How to profit from the rising price of farmland
By
Investment Director – The Fleet Street Letter
David Stevenson May 16, 2012
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For farmers in Britain, Mark Twain might have been early with his advice of “buy land – they’re not making anymore”.
The real – ie, inflation adjusted – worth of UK agricultural land hardly changed from the 1950s through to the mid-1990s.
Then, as the country’s housing market started booming, farmland prices joined in the fun. But unlike British residential property, which has since stuttered, agricultural values have kept on climbing.
So is this the peak, or is buying farmland still a good idea? We’ll take a look below – but the good news is, there’s a stock you can buy that’ll make you money either way.
Farmland looks expensive compared to stocks
UK farmland prices have almost trebled in the last decade, climbing from £2,000 per acre in 2001 to £5,500 at the end of 2011. Indeed, values in Wales have doubled in just the last five years, according to a RICS survey in February.
So is farmland still good value? One of the best ways to value agricultural land – as with most other assets - is to see what return it’s generating. In other words, you compare its yield against a benchmark, such as the yield on the stock market.
Despite rising prices, even as recently as 2005 buying farmland still looked a good deal. At the time it was yielding only slightly less than the FTSE 100. Here at MoneyWeek, we advised investors to get a slice of the action.
However, farmland has got a lot more expensive since then. By contrast, the stock market is hardly any higher now than either 2001 or 2005. This means the yield ratio is right out of kilter.
Farmland yields have dropped as values have soared, while the yield on equities is higher than it was. British farmland now looks very pricey compared with the dividends you can get on shares.
Outside the UK, it’s a similar story. US farmland prices have doubled over the last decade. A month ago, Reuters reported that a farm in eastern Nebraska sold for $12,000 an acre. That’s around £7,500, which puts even the prices in Britain in perspective.
That level of land prices is high enough to make life tough for aspiring American farmers. If they’re buying the land on borrowed money, they could struggle to make enough profit to service their loan interest.
Just to pile on the pressure, the US corn harvest now looks set to be better than was expected a month or two back. That’s because they had plenty of rain in April. That means that corn prices could drop as low as $4.20 per bushel, according to the US Department of Agriculture (USDA). This compares with last year’s average price of $6.20 per bushel.
It’s good news for consumers of corn, of course – but this would really put the squeeze on American farmers’ incomes. Further, the USDA expects that this year, US farmers will plant the most corn since 1937 (inspired by last year’s high prices), which would lead to a record harvest.
Corn prices would then drop further. There would be a knock-on effect on farm prices that would stop the US bull market in agricultural land in its tracks. And the downswing would soon filter across to Britain.
So should you now forget about farmland, and look to invest your money elsewhere?
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Demand for agricultural produce will keep rising
We wouldn’t be too hasty. It’s not that simple. Yes, the shorter-term outlook for farmland prices may not look great. There’s a good chance that values may now drop back on both sides of the Atlantic. But in the long run, the global case for agricultural land remains a good one.
Demand is likely to stay strong. The world population is still climbing. So the need for food will keep growing.
What’s more, in emerging economies millions of people who’ve been on the poverty line are joining the middle class. This is clearly a good thing. But it also means more people spending more money on pricier food that will be more expensive to produce.
As far as supply is concerned, there’s less cultivated land than in the past. Although farming methods and genetic modification have made a big difference to productive yields, the UN Food and Agriculture Organisation estimates that over the last several decades, cultivated land per head has fallen by 43% worldwide.
In addition, factors such as topsoil erosion, bad weather, and lack of water availability are further reducing the supply of arable land. Growing use of biofuels – which require ingredients such as starch crops and vegetable oils – is also diverting output away from the food markets.
A quantum leap in agricultural productivity may solve the world’s food problems one day, but don’t bet on it happening in the next few years.
Then of course, there are the world’s central banks. As long as they keep flooding the planet with more paper money, it has to go somewhere. And a fair amount is likely to find a home in punting on agricultural commodities.
In the long run, then, both food and farmland prices seem set to keep on rising worldwide.
How to play rising food prices
What’s the best method of playing this? There are enough uncertainties about the near-term picture to put me off the idea of farmland itself. But it looks like there’s a better way.
Bunge (NYSE:BG) is a global agribusiness and food company. It buys, sells, stores, transports and processes oilseeds and grains. It makes protein meal for animal feed and edible oil products for commercial customers. Bunge also produces sugar and ethanol from sugar cane. Further, it mills wheat and corn. The firm also sells fertiliser.
In other words, Bunge is a good all-round play on agriculture and food. And as the chart shows, it tends to do well when food prices are rising.
Source: Bloomberg
As I’ve explained, in the short run, we could see the opposite. But further out, this is the sort of stock to cash in on pricier food. On a current year price/earnings (p/e) ratio of ten, and on an 18% discount to stated book value, Bunge is cheap enough to hold up well until that happens.
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