Purchase Date: 12th April 2017
This week we have chosen Australian Agricultural Company (AAC) as our stock of the week. AAC is a vertically integrated beef producer that focuses particularly on high quality beef for export markets. They are Australia’s largest beef producer and they have the largest Wagyu beef herd in the world. Here at Equity Mates we like the long term prospects of the Australian agricultural sector and we think AAC are well positioned to take advantage of the sector’s future growth.
The strong long-term outlook for Australia’s agricultural sector as a whole has been buoyed in recent years by a string of free trade agreements. The Australian government has secured trade deals with Japan, South Korea, and most importantly, with China. The TPP was to be the cherry on top, and whilst it seems dead for the moment – if it is revived Australian agricultural products will have much greater access to Asian export markets. There has been a surge in demand for beef in Asian markets, which has driven the global beef price up 7.4% p.a over the decade to 2015. While 2016 saw beef prices decline, 2017 is shaping up as a stabilising year for the global beef price. Australian beef sales to China alone grew six-fold between 2012 and 2015, and as long as China is able to keep growing it’s middle class this trend is likely to continue.
So why AAC? Just because Australia’s agricultural sector appears to have a bright future doesn’t mean every company in the sector is worth investing in. We particularly like AAC’s move to vertically integrate. Vertical integration occurs when a company takes over more than one of the stages of production. So for example, AAC traditionally maintained a herd of cattle and then would sell the cattle to the abattoirs. This meant they controlled only the first stage of production. In recent years they have purchased an abattoir and now sell the final product, packaged beef, into export markets. Being vertically integrated gives AAC significantly more pricing power (i.e. they have more ability to set a price, rather than having to take whatever the global beef price dictates). The early results of this move towards vertical integration are positive, with a 45% improvement in revenue between 2014 Financial Year (FY) and 2016 FY despite a similar size herd of cattle.
The company’s management continue to work on decreasing costs and improving their branded beef sales. In their 2017 Half Year results they managed to decrease production costs by 25% while improving the sales price for their branded Wagyu beef by 6%. This has led to an improved operating margin of 6.5% in 2017 Half Year 1, compared to 4.5% in 2016 HY1. Notably, AAC’s revenue did fall in their 2017 half year results, however this can be explained by the increased herd size, which will take some time to be converted into revenue.
The company’s share price is $1.68 which is trading at a Price/Earning multiple of about 14 and they have a NTA per share of $1.75. So we see $1.68 as a reasonable price to pay as AAC continues its transition to a vertically integrated beef producer. The transition is not without risks and we will be carefully watching the performance of AAC’s branded beef products in Asian export markets. Of particular interest will be the relative demand for beef as compared to other livestock, as poultry, pork and even buffalo continue to attempt to grow market share in Asia. However, at this stage we feel relatively comfortable adding AAC to our hypothetical portfolio.