By Raymond Chan
 
The end of the commodity boom sent all hard commodity prices to depressed levels (iron ore, oil, gold fell over 50% from their respective highs). While most believe agricultural commodities should avoid the selloff, given the structural demand from a growing Asian population, the agricultural commodities index has almost halved from a 2010 high (as shown in Chart 1).



chart1Ray

There are three key reasons we should re-visit the agricultural sector.

Firstly, the Australian agricultural sector (i.e. farm and related sectors) is economically significant to us with gross production of $155 billion per annum (or 12.1% of GDP). The three biggest industries are: 1) cattle; 2) wheat and 3) dairy. There are 140,000 farmers plus 1.6 million people employed in agriculture and its related industries (17.2% of national workforce).

Secondly, Australian farmers not only produce almost 93% of Australia’s domestic food supply, they are also the fourth biggest exporter of production in global agricultural markets. (No.1 wool and goat meats, No.2 beef, No.3 wheat and sugar).

Last but not least, Australia is the food bowl to Asia.

Recently, Latte with Ray found the Australian cattle price trend was the most constructive, as shown in Chart 2. The domestic cattle price traded at a lower level between 2012 and 2013 due to a relatively high Aussie dollar, the Indonesian life stock ban and poor seasonal conditions. This is set to change now with a lower Aussie dollar, the lowest cattle herd in many years and the China / Australia Free Trade Agreement.

chart2Ray

Our analyst Belinda Moore commented,

“The Australian agricultural industry is a key beneficiary of the Free Trade Agreement (FTA) with China, which will result in the elimination of tariffs over the medium to longer term. The deal follows FTA agreements earlier in the year with Japan and South Korea. The China deal is the most important given China is our major trading partner with Australian farm exports doubling in the five years to 2013 and valued at over $7 billion in 2013. As many commentators have said, the future in Australia is about the "dining boom". The National Farmers Federation (NFF) said the three FTA agreements pave the way for the golden age of Australian agriculture in the Asian century.”

To play this theme, there are a number of ASX-listed stocks with leverage to the upside (and downside) on cattle price trends. The most obvious one is AAC (Australian Agricultural Co). Having said that, we found another ASX company, which will indirectly benefit from the trend - ELD (Elders).

Elders (ELD) is an iconic brand in rural Australia with a 175-year history. It has a national distribution network, with 370 points of presence and relationships with 40,000 active customers. In the past five years, the business was poorly managed with high level of debts. Now, with the right management team (ex Wesfarmers executive), a recapitalised balance sheet (interest coverage exceeding four times) and a strategy in place (agency model versus old capital intensive model) which aims to deliver $60 million of EBIT (earnings before interest and taxes) and a ROC (return on capital) of 20% by 2017, we believe that now is the time to re-look at Elders.