07 October 2015

Important Information
This material is for distribution to Professional Clients (as defined by the FCA Rules) and should not be relied upon by any other persons. Issued by BlackRock Investment Management (UK) Limited, authorized and regulated by the Financial Conduct Authority. Registered office: 12 Throgmorton Avenue, London, EC2N 2DL. Tel: 020 7743 3000. Registered in England No. 2020394. For your protection telephone calls are usually recorded. BlackRock is a trading name of BlackRock Investment Management (UK) Limited. This document is for information purposes only and does not constitute an offer or invitation to anyone to invest in any BlackRock funds and has not been prepared in connection with any such offer.

Agriculture: finding value away from the mainstream

Another bumper harvest in the US, as shown by the World Agricultural Supply and Demand Estimates Report, has sent agricultural prices lower and would seem to suggest a more difficult period for the agriculture sector: Indeed, after a brief rally, prices for corn, soybean and wheat are significantly down for the year, according to Bloomberg data. The agricultural equipment sector is also under pressure, as dealers continue to hold stubbornly high inventories, as stated in Cleveland Research dealer surveys. However, we see pockets of value among the agriculture names, notably among the livestock and packaged food groups.

Livestock benefits from lower grain prices

Livestock producers are often beneficiaries of more difficult conditions elsewhere in the agricultural sector, as sustained lower grain prices tend to mean lower feed costs for poultry, hogs and grain-fed cattle. Looking at company reports, US poultry producers are currently recording the highest gross margins in their history, thanks to a ‘perfect storm’ whereby chicken demand is recovering and beef (an alternative protein source) prices are relatively high, as indicated by Bloomberg data. Equally, capacity is under control and companies are showing good capital discipline.

We believe that these positive conditions can persist. Some of these companies have taken advantage of the benign environment to move up the value chain, expanding into packaged and branded foods. Some companies are also pursuing merger and acquisition strategies to this end. Packaged food groups are prospering, as consumers have more discretionary spending, which in turn is increasing demand for branded and packaged foods. At the same time the input costs – in the form of grain and oilseed prices – are falling according to Bloomberg. This is particularly true for those exposed to health and wellness products.

Companies in the packaged food group tend to have significantly lower correlation with the price of commodities (evidenced by beta analyses on Bloomberg) in comparison to their upstream counter parts, as such, exposure to this sub-sector can provide insulation against some of the volatility associated with commodity companies. This ‘independence’ is particularly true for those companies who pursue brand strategies to improve pricing and protect margins. We believe that there are a number of high quality growth companies displaying these characteristics.

For the remainder of the agriculture sector, we see no immediate improvement in conditions. The favourable weather conditions means that US farmers are likely to reap another strong harvest in corn, soybeans and wheat. This is likely to leave inventories higher for the third year running. While this may ultimately lead to a curbing of supply, this is not likely to have an impact in the short-term.

Long-term outlook sound

The long-term arguments for agriculture remains sound – the growing middle classes in emerging markets are adopting a Western-style diet, increasing the overall demand for protein, while Western economies shift to healthier lifestyles. However, within this, the relative attractiveness of different companies will change in line with different agricultural conditions and valuations. With this in mind, we are currently insulating our portfolios against the weaker commodity-exposed segments and towards the livestock and packaging areas, which – we believe – still offer exciting growth opportunities.

CARS ref: RSM-2101
This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or financial product or to adopt any investment strategy. The opinions expressed are as of 02 October 2015 and may change as subsequent conditions vary.

We see pockets of value among the agriculture names, notably among the livestock and packaged food groups.