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Opportunities in agricultural are long-term, says Bill Barbour, Investment Specialist at DWS Investments.

PRICES OF agricultural commodities are seeing record highs given the rising demand for food products and the shortage in supply. Corn, for instance, has been a strong performer as renewed interest in ethanol production in the US and demand for livestock feeds in emerging economies grew.

Not far behind, the palm oil sector is also experiencing a boom, which is seen to continue in the long run. In a March 25 report, BNP Paribas rated Asia's plantation sector as “overweight” as prices of soy, rape and corn remain high due to pressures in production. And palm oil used as a substitute for soy oil is set to benefit from this trend.

For one, demand for crude palm oil (CPO) is on a continuous rise in India. The country is among the biggest importers of palm oil, which is used to make the common food ingredient, vanaspati.

The BNP Paribas report says India is expected to buy about 4.8 to 5 tonnes of palm oil for 2008, more than the 4.3 tonnes it did in 2007. For January 2008 alone, its palm oil import reached 417,000 tonnes – already 70 per cent more than the imports during the same month last year.

Commodities guru Jim Rogers who spoke at a briefing to launch ABN AMRO’s latest certificates linked to the Rogers International Commodity Enhanced Index last March, said the current commodities rally still has a long way to go.

 “Demand is going up at a time when everything is in decline,” said Mr Rogers. “If I would be buying commodities, I would be buying agriculture. I think the best opportunities would be in agriculture,” he added.

Driving forces

In its global agri-business report, DWS Investments underlined the key drivers of the agricultural boom. The report, titled “Structural Change Reshaping Global Agribusiness Markets – Opportunities for Investing” lists five key factors for the rise in agricultural prices:  global economic growth, increasing population growth and urbanization, income growth, land and water shortages and the use of bio-fuels.

As growth rates equal to rising income for emerging markets like China and India, the rise of the middle class has also resulted in growth for food demand such as meat and dairy products, which in turn increased the demand for livestock feeds such as corn, said the report. As of April 23, corn prices are at US$544 per bushel at the Chicago Board of Trade (CBOT).

Increased urbanisation has also seen people migrating to cities and farmlands are being converted to housing and construction, thereby resulting in a shortage of agricultural land.

Increasing attention on the use of biofuels in developed countries like Europe has also put pressure in the prices of food crops. The report further noted that the growth in agriculture is secular, rather than cyclical, and therefore prices will continue to escalate.

‘‘The opportunities are long-term. The lasting nature of the influential factors suggests that the trends playing out in agriculture are still in their infancy and thus there appears to be solid potential for further gains,’’ said Mr Bill Barbour, Investment Specialist at DWS Investments.

Mr Rogers shares the same view that the current commodity bull-run still has a long way to go: “My view is that we are probably about a third of the way through the bull market,” pointing to factors such as the lack of recent oil discoveries, declining hectares for wheat farming and low levels of food inventory.

Commodity plays

Commodity-based companies are indeed reaping the benefits of higher demand, especially for palm oil. Merrill Lynch has upgraded its rating for Wilmar International Ltd in its April 18 report, from “neutral” to “buy” in view of the prospects for the company to continue the upward growth of its CPO refining margins, improved pricing environment and higher long-term assumptions for CPO prices.

Wilmar is the largest integrated agribusiness group in Asia and is engaged in palm plantation, palm oil processing, soybean processing, branded vegetable oils production and agriculture trading.

The company has sold more than half of its CPO production for financial year 2008 at above RM3,500 per ton, which is above the average year to date spot CPO price of RM3,472/mt.

Merrill Lynch gives Wilmar the “buy” rating at a target price of $5.35. As of April 23, Wilmar’s price closed at $4.82.

Despite China’s curbing of its soybean processing, Nomura Equity Research has also given Wilmar a “strong buy” rating in its April 22 report with a target price of $5.50. “We do not expect this new measure to affect Wilmar, despite it being a large foreign player in China’s soybean crushing business,” the report said.

It noted that Wilmar will have sufficient production capacity for the next three years, as it is running at
a low utilisation of about 60 per cent currently.

Nomura Equity Research also gave second-largest listed palm oil company, Golden Agri Resources (GAR) a “buy” rating as it is also set to benefit from rising CPO prices and rising crop output for financial year 2008.

Its April 3 report said, “We expect palm oil demand to outstrip supply, with demand growth driven by stronger consumption in China owing to food requirements and the substitution effect due to a sharp decline in soybean production in the US.”

With a total plantation area of 360,000 hectares in Indonesia, GARalso has a large landbank reserve of 1.3 million hectares and thus, the issue of land scarcity is not an issue for the company. Its efficient planting technology, above average yields and oil extraction rates, has made Nomura recommend its current rating at a target price of $1.13. GAR’s share price closed at $0.93 on April 23.

Meanwhile, the recent cut between 20 to 25 per cent in India’s import tariffs for crude palm oil (CPO) only signals more cuts to come, said the BNP Paribas report. It maintained an “overweight” rating for the Asia plantation sector in view of sell-downs in the commodities sector. Top picks included KL Kepong, Golden Agri Resources, Astra Lagro Lestari and Wilmar International.

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Wilmar has been a five-bagger in the last 2 years.

Investments in palm oil plantation

Riding on the momentum of a booming palm oil industry, some companies like 
Country Heights Grower Scheme based in Malaysia are starting to see the advantage of converting available farm lands into palm oil plantations and offering them as opportunities for investment.

Investors can make profit through a scheme that will have them invest in the palm oil plantation for 23 years and earn based on a rate of return of eight percent per annum during the first three years.

For the subsequent years, net yield of the plantation will be pegged to the
CPO price.

“When the Management Company decided to launch this unique investment
scheme, they actually designed it to be a long-term investment product. Our product is slightly different from any other investment out there due to the lifespan of the oil palm plantation whereby investors are able to enjoy better profit if they maintained their investment up till the maturity period of 23 years,” said Ms Vanessa Wan, senior marketing executive at Country Heights Grower Scheme.

The company is banking on the consistent rise in demand for palm oil in the global market and the increase of biofuel use in the US and Europe to sustain it. “Countries such as US and Europe have gradually shifted to palm oil-based bio-diesel.

The US predicted that the demand for palm oil to rise from 2.84 billion
litres to 7.57 billion litres in the next 18 months,” Ms Wan added. DWS Investment’s agri-market update for March showed soft commodities traded on a volatile pattern with prices of soy declining from 17 to 23 per cent, while corn traded higher in view of the announcement that roughly two million acres will be allocated for corn this year during the US planting season.

Still, with inventories at low levels and demand for agricultural products rising,
the downturn in soft commodities may not be easily sustained and more commodity price increases may be ahead.

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This article was recently published in Smart Investor magazine and is reproduced here as part of a special collaboration between the magazine and NextInsight.
 

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