At our recent AGM, we discussed our belief in consumer goods, consumer services and agribusiness. We believe that demand in these areas will be driven by expanding domestic consumption, and in particular new consumption arising from the development of central and western China.
Agribusiness is a sector where we are devoting considerable resources, including the majority of our Chengdu team’s efforts. Demand for meat products has risen at a CAGR of 5% over the past 3 years. Morgan Stanley forecasts pork imports to grow at a 17% CAGR over the coming 10 years. China’s “consumer class” (urban residents) spend 267% more per capita on food than rural residents.
There is also a clear overlap between agribusiness, our existing portfolio, and some of the preferred consumer businesses we are approaching. Specifically, we are excited about well branded, quality providers of food and beverages in the mid- to high- price points that will be able to meet demand from emerging consumers.
Despite compelling fundamentals, investors have lost faith in domestic companies operating in the sector. Fears of irregularities at businesses like Yurun Foods, Chaoda Agriculture and Sino Forest have caused interest in the sector to enter a state of hibernation. The spill-over effect has reached businesses otherwise deemed solid, such as Asian Citrus, in which we are an investor. While concerns about certain specific companies are valid, pessimism in certain instances has reached extremes.
We believe that agribusiness suits our approach well. We benefit from the luxury of a more patient time horizon and have the operational resources necessary to add value in due diligence, operations, business development and finance. This allows us to better diligence a company’s assets and financial statements and to approach opportunities with greater insight, opportunism, and flexibility.
Below are several compelling data points on the sector:
• Demand for high quality agricultural products is large and growing.
-China accounts for a massive share of global agricultural consumption
-Demand for meat has risen at a 5% CAGR/3yr
-Morgan Stanley forecasts pork imports to grow at a 17% CAGR/10yr
• Urbanization is driving demand for higher quality food products.
-In 1970, only 17% of the country’s population (or 144 million people) lived in cities;
-Today, over 622 million people ( 50% of the total population) live in urban areas;
-Chinese urban residents spend 267% more per capita on food than rural residents.
• Local production is constrained, leading to a significant consumption-production gap
-China feeds 1.4 billion people with only 6% of the world’s freshwater and 0.08 hectares of arable land per capita (less than half the global average);
-The average farmer in China still farms less than 1 hectare of land, compared with more than 16 hectares per farmer in Brazil and 160 in the US.
• Prices are rising for the agricultural products provided by our pipeline and portfolio companies.
• Land usage rights are being liberalized, but slowly
• Land usage rights for agricultural products are liberalizing, but slowly. Forestry has benefitted the most from liberalization, but ownership falls into several categories which range from long leases constituting effective ownership to non-transferrable usage rights with, or without, a requisite cutting quota. Some critical questions we ask during due diligence include the scope of usage rights, cost basis, production levels, utilization rates and tradability of land assets.
• Determining true operating metrics often requires extensive interaction
Agricultural businesses suffer in many cases from a fragmented customer base. Further, they often supply downstream producers on an exclusive basis or as a related party (for example, timber land supplying timber mills owned by related parties). This poses difficulty in diligencing operating metrics and provides an inherent information edge to firms capable and willing to do the necessary field work to determine the soundness of metrics, verify contracts, diligence production techniques, determine capacity and utilization, and understand seasonality.
