2023-03-10 13:00:47 ET
Summary
- The level of financial gearing in agribusinesses is higher than the level in most other industries.
- Potentially lower engagement towards fertilizers and other equipment may dampen yields.
- VanEck Vectors Agribusiness ETF’s valuations are cheap.
If agriculture goes wrong, nothing else will have a chance to go right. - M.S. Swaminathan
The VanEck Vectors Agribusiness ETF ( MOO ) is a $1.32 bn-sized portfolio that focuses on companies that generate at least half their revenue from the agribusiness space. Investors who opt for this product will get exposure to companies across the agribusiness value chain, including seeds, fertilizers, food producers, farming equipment, livestock, and plantations. It's fair to say that over the last 6 months, investors appear to be losing interest in this portfolio, with its assets under management declining by 10%, even as the scenario with the broader markets has been reasonable enough.
If one pays attention to some of the growing headwinds that could afflict this space, the rotation away from MOO shouldn't come as a great surprise.
Firstly, it's fair to say that large segments within the agribusiness value chain don't quite have the same pricing power that was seen over 12- 18 months ago. The UN Food price index has been on a downward slide for 11 straight months and is down by 19% since peaking in March last year. Meanwhile, important agri-commodities such as wheat are taking some pretty big hits off late.
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Andrey Sizov, an expert on the Black Sea agricultural market trends, recently joined me on a chat on the Lead-Lag Live Platform . Sizov noted how huge inventories, higher acreage, and lower margins had begun to leave an adverse mark on some of the important agricultural markets.
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A study by the IMF also showed that a 1% increase in the Fed's main interest rate, could reduce commodity prices by 13%, by a lag of 1 quarter.
While topline pressures could come through, I'm more concerned about the debt servicing abilities of incumbents involved in this space. For the uninitiated, farming is intrinsically a business where there is a high degree of financial gearing, and this has become a dominant theme over time.
What compounds the issue is the fact that most of the farming operations in the U.S. are financed by variable-rate debt , and this can be quite the sucker-punch when a hawkish environment gains traction. As noted in the 'Opening Thoughts' section of The Lead-Lag Report, the health of the U.S. economy in the near term will only embolden the Fed to tighten rates beyond what was originally expected.
What's worrying is that USDA data already showed that the aggregate interest expense of the farm sector was already growing at 32% on a YoY basis towards the end of last year. According to the Kansas City Fed, the average size of bank loans for operating a farm is already at 5-decade highs, while the average interest rate on these loans is at its highest point since 2019!
As you can see from the image above, in aggregate, there aren't too many other industries that feel overburdened in an elevated financial environment.
Banks who are well aware of the inherent weakness of agribusinesses in an environment such as this will only tighten underwriting standards even further. With limited credit on offer, you could find these companies compromising on farm equipment, and things like fertilizers, which could then bring down yields even further.
Speaking of fertilizers, Mark Rossano, a keen observer of developments in the farming sector, had come in for a chat on The Lead-Lag Live podcast , and he highlighted how economies such as China had previously paid a heavy price for overfertilizing the soil between 2016-2018.
Conclusion
While the near-term fundamentals don't look too great for agribusinesses, valuations are quite tasty, with MOO trading at only 11.46x forward P/E.
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However, investors should also be mindful of the fact that this is very much a large-cap-centric ETF ( ~92% of total holdings) which is not too optimal. Observers who have been following some of the infographics I put out on the timeline of The Lead-Lag Report would note that I've expressed some skepticism over further long-term large-cap outperformance without the aid of QE. Over the last decade or so, QE was very instrumental in supporting the appetite for ample buybacks by large-caps but going forward this narrative could ebb.
Also note that ~53% of VanEck Vectors Agribusiness ETF's holdings come from cyclical segments such as materials and industrials. In a recent Instagram post from The Lead-Lag report, I highlighted the results from my back-testing studies, which showed that investing in these sectors could be more rewarding during periods of high volatility. Considering the low readings with the VIX off late, I suspect there could be better opportunities to own this portfolio.
For further details see:
VanEck Vectors Agribusiness ETF: Watch The Debt Burden