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 $5.4 million the company has set aside is too conservative.
If the outlook for the state’s housing market has improved materially over the past six to 12 months, consensus estimates on Wide Bay’s net profit could be upgraded by as much as 20% plus.
This will feed through to higher dividends, as Wide Bay aims to pay out between 70% and 80% of profits as dividends. The 2013-14 expected yield for the stock is 7.3% once franking credits are included.
Even without a profit upgrade, the stock’s valuation looks relatively undemanding as its price to book value is hovering around one times when its peers, such as MyState (MYS), fetches 1.5 times.
Further, there is growing corporate interest in the sector as highlighted by Tom Elliott’s article in Eureka Report today.
These factors will likely push Wide Bay higher in the next few months and I am upgrading the stock to “outperform” from “neutral”.
Think big, go smalls!
The Uncapped 100 is a basket of ‘small capitalisation’ stocks constantly monitored by Eureka Report. The list represents the ‘universe’ of 100 stocks from which we regularly make recommendations that may take the form of ‘outperform’, ‘neutral’ or ‘underperform’. At Eureka Report we recommend private investors active in the ‘small cap’ market might hold six to 12 individual ‘small cap’ stocks to create ample diversification . In turn the allocation to small caps in a balanced portfolio should reflect your risk tolerance and should be balanced by holdings in other asset classes such as blue chip shares, fixed interest products, property and cash.
Uncapped 100 - Australia's most interesting small cap stocks
|Small cap stocks covered by the Uncapped team|
|Code||Name||Rationale||Market cap ($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.||1,063.41||63.44||Telecommunication Services|
|GEM||G8 Education||Only listed childcare operator. Acquisition strategy paying off with stock delivering solid gains.||972.98||145.98||Consumer Discretionary|
|NHF||NIB Holdings /Australia||Only listed health insurer. Widely held. Good performer.||961.42||28.02||Financials|
|ARP||ARB Corp||Well covered but good candidate for core holding due to quality management.||874.85||20.62||Consumer 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||-10.89||Industrials|
|MRM||Mermaid Marine Australia||Its strategically located facility on WA coast gives it a key advantage over competition in servicing Gorgon & Pluto projects.||849.18||24.4||Industrials|
|AAD||Ardent Leisure Group||Widely held stock. Earnings more defensive than anticipated. Good yield. Potential core holding.||769.49||49.09||Consumer 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.||684.24||23.34||Health Care|
|AUB||Austbrokers Holdings||The insurance broker is a strong performer. Widely held and well liked by small cap investors.||681.20||59.18||Financials|
|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||-10.58||Materials|
|SGN||STW Communications Group||One of few companies able to benefit from online shift. Widely held and good insto support.||650.16||72.78||Consumer Discretionary|
|BGA||Bega Cheese||Corporate interest in Australian food companies makes the cheese maker worth following.||586.20||121.43||Consumer Staples|
|RFG||Retail Food Group||Owns a number of well know franchise brands. Widely followed by instos.||560.30||48.81||Consumer Discretionary|
|CWP||Cedar Woods Properties||Property developer with good ROE and earnings growth track record.||535.52||83.2||Financials|
|ACR||Acrux||One of the most successful Australian biotechs in recent history. Widely held by instos.||510.39||-13.05||Health Care|
|CCV||Cash Converters International||Strong performance is attracting investors. It's Australia's only listed pawn shop and pay day lender.||509.68||52.61||Consumer Discretionary|
|BRU||Buru Energy||Substantial size but not often covered by press. Widely held with good insto support.||490.81||-44.24||Energy|
|NXT||NEXTDC||The cloud computing company is an IT sector darling. Fairly widely held and followed.||479.41||21.39||Telecommunication Services|
|RCR||RCR Tomlinson||Good first half FY13 result and outlook, but will its fortunes change this year with the mining capex slowdown?||472.97||97.52||Industrials|
|AMM||Amcom Telecommunications||Well covered junior telco but good candidate for core holding.||468.33||46.04||Telecommunication Services|
|TGR||Tassal Group||Salmon farmer is finally turning a corner with an improved harvest strategy and growing demand for product.||461.50||138.23||Consumer 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.||457.99||40.43||Energy|
|HZN||Horizon Oil||One of better regarded small energy stocks that doesn't receive much media attention.||442.39||-8.09||Energy|
|CCP||Credit Corp Group||Strong price run attracted good investor interest. Leveraged to any rise in loan defaults. Not well covered by press.||429.95||45.28||Industrials|
|TOX||Tox Free Solutions||Widely held stock in the waste solutions business. Its unique because it operates in a defensive-growth niche.||429.36||18.4||Industrials|
|FGE||Forge Group||One of the better performers in its industry. Good track record and potential core holding.||426.54||28.68||Industrials|
|MYS||MyState||Well regarded and could make good alternative to bank stocks. Has good yield and earnings growth over past few years.||407.55||43.08||Financials|
|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||-33.52||Information Technology|
|MYX||Mayne Pharma Group||Sizeable generic drug maker with interesting board members.||397.24||220.45||Health Care|
|NWH||NRW Holdings||One of the better regarded mining & civil contractors with good track record in delivering on projects.||375.80||-24.1||Industrials|
|TGA||Thorn Group||One of few retail stocks that is performing well. The Radio Rentals chain owner is also well supported by instos.||355.86||30.17||Consumer 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.||355.48||74.43||Financials|
|BNO||Bionomics||One of the larger cancer treatment developers in this market.||346.12||159.98||Health Care|
|UXC||UXC||Company has turned corner and enjoyed re-rating. What's next?||338.49||26.78||Information Technology|
|IPP||iProperty Group||Worth watching as it is trying to be the REA Group of Asia.||337.40||102.17||Information Technology|
|GID||GI Dynamics Inc||Largely forgotten by investors but could attract attention this year as it looks to gain US approval to use its intestinal liner on diabetics.||317.83||29.37||Health Care|
|RKN||Reckon||Fierce competition for cloud base accounting software puts it in firing line.||301.04||1.63||Information Technology|
|NWT||Newsat||Potential large cap if it can launch its own satellite in 2015.||278.32||-4.9||Telecommunication Services|
|AEU||Australian Education Trust||Well performing childcare centre property owner. Good yield story and outlook.||276.36||40.42||Financials|
|RIC||Ridley Corp||High corporate interest in the sector and the shrinking pool of agri listed stocks make Ridley worth following.||261.64||-17.72||Consumer Staples|
|GXL||Greencross||Acquisitive veterinary group. Good profit growth and share price performance, but gets little press.||261.62||145.28||Health 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.||254.33||22.98||Financials|
|MXI||MaxiTRANS Industries||Transport equipment maker posted good interim result. Has appealing yield and growth.||253.91||62.78||Industrials|
|SIV||Silver Chef||Strong jump in the share price of the equipment financing group has attracted a good following.||251.98||101.2||Industrials|
|SPL||Starpharma Holdings||Noteworthy for its good pipeline of innovations. Well run, widely followed.||250.07||-38.25||Health Care|
|SHV||Select Harvests||Noteworthy for turbulent past and exposure to soft commodity market.||240.77||267.69||Consumer 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.||239.54||9.23||Materials|
|AJA||Astro Japan Property Group||Strong leverage to Japanese economy makes this an interesting stock to watch.||233.90||21.32||Financials|
|TFC||TFS Corp||The sandalwood products company offers exposure to both the agri and cosmetics industry. It will start commercial harvest this year.||219.50||109.12||Materials|
|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 further||214.65||76.54||Industrials|
|VOC||Vocus Communications||Telecom stocks are in favour but Vocus is one of the least covered||209.87||45.68||Telecommunication Services|
|ACL||Alchemia /Australia||One of the few biotechs with revenue stream. Good pipeline of oncology treatments.||207.58||5.79||Health Care|
|DWS||DWS||Will be a big beneficiary if governments start spending on IT again.||206.49||4.7||Information Technology|
|NAN||Nanosonics||A successful medical tech story. Should be close to turning in maiden profit with its disinfection device.||205.00||56||Health 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||-14.07||Financials|
|IFM||Infomedia||Interesting tech play in the car parts market. Strong share price gain but gets little air play.||184.50||94.07||Information Technology|
|DTL||Data#3||Well respected IT company that receives little press coverage.||183.23||9.94||Information Technology|
|PFL||Patties Foods||Illiquid stock but has suite of well recognised consumer brands. Defensive yield.||182.87||-16.27||Consumer Staples|
|SFH||Specialty Fashion Group||In early stages of turnaround. Can the women's apparel retailer sustain the momentum?||176.86||80.65||Consumer 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.||176.26||78.31||Consumer Discretionary|
|HSN||Hansen Technologies||Operates in a high potential/growth industry but is not covered by press or brokers.||170.21||29.65||Information Technology|
|IMD||Imdex||Drilling company is well supported by instos and should benefit from any rebound in exploration activity.||161.01||-45.52||Materials|
|CKF||Collins Foods||One of the few food franchise listed companies.||160.43||62.01||Consumer Discretionary|
|NEA||Nearmap||A stellar performer with an Interesting business that offers high quality aerial maps to companies & government.||160.06||#N/A N/A||Information 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.||149.43||2366.67||Information 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.||138.45||47.46||Telecommunication Services|
|LCM||LogiCamms||Strong price performance and reasonable valuation attracting interest.||134.88||84.23||Industrials|
|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||-54.55||Materials|
|MLB||Melbourne IT||A perennial underperformer could be interesting turnaround story as management is in midst of restructuring the business.||132.57||1.34||Information Technology|
|AZZ||Antares Energy||Liquid with good insto support. Already in production with exploration upside in Texas.||128.77||-10.62||Energy|
|ESV||Eservglobal||Mobile money transfer company that has been gaining traction. Widely held by instos but low press coverage||124.52||185.71||Information 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||-14.37||Consumer Discretionary|
|GHC||Generation Healthcare REIT||One of the more interesting REITs. Income is more defensive than typical property stock and its greenfield expansion gives it earnings growth potential.||115.36||30||Financials|
|WDS||WDS||Widely held with strong insto support. Engineering contractor diversified across mining, energy and infrastructure.||115.07||37.6||Industrials|
|REX||Regional Express Holdings||Well run airline that is overshadowed by Virgin and Qantas.||112.29||-13.56||Industrials|
|AMA||AMA Group||Good turnaround story but under the automotive services group is radar of most.||111.30||45.96||Consumer Discretionary|
|UBI||Universal Biosensors Inc||Well regarded biotech and one of few that's successfully manufacturing in Australia. Struck deal with a few global medical companies.||108.25||-31.11||Health 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.||104.53||71.24||Consumer 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||-16.52||Health Care|
|CAA||Capral||An aluminium manufacturer that is actually holding up relatively well given that manufacturing is on the nose.||87.38||0||Materials|
|DRM||Doray Minerals||Widely held by instos. One of the more favoured gold explorers by brokers.||86.54||-27.81||Materials|
|RUL||RungePincockMinarco||IT company to resource industry. Facing tough operating climate with new CEO trying to restructure and turnaround company.||81.98||31.82||Industrials|
|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||-42.37||Industrials|
|CLV||Clover Corp||One of the star performers in 2012. Operates in growing but relatively stable niche.||79.29||-1.02||Health Care|
|YTC||YTC Resources||Next 12-mths will be eventful after YTC secured funding for its projects from Glencore.||75.02||0||Materials|
|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||-47.17||Materials|
|PEN||Peninsula Energy||Widely held by instos and large free float. It's the only uranium miner on the list.||74.01||-7.41||Energy|
|LGD||Legend Corp||Electronic parts supplier to utilities and other industries. Stable earnings with good yield. Often overlooked.||72.44||-0.75||Information Technology|
|TAN||Tandou||The only direct equity exposure to cotton prices. Also trades water rights and receives little press.||69.43||12.57||Consumer Staples|
|CKL||Colorpak||The small cap packaging company has grown via acquisitions over past few years.||68.90||63.97||Materials|
|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.||65.74||44.12||Consumer Discretionary|
|CUV||Clinuvel Pharmaceuticals||Interesting skin disorder treatment developer that has done reasonably well over past year||57.52||-6.52||Health 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.||57.35||736.36||Financials|
|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||-85.03||Materials|
|TSM||ThinkSmart||Potential turnaround story worth keeping eye on.||55.18||30.77||Financials|
|EBT||eBet||Potential alternative to star performer Ainsworth Tech. Has exclusive deal with US poker machine maker WMS.||47.81||163.87||Consumer 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||-8.69||Industrials|
|UML||Unity Mining||Growing Tassie gold producer with high free float. Valuation looks compelling too.||43.52||-48.33||Materials|
|NTC||NetComm Wireless||Under appreciated small IT hardware maker that is punching above its weight. Hardly covered by press.||32.17||92.31||Information Technology|
|PGC||Paragon Care||Emerging hospital equipment supplier that has been ignored by market.||17.76||147.88||Health Care|
|Source: Eureka Report, Bloomberg|