has set aside is too conservative. 

If the outlook for the state’s housing market has improved materially over the past six to 12 months, consensus estimates on Wide Bay’s net profit could be upgraded by as much as 20% plus.

This will feed through to higher dividends, as Wide Bay aims to pay out between 70% and 80% of profits as dividends. The 2013-14 expected yield for the stock is 7.3% once franking credits are included.

Even without a profit upgrade, the stock’s valuation looks relatively undemanding as its price to book value is hovering around one times when its peers, such as MyState (MYS), fetches 1.5 times.

Further, there is growing corporate interest in the sector as highlighted by Tom Elliott’s article in Eureka Report today.

These factors will likely push Wide Bay higher in the next few months and  I am upgrading the stock to “outperform” from “neutral”.

Think big, go smalls!


The Uncapped 100 is a basket of ‘small capitalisation’ stocks constantly monitored by Eureka Report. The list represents the ‘universe’ of 100 stocks from which we regularly make recommendations that may take the form of ‘outperform’, ‘neutral’ or ‘underperform’. At Eureka Report we recommend private investors active in the ‘small cap’ market might hold six to 12 individual ‘small cap’ stocks  to create ample diversification . In turn the allocation to small caps in a balanced portfolio should reflect your risk tolerance and should be balanced by holdings in other asset classes such as blue chip shares, fixed interest products, property and cash.

Uncapped 100 - Australia's most interesting small cap stocks

Small cap stocks covered by the Uncapped team
CodeNameRationaleMarket cap ($m)Total return 1-year (%)Sector (GICS)
MTU M2 Telecommunications Group Amazing growth story and well run company. High free float and strong insto support.1,063.4163.44Telecommunication Services
GEM G8 Education Only listed childcare operator. Acquisition strategy paying off with stock delivering solid gains.972.98145.98Consumer Discretionary
NHF NIB Holdings /AustraliaOnly listed health insurer. Widely held. Good performer.961.4228.02Financials
ARP ARB Corp Well covered but good candidate for core holding due to quality management.874.8520.62Consumer Discretionary
MMS McMillan Shakespeare One of the best performers since the GFC, but ongoing risk of change to FBT rules is hanging over the company.851.06-10.89Industrials
MRM Mermaid Marine Australia Its strategically located facility on WA coast gives it a key advantage over competition in servicing Gorgon & Pluto projects.849.1824.4Industrials
AAD Ardent Leisure GroupWidely held stock. Earnings more defensive than anticipated. Good yield. Potential core holding.769.4949.09Consumer Discretionary
SRX Sirtex Medical A shining star in the biotech space and one of the best performing stocks in 2012. Great product (liver cancer treatment) and bright outlook.684.2423.34Health Care
AUB Austbrokers Holdings The insurance broker is a strong performer. Widely held and well liked by small cap investors.681.2059.18Financials
BDR Beadell Resources Will be a very big FY14 for miner as it has to prove it aims to produce 200,000 ounces of gold a year.668.00-10.58Materials
SGN STW Communications Group One of few companies able to benefit from online shift. Widely held and good insto support.650.1672.78Consumer Discretionary
BGA Bega Cheese Corporate interest in Australian food companies makes the cheese maker worth following.586.20121.43Consumer Staples
RFG Retail Food Group Owns a number of well know franchise brands. Widely followed by instos.560.3048.81Consumer Discretionary
CWP Cedar Woods Properties Property developer with good ROE and earnings growth track record.535.5283.2Financials
ACR Acrux One of the most successful Australian biotechs in recent history. Widely held by instos.510.39-13.05Health Care
CCV Cash Converters International Strong performance is attracting investors. It's Australia's only listed pawn shop and pay day lender.509.6852.61Consumer Discretionary
BRU Buru Energy Substantial size but not often covered by press. Widely held with good insto support.490.81-44.24Energy
NXT NEXTDC The cloud computing company is an IT sector darling. Fairly widely held and followed.479.4121.39Telecommunication Services
RCR RCR Tomlinson Good first half FY13 result and outlook, but will its fortunes change this year with the mining capex slowdown?472.9797.52Industrials
AMM Amcom Telecommunications Well covered junior telco but good candidate for core holding.468.3346.04Telecommunication Services
TGR Tassal Group Salmon farmer is finally turning a corner with an improved harvest strategy and growing demand for product.461.50138.23Consumer Staples
SEA Sundance Energy Australia Analysts have a favourable take on the oil & gas explorer, but stock is still under radar of most. Sundance provides exposure to prospective Eagle Ford shale.457.9940.43Energy
HZN Horizon Oil One of better regarded small energy stocks that doesn't receive much media attention.442.39-8.09Energy
CCP Credit Corp Group Strong price run attracted good investor interest. Leveraged to any rise in loan defaults. Not well covered by press.429.9545.28Industrials
TOX Tox Free Solutions Widely held stock in the waste solutions business. Its unique because it operates in a defensive-growth niche.429.3618.4Industrials
FGE Forge Group One of the better performers in its industry. Good track record and potential core holding.426.5428.68Industrials
MYS MyState Well regarded and could make good alternative to bank stocks. Has good yield and earnings growth over past few years.407.5543.08Financials
SLX Silex Systems Its uranium enrichment technology could become one of Australia's best innovations given its potential to change the nuclear power industry.405.20-33.52Information Technology
MYX Mayne Pharma Group Sizeable generic drug maker with interesting board members.397.24220.45Health Care
NWH NRW Holdings One of the better regarded mining & civil contractors with good track record in delivering on projects.375.80-24.1Industrials
TGA Thorn Group One of few retail stocks that is performing well. The Radio Rentals chain owner is also well supported by instos.355.8630.17Consumer Discretionary
MOC Mortgage Choice Has a good track record and is leveraged to any housing recovery. The stock is also liquid with good insto support.355.4874.43Financials
BNO Bionomics One of the larger cancer treatment developers in this market.346.12159.98Health Care
UXC UXC Company has turned corner and enjoyed re-rating. What's next?338.4926.78Information Technology
IPP iProperty Group Worth watching as it is trying to be the REA Group of Asia.337.40102.17Information Technology
GID GI Dynamics IncLargely forgotten by investors but could attract attention this year as it looks to gain US approval to use its intestinal liner on diabetics.317.8329.37Health Care
RKN Reckon Fierce competition for cloud base accounting software puts it in firing line.301.041.63Information Technology
NWT Newsat Potential large cap if it can launch its own satellite in 2015.278.32-4.9Telecommunication Services
AEU Australian Education TrustWell performing childcare centre property owner. Good yield story and outlook. 276.3640.42Financials
RIC Ridley Corp High corporate interest in the sector and the shrinking pool of agri listed stocks make Ridley worth following.261.64-17.72Consumer Staples
GXL Greencross Acquisitive veterinary group. Good profit growth and share price performance, but gets little press.261.62145.28Health Care
IMF IMF Australia Litigation funder is unique stock. Stock not liquid but its outlook appears promising given the number of potential class action lawsuits.254.3322.98Financials
MXI MaxiTRANS Industries Transport equipment maker posted good interim result. Has appealing yield and growth.253.9162.78Industrials
SIV Silver Chef Strong jump in the share price of the equipment financing group has attracted a good following.251.98101.2Industrials
SPL Starpharma Holdings Noteworthy for its good pipeline of innovations. Well run, widely followed.250.07-38.25Health Care
SHV Select Harvests Noteworthy for turbulent past and exposure to soft commodity market.240.77267.69Consumer Staples
TGS Tiger Resources Future lies in its Kipoi copper mine expansion in the Congo but miner is fully funded with DRC govt holding 40% stake in tenement. Next 12mths will be interesting.239.549.23Materials
AJA Astro Japan Property GroupStrong leverage to Japanese economy makes this an interesting stock to watch.233.9021.32Financials
TFC TFS Corp The sandalwood products company offers exposure to both the agri and cosmetics industry. It will start commercial harvest this year.219.50109.12Materials
CLH Collection House In similar space as Credit Corp. Strong stock performance has attracted a following and the stock appears to be well placed to run further214.6576.54Industrials
VOC Vocus Communications Telecom stocks are in favour but Vocus is one of the least covered209.8745.68Telecommunication Services
ACL Alchemia /AustraliaOne of the few biotechs with revenue stream. Good pipeline of oncology treatments.207.585.79Health Care
DWS DWS Will be a big beneficiary if governments start spending on IT again.206.494.7Information Technology
NAN Nanosonics A successful medical tech story. Should be close to turning in maiden profit with its disinfection device.205.0056Health Care
WBB Wide Bay Australia The building society is trying to turn its fortunes around. Also worth watching for its exposure to Queensland housing market, particularly around major resource projects.202.57-14.07Financials
IFM Infomedia Interesting tech play in the car parts market. Strong share price gain but gets little air play.184.5094.07Information Technology
DTL Data#3 Well respected IT company that receives little press coverage.183.239.94Information Technology
PFL Patties Foods Illiquid stock but has suite of well recognised consumer brands. Defensive yield.182.87-16.27Consumer Staples
SFH Specialty Fashion Group In early stages of turnaround. Can the women's apparel retailer sustain the momentum?176.8680.65Consumer Discretionary
RCG RCG Corp The footwear retailer is one of the best performing consumer stocks as online competition is not a big threat. Company has a good yield as well.176.2678.31Consumer Discretionary
HSN Hansen Technologies Operates in a high potential/growth industry but is not covered by press or brokers.170.2129.65Information Technology
IMD Imdex Drilling company is well supported by instos and should benefit from any rebound in exploration activity.161.01-45.52Materials
CKF Collins Foods One of the few food franchise listed companies.160.4362.01Consumer Discretionary
NEA Nearmap A stellar performer with an Interesting business that offers high quality aerial maps to companies & government.160.06#N/A N/AInformation Technology
MNW Mint Wireless Huge market potential if the mobile card payment solutions provider can gain market traction. Management aiming for $1 billion in transaction value a year.149.432366.67Information Technology
BGL BigAir Group The wireless microcap has gained strong following over past year or two but is often overlooked by investors and the press.138.4547.46Telecommunication Services
LCM LogiCamms Strong price performance and reasonable valuation attracting interest.134.8884.23Industrials
SAR Saracen Mineral Holdings Emerging gold producer that is widely held by instos. Hitting milestones and looks cheap. Key asset is close to gold majors, which makes it a potential takeover target.133.93-54.55Materials
MLB Melbourne IT A perennial underperformer could be interesting turnaround story as management is in midst of restructuring the business.132.571.34Information Technology
AZZ Antares Energy Liquid with good insto support. Already in production with exploration upside in Texas.128.77-10.62Energy
ESV Eservglobal Mobile money transfer company that has been gaining traction. Widely held by instos but low press coverage124.52185.71Information Technology
MCP McPherson's The personal care and household products supplier had been relatively insulated from volatile discretionary spend and online threat, but its latest profit warning shows it's not immune.122.11-14.37Consumer Discretionary
GHC Generation Healthcare REITOne of the more interesting REITs. Income is more defensive than typical property stock and its greenfield expansion gives it earnings growth potential.115.3630Financials
WDS WDS Widely held with strong insto support. Engineering contractor diversified across mining, energy and infrastructure.115.0737.6Industrials
REX Regional Express Holdings Well run airline that is overshadowed by Virgin and Qantas.112.29-13.56Industrials
AMA AMA Group Good turnaround story but under the automotive services group is radar of most.111.3045.96Consumer Discretionary
UBI Universal Biosensors IncWell regarded biotech and one of few that's successfully manufacturing in Australia. Struck deal with a few global medical companies.108.25-31.11Health Care
JIN Jumbo Interactive Innovative small cap facing off industry dominated by giants. Worth watching to see if it can carve out a profitable global business.104.5371.24Consumer Discretionary
POH Phosphagenics Sizable biotech with a game changing FY14 year ahead. Good insto following but questions of poor audit and governance standard could dog company.97.96-16.52Health Care
CAA Capral An aluminium manufacturer that is actually holding up relatively well given that manufacturing is on the nose. 87.380Materials
DRM Doray Minerals Widely held by instos. One of the more favoured gold explorers by brokers.86.54-27.81Materials
RUL RungePincockMinarco IT company to resource industry. Facing tough operating climate with new CEO trying to restructure and turnaround company.81.9831.82Industrials
BOL Boom Logistics Crane hire group is riding out the downturn in construction.  It's widely held by instos and is very liquid.80.00-42.37Industrials
CLV Clover Corp One of the star performers in 2012. Operates in growing but relatively stable niche.79.29-1.02Health Care
YTC YTC Resources Next 12-mths will be eventful after YTC secured funding for its projects from Glencore.75.020Materials
AOH Altona Mining Noteworthy copper play with Xstrata pull-out of Roseby project in Australia and the good ramp up of its Finnish project.74.51-47.17Materials
PEN Peninsula Energy Widely held by instos and large free float. It's the only uranium miner on the list.74.01-7.41Energy
LGD Legend Corp Electronic parts supplier to utilities and other industries. Stable earnings with good yield. Often overlooked.72.44-0.75Information Technology
TAN  Tandou The only direct equity exposure to cotton prices. Also trades water rights and receives little press.69.4312.57Consumer Staples
CKL Colorpak The small cap packaging company has grown via acquisitions over past few years.68.9063.97Materials
OTH Onthehouse Holdings Alternative small cap to online property leader REA Group. It is trying to use more timely housing data as a competitive edge against REA.65.7444.12Consumer Discretionary
CUV Clinuvel Pharmaceuticals Interesting skin disorder treatment developer that has done reasonably well over past year57.52-6.52Health Care
EML Emerchants Trying to change way corporates and governments disburse cash with its trackable and controllable debit card offering. If company can get $1 billion in loaded value on cards, the stock will surge.57.35736.36Financials
GXY Galaxy Resources Good upside potential if it can get its problem-prone Jiangsu plant back on track. Won't be easy to right this ship.56.42-85.03Materials
TSM ThinkSmart Potential turnaround story worth keeping eye on.55.1830.77Financials
EBT eBet Potential alternative to star performer Ainsworth Tech. Has exclusive deal with US poker machine maker WMS.47.81163.87Consumer Discretionary
KOV Korvest The construction products and services supplier has been hit by project delays and deferrals. But its relatively high yield could give it some support.47.25-8.69Industrials
UML Unity Mining Growing Tassie gold producer with high free float. Valuation looks compelling too.43.52-48.33Materials
NTC NetComm Wireless Under appreciated small IT hardware maker that is punching above its weight. Hardly covered by press.32.1792.31Information Technology
PGC Paragon Care Emerging hospital equipment supplier that has been ignored by market.17.76147.88Health Care
Source: Eureka Report, Bloomberg