Back to the land

The Covid-19 pandemic has helped focus investors on the possibilities of the dairy industry. Phil Edmonds reports.

There’s no chance we’ll look back fondly on the events that have unfolded this year, but there’s no getting away from the fact that it’s taken the catastrophe to help light investors' eyes again to the merits of dairy.

Milk prices are up against initial odds, demand for New Zealand dairy products has not slowed and after some business model resetting, farm profitability is returning. The questions now are will new investors follow the numbers? If not, why not?

First, the helicopter view. The unprecedented low interest rate environment created by the economic upheaval has sharpened investors' focus on yield. With returns in every sector of the economy squeezed, and some facing structural challenges that present newfound risk, attention is inevitably falling on those propositions that look more stable.

At a cursory level, those with just half an ear tuned to sector fortunes will have noted global milk price resilience (contrary to many expectations) as other commodities (especially non-food related) have emerged from Covid-19 less assured. Westpac senior agri economist Nathan Penny says while dairy returns have not been excessive, they haven’t taken a hit like others.

“Inevitably you will get ambivalent investors, who will be looking at dairy more favourably.”

To be clear from the outset, dairy is not all of a sudden a beacon of light, nor is it necessarily getting more attention than other food sectors. Indeed, fresh stardust has settled across all agriculture since the world turned upside down earlier in the year.

During the first wave of lockdowns – in NZ and overseas – access to food was one of the few concerns people had (or at least needed to have). The reality has been that irrespective of ability to pay, some food has been unattainable. And scarcity is something that clearly makes people think about investing.

NZX Head of Analytics Julia Jones says there is evidence that investors are tuning into this new realisation overseas. So far, it’s too early to say that cheque books have been opened and food-producing asset prices are set to climb, but the key outcome in NZ from the emerging global sentiment has been fresh interest in understanding where people looking for a food haven can invest.

During the first wave of lockdowns – in NZ and overseas – access to food was one of the few concerns people had.

As far as land-based assets are concerned, dairy has been off neutral investors’ radar since milk price volatility moved into unmanageable territory and a consensus emerged around a disconnect between dairy farm prices and dairy business profitability. That was compounded by an attitude towards structuring farm businesses as property developments with a focus on adding value to the land, rather than cash yield.

But those forces no longer dominate the industry’s fundamental proposition. “The days of getting swings from $8.00/ kg milksolids (MS) to $4.30/kg MS are well past us,” Penny says. “That is increasingly clear. That volatility has narrowed, and the long run milk price looks closer to $7.00/ kg MS than $6.00/kg MS.”

Meanwhile, the price of dairy land is now more likely to reflect the value of the businesses that operate on it. Tougher bank restrictions on rural lending and tighter rules around foreign investment were contributing factors to easing land prices, but values also fell because investors weren’t necessarily liking what they saw, with returns not reaching levels that matched alternative offerings. Anecdotal information on recent dairy farm sales suggests competition is creeping back into the market, and that capital providers are willing to support buyers with robust financial positions. In addition to encouraging signs of more stable milk prices, and implications of that for land prices, Penny points to more maturity in dairy farm businesses that has arisen in the post-growth phase hangover. Businesses have been keeping more of an eye on costs as they’ve adjusted to pay for the massive expansion in the 2000s.

‘Entry costs into investment in kiwifruit are rising, so that is bringing the yields down.’

SUN SHINING ON HORTICULTURE INVESTABILITY

While the top-level fundamentals are looking positive and potentially setting dairy on course for an upswing in fortunes, there’s no sign that the investment tide is turning away from other primary sector assets.

Horticulture still holds the allure it has enjoyed for the past few years.

“The shine hasn’t come off horticulture. It’s done a brilliant job through marketing channels and connecting to consumers and has succeeded in creating value by not doing much to it,” Jones says. These types of attributes have clearly been ticking investors’ boxes – evidenced by horticulture sector investor MyFarm, which noted in November that demand for horticultural investments that generate a cash return has seen it raise $102 million of investor equity since April, double the average it raised between 2016 and 2018.

Penny accepts that for now, you would still expect investors to head horticulture’s way. But he says the gap is narrowing.

“Entry costs into investment in kiwifruit are rising, so that is bringing the yields are down. For existing players that still tends to be doable – cashflows are strong so they are often able to fund new costs from cash. For an outside investor though, it’s becoming more expensive and yields not as good as they were two or three years ago. All that makes dairy more comparatively favourable.”

Jones also notes that new investors aren’t likely to have a ‘one, but not the other’ mindset.

“We need all our food sectors performing to optimum levels at all times. We need to make sure they’re all attractive, and also recognise they are not mutually exclusive. We can’t just end up with a tonne of kiwifruit everywhere we look – we never want just one investment solution.”

GETTING INTO AND OUT OF THE MARKET

As we all know, it’s not as simple as a sector looking attractive to start the money flowing, and dairy has got two particular challenges that don’t necessary blight other sectors – lack of liquidity and regulatory uncertainty.

Gaining exposure to land-based assets in NZ has never been easy. For dairy it has typically meant taking an active stake in the operation, which inevitably requires experience and involvement in farming. If a neutral investor ran into a multi-million dollar windfall would they dump it in a dairy farm, if on paper it looked like the best way to safeguard their capital? Let’s just say no.

As well as needing know-how, investing in agri-land does not tend to offer easy exits. In an environment where more liquid assets present returns that match, let alone surpass dairy offerings, it certainly makes it a harder sell.

But Covid-19 has begun to change that. As mentioned earlier, the differential on yields has narrowed. Meanwhile, and to some extent coincidentally, the advent of the NZ Rural Land Company, established in June this year with a mission to raise at least $75m to spend on rural land presents a step forward for new investors to participate.

The NZ Rural Land Company has specifically stated that dairy farms are its initial target. With early encouraging signs of success, it is now planning to list on the NZX in December, opening the opportunity for retail as well as larger investors to get a piece of the dairy prize.

A public listing will undoubtedly help solve liquidity, although others have also been working to address that problem over the last few years. Capital-raising platform Syndex has been offering investors access to assets behind the farmgate since its inception, and chief executive Ross Verry says a fair chunk of all its business has been agri-based. As part of its offering, Syndex also provides opportunities for investors to exit.

Verry says Syndex is committed to improving access to assets in the primary sector, and has established a partnership this year with NZX – to work on agri.

“From our perspective, if there are farming businesses that need capital for growth or a succession event, we think there are smart and innovative ways of structuring investment vehicles to help them access capital from external investors. Our job is to try and make those primary sector businesses as investable as possible, with a secondary market enabling price discovery and exit strategies.

“The other benefit of Syndex’s platform is that it requires investment propositions to offer information needed to help make good investment decisions. That means greater transparency.”

UNCERTAINTY AROUND ENVIRONMENTAL COMPLIANCE

The other contemporary issue challenging the investor community contemplating dairy assets is the uncertainty over environmental regulation, which has hardly acted as a motivating force for those looking to house their spare cash.

Uncertainty is the enemy for any investor, so how is the need to factor in unknown environmental compliance costs being worked through by those courting new money?

Rabobank New Zealand chief executive Todd Charteris believes the weight of attention given to environmental regulation has effectively acted to normalise it, particularly since the election.

“I think there will be more certainty off the back of the election. A stable, single party Government should mean the direction will be clearer. That’s not to say everyone will agree with it. There will be some issues to work out, but it will be a case of getting down to the detail of what it means for individual farms.”

Of course, the banks are the last stakeholders in the sector that want to see farm prices slump due to farmers being wary of spending capital to ensure their operation remains compliant, and they’re actively looking to fund projects that meet new standards.

A Rabobank report released in November identified the market for sustainable finance – finance specifically used for activities which produce a verifiable positive impact on the environment or society – is continuing to grow in scope and scale in NZ to meet both governmentset environmental targets and the agri sector’s own sustainability aspirations.

Rabobank sees global financial markets increasingly looking to redirect capital into businesses that deliver positive environmental outcomes, and away from investments considered unsustainable.

In terms of the impact of these future costs acting as a deterrent, Penny believes they are, at a national level at least, already being priced into land values. But investors should be recognising that environmental costs are not unique to NZ dairy farmers – they will be hitting farmers in all markets.

“If everyone’s costs are rising then ultimately the consumer has to bear those costs and you have to assume people are going to eat regardless. If New Zealand can

cover those costs more efficiently than rivals in Europe, United States, Australia etc, investors should be able to identify a competitive advantage – rather than a risk.” Jones agrees. “Environmental standards are what they are – an opportunity. Standards have only come about because consumers want them, and New Zealand is in a far better position than many other countries to implement them.”

GROWING DEMAND DESPITE COVID

It’s not only about getting dairy’s house in order in NZ that is raising investors' eyes. The demand side still looks very encouraging – even if all the projections of growth are being recalibrated as the impact of Covid-19 gets worked through in different markets.

While China will never be far from NZ’s focus, more attention is likely to be paid to emerging markets, including those in South East Asia. Charteris’ enthusiasm for dairy’s future in NZ is as much about opportunities to meet new demand as our price competitiveness.

“There’s a really growing deficit in that block of countries, and we think that deficit is going to grow from something like 13 billion litres now to 19 billion litres in the next 10 years. That represents a massive opportunity for us to supply dairy products. That anticipated demand should underpin farmgate returns for New Zealand producers, and as a result, land values.” Plenty of lessons have arisen from Covid-19 for investors, but an important one is that food producing land (and water) will always be solid, long-term propositions. There are few others like it. NZ’s role in contributing to food security and meeting the needs of a growing global population is going to be around long after we’re gone. Land and water have come into their own again, and it shouldn’t be any wonder that dairy, as much as any other food-producing sector is back in the limelight.

Verry suggests looking at long-term investment trends at the moment is more relevant than ever.

“Historically land and food have been good investments. They do run a little bit counter cyclical to some of the more volatile investments. But land and food has been a good hedge against inflation and they provide reliable long-term returns.” Perfect for the times.