Chapter 12
Canada: A Breadbasket's Great Comeback
Once flyover country, Saskatchewan is a focal point in Canada's growing economy. So I couldn't resist dropping in on this resource-rich province. It has become an agricultural power.
Many things come from this one province of Canada that many Americans would have a hard time finding on a map. (Brad Farquhar, who we will hear from shortly, relates the following story: “Once on a flight from Memphis to New Orleans, I sat next to southern woman who asked me where I was from. I told her Saskatchewan. When I told her it was north of Montana and North Dakota, she said to me, [with southern drawl] “Son, there ain't nothin” north of North Dakota!”) Yet, Saskatchewan makes up a large percentage of the world's exports in a number of goods:
67 percent of the world's lentils
56 percent of the world's peas
25 percent of the world's mustard
40 percent of the world's flaxseed
18 percent of the world's canola
33 percent of the world's durum
As far as natural resources go, fortune has smiled broadly on this land between the forty-ninth and sixtieth parallels. It is the world's largest producer of uranium and potash. The former is a critical component in the “nuclear renaissance.” The latter is a key fertilizer. It is rich in oil and gas.
These resources have produced abundant cash flows, which you can see in the tax records. At a time when governments everywhere faced gaping budget shortfalls, Saskatchewan has been awash in cash. In 2008, when the financial crisis hit, the province reported a $3.1 billion surplus on a budget of $9.4 billion. Not needing so much money, the government announced the largest cut in personal income taxes in its history. It paid off 40 percent of its provincial debt. Prudently, the government decided to sit on a $2 billion cash cushion, just in case. Today, the government still maintains a surplus, although not nearly as large as in 2008.
Now, once-sleepy Regina is coming into its own as the commercial hub of Canada's hottest economy. Regina reminded me of Omaha, another city in a prairie-ocean. The downtown is small, and the city looks and feels mostly new.
I stayed at the elegant Hotel Saskatchewan. Its Manitoba Tyndall stone façade and richly appointed interior are a piece of history, built by the Canadian Pacific Railroad in 1927. Down the street, I saw the headquarters of Viterra, a leading grain handler and processor. Around the corner, a new 20-story office tower was in the works as new headquarters for the fertilizer giant Mosaic.
Brad Farquhar, vice president and partner of Assiniboia Capital, showed me around. (You may remember him from our brief visit with Mongolia). I also met with Doug Emsley, co-founder and president of Assiniboia. I first started writing about Saskatchewan's farmland in 2008. After my first story, Brad wrote to me. That was in November 2008, and we've been correspondents ever since. I'll have more on Assiniboia in this chapter, but first, let's investigate how far Saskatchewan has come.
From the beginning, people had large ambitions for the province. They thought the population would grow by millions of people and that Saskatchewan would be a great breadbasket, a thriving new land. It didn't work out that way. Today, the population of the province is only about 1 million people.
The legislative building in Regina reflects what people thought that it would be. It is a massive building, completed in 1912. It's a big building for the province, even today. In fact, it is the largest capital building in Canada. But events, man-made and natural, would thwart those early ambitions.
The Great Depression hit Saskatchewan with particular force, as it did the American prairie states. Beginning in 1929, Saskatchewan suffered through nine consecutive years of drought and crop failure. The province suffered what must be one of the biggest declines in income suffered by any people anywhere during peacetime. “Incredibly,” writer Edward McCourt tells us in his book Saskatchewan, “the net agricultural income for 1931 and 1932 were reported in minus figures.”
I have a minor hobby interest in the implosion of the 1930s, so I had to explore this a bit further. A reporter in 1934 described the landscape in southern Saskatchewan as “lifeless as ashes . . . for miles, there was scarcely a thing growing to be seen.” He went on:
Gaunt cattle and horses with little save their skins to cover their bones stalked about the denuded acres, weakly seeking to crop the malign French weed which seemed to be maintain some sickly growth . . . . The few people in evidence in the little towns appeared haggard and hopeless.
I can only imagine how difficult it must have been to carve out a living in this unyielding landscape. It reminds us that no matter how good things look, any agricultural enterprise is at the mercy of the weather.
The Great Depression would have a long-lasting effect. It helped push Saskatchewan politics decisively collectivist. The government would clamp down on enterprise for decades afterward, including a decision in 1975 to nationalize the potash industry. It only recently started to go the other way and loosen up.
Our conversation on these matters led Brad to muse: “In some ways, this place is only now starting to get out from under the effects of the Great Depression.”
Today, the trend is more toward opening up for business. The province, as I pointed out earlier, runs a surplus, virtually unheard-of in governments today, and maintains a AAA rating. Moreover, because of that long, moribund period from the Great Depression until just recently, large chunks of Saskatchewan's resource-rich land remain untapped.
And that helps explain Assiniboia Capital's success here, too. Brad and Emsley had a good idea and fortunate timing. They saw an opportunity opening up in Saskatchewan farmland, thanks to the relaxing of restrictive rules on farm ownership. (For a time, non-Saskatchewan Canadians couldn't own Saskatchewan farmland.) From 1974 to 2003, you had to be a resident to own farmland.
“During this period, Saskatchewan was a net exporter of people,” Farquhar's prospectus points out. “It was a province whose population was in decline.” Doing away with these restrictive ownership requirements in 2003 has unlocked some of the value. Annual declines in farmland values immediately began to reverse.
Brad and Doug saw 55 million acres of opportunity in Saskatchewan. Almost half of all the farmland in Canada is found in its golden prairies. Wheat, canola, and barley represent three-quarters of the crop acres in the province. So they started Assiniboia with the idea of investing in farmland. Today, the company is the largest farmland fund in Canada, with over 110,000 acres managed and owned.
Saskatchewan farmland has a lot of ground to make up, though. Only 22 years ago, farmland here was more valuable than in neighboring Manitoba. But today, Manitoba's farmland is more than 50 percent higher than Saskatchewan's. The Saskatchewan discount is attracting ranchers and grain farmers from neighboring Alberta, as well as immigrants from abroad. The government of Saskatchewan actually has a fast-track program in place to assist immigrants looking to farm in the province.
Statistics compiled by the Canadian government show that the average farmer in Saskatchewan is 52 years old. That leads Assiniboia's team to conclude in its prospectus: “The aging farming population in Saskatchewan has created a buying opportunity that [we] believe may not return for another generation.” Brad adds that the average age of Saskatchewan farmers (53) is not out of line with the rest of Canada, and is in fact less than in the USA (55.3 years). “The challenge is the drop in the number of younger farmers as a percentage of the whole.” This next generation is less interested in farming. The older generation will, in many cases, have to sell to folks beyond kith and kin. Folks like investors in Assiniboia.
Assiniboia's farmland LP has delivered superb returns so far. At inception in December of 2007, the NAV of the fund was $25 per unit. By October 31, 2011, the NAV was $41.48 per unit.
That doesn't include $2.37 in distributions made along the way through December. Brad likes to call farmland “gold with yield,” because farmland prices tend to correlate with gold, but it pays its investors income. All told, that's a 75 percent return since late 2007, during a time when the U.S. stock market has been firmly in the red.
Even now, Saskatchewan farmland is still a bargain, trading at a significant discount to its neighbors on a per acre basis (Figure 12.1).
Crop prices still promise a good return for farmers, but financing is harder to acquire. Farming is a capital-intensive business. You need to spend a lot of money before you see a dime. So farmers often put off expansion simply because money is tight.
Say you were a farmer in Saskatchewan, and you wanted to add acres to your farm to take advantage of market prices. You'd have to purchase or rent more land. You'd probably need new tractors and combines to handle the extra workload. You'd need more on-farm storage. You'd need fertilizer, seed, and chemicals.
How much would all that cost? Brad Farquhar said it is normal for farming expansion to cost $150–$300 per acre. That means a 2,000-acre expansion needs an investment of $300,000–$600,000. (Those costs do not include land costs. Buying the land would add another $400 to $1,500 per acre in cost.)
Some farmers have the financial capacity to do that on their own, but most typically turn to a local bank or credit union. In the credit crisis meltdown days, it was tough for anybody to get a loan. Credit is not as easy as it was in the balmy days of no-doc loans and no money down.
So while a farmer could make an extra $100 an acre in revenues for every $30–50 an acre spent in fertilizer, he doesn't necessarily do it. In fact, farmers cut back on fertilizer in the meltdown days, from which we are rebounding. Then, too, there are timing issues. Nitrogen fertilizer is often cheapest in July, right when farmers have maxed out on their borrowing capacity. That means that they can't take advantage of the lower prices.
These funding gaps are where Brad's Assiniboia steps in to fill the void. They provide the funding as an investor, with the profits shared between the farmer and Assiniboia. The firm has a simple truism as its mantra: “The returns are highest where capital is scarce.” Saskatchewan farming (and agriculture generally, at least at the farm level) is one such place.
You'd think something like this would have evolved sooner. But it was a new concept when the firm began approaching farmers in 2009. As Brad describes it, after a lot of time at farmers' kitchen tables and hundreds of cups of coffee later, farmers began to sign up for Assiniboia's program.
Canola: Canada's Most Valuable Cash Crop
His firm is high on canola. Why canola? The heart of canola country is right in Assiniboia's backyard, in Saskatchewan. It's like the Silicon Valley of canola. Brad points out that “recent genetic developments are pushing yields to whole new levels.” These breakthroughs are happening in Saskatchewan and lead to better economics.
Peter Phillips of the University of Saskatchewan calls canola “one of our visible and uniquely Canadian success stories.” About 20 percent of the world's production comes from Canada, which is eager to ship to drought-parched China. Last year's exports there topped $1.8 billion. It's currently a $15.4 billion industry, surpassing wheat. And Brad's investors have a direct play.
Brad's firm ran a pilot program in 2009 on about 25,000 acres. Even though it suffered through an incredibly wet summer in 2010, the partnership broke even, proving the durability of the model. It remains an attractive and more aggressive way to investing in farming.
“Average crops should provide good returns, but any above-average production or commodity price makes the return numbers take off,” Brad says. “And the majority of the downside is covered by crop insurance. So it's like having a perpetual call option on canola.”
Brad prepared the next chart, which shows a few scenarios of how a share in his limited partnership (LP) might fare depending on crop yield and price. You can see that a low yield and a low price make for a poor result. But the range of outcomes skews to the upside. A bumper crop and a strong price could hand you a 101 percent gain. (Note: In Figure 12.2, “bu” stands for bushel.)
One other thing I like about this model is that farmers have skin in the game. About half or more of the profits will go to them, so they have every incentive to make it work.
Brad drove me over to a canola farm. It's beautiful, flat country. We walked around to check out the canola crop. Along the way, we stopped to scope out the red lentil crop coming in.
Just to see it all, touch it, and walk on it, the experience makes everything more real. It's no longer just numbers I imagine when I think about Saskatchewan farmland. I'll think about how this summer's yellow blooms will turn into green pods, with their small, narrow seeds. How the seed will go off to the local crusher. I'll remember these plains. This farm. (Investors have a tendency to get lost in abstractions. Stocks become only ticker symbols, and they don't think about what they own, what those shares represent. I've always tried to resist that kind of abstracting.)
Having seen it for myself, I think the boom in Saskatchewan farmland still has lots of legs.
Taking the long view, we are running out of dirt.
—David R. Montgomery, geologist
The world needs to boost its production of food. The United Nations estimates that the world will need to boost investment in agriculture by $83 billion a year, that's a 50 percent annual increase—to feed a growing population. Its estimate may prove an errant shot from an uncertain bow into an unpredictable future. But it doesn't matter. Investing is more like horseshoes and hand grenades, as the old saying goes; close counts.
If the United Nations is half-right—others have done similar work with similar conclusions—then we're talking about a healthy bull market in all things green. The question is where does the boost in production largely come from? One answer is Brazil, as we discussed in another chapter of this book. However, Saskatchewan is part of that food equation, too.
Quality soil is the thing in demand. The world continues to deplete its base of arable land. Until the final decades of the twentieth century, the amount of new farm acreage added to the mix by clearing land offset the losses on a global basis. In the 1980s, the amount of land under cultivation began to fall for the first time since humble early humanity began to farm the rich land around the Tigris and Euphrates. It continues to fall today.
Though it's been going on for some time, the dramatic blows are showing their effect. In East and North Africa, in the plains of India all the way to Turkey, the story is the same. Some of it is just human carelessness about the land. Some of it is climate-driven: the declining snow melts of the Himalayas and more-frequent crop-killing heat waves in places such as India.
Climate change has been going on for a long time, too. As Peter Matthiessen points out in The Snow Leopard, the Gobi Desert was once fertile. In Central Asia, he writes, “broad lakes vanished in dry pans, and grasslands turned into shifting sands.” Many of these changes happened in only a few hundred years. “The death of a civilization can come quickly; the change in climate that dried up rivers and destroyed the savannas of the central Sahara scattered the great pastoral civilizations of [Africa] in just a few centuries after 2500 B.C.”
Such changes impact economics as well. We are close to passing some giant milestones. China is the largest net importer of soybeans in the world. A mere 15 years ago, it made more than it needed and exported soybeans. Some think that India could import as much as 2 million metric tons, the most in the world. Traditionally, India has been the world's third-largest exporter.
During the summer 2008 grain crunch, Iran bought a large amount—more than 1 million tons—of wheat from the United States. That's something we'd not seen in 27 summers. In Iran's case, a tough drought cut the wheat harvest by a third, forcing the country to look abroad. Nevertheless, the fact that Iran had to come to the United States is telling. It's like Lee asking Grant for rations in the summer of 1863. As one analyst put it: “Do you think Iran would come to the United States if they had any place else they could buy it . . . . They're searching the world for wheat. They're buying from the United States because it's the only thing they can buy.”
Markets, like great, unscripted dramas, develop their own plotlines as time rolls on. The new drama surrounds the fewer options for importers looking for large quantities of high-quality grains. But it points to a deeper issue: the emerging shortage in fertile soil. Yes, we're running out of good dirt.
In fact, fertile soil, good dirt, may become more important to land values than oil or minerals in the ground. Some say it is a strategic asset on par with oil. As Lennart Båge, former president of a U.N. fund for agricultural development, says, “Now fertile land with access to water has become a strategic asset.”
Doubtful? Consider rising export restrictions around the globe, which act as a sort of fence keeping the goods within borders. India curbed exports on rice. The Ukraine halted wheat shipments altogether. The number of grain-exporting regions has dwindled, like the vanishing buffalo herds. Before World War II, only Europe imported grain. South America, as recently as the 1930s, produced twice as much grain as North America. The old Soviet Union, for all its faults, exported grain. Africa was self-sufficient. Today, only three major grain exporters remain: North America, Australia, and New Zealand.
It is no surprise, then, to find faith in the global food supply at generational lows. So begins the scramble to secure farmland. Saudi Arabia, for example, is particularly at the mercy of the winds of global agriculture. It has little ability to produce its own food. “The kingdom,” reports the Financial Times, “is scouring the globe for fertile lands in a search that has taken Saudi officials to Sudan, Ukraine, Pakistan, and Thailand.” Saudi Arabia's quest is not one it pursues alone. There are many hunters.
The UAE has been looking to lock down acreage in Sudan and Kazakhstan. Libya wants to lease Ukrainian farms. South Korea pokes around in Mongolia. Even China is exploring farmland investments in Southeast Asia. You'll recall that China does have plenty of cultivable land, just not plenty of water.
“This is a new trend within the global food crisis,” says Joachim von Braun, the director of the International Food Policy Research Institute. “The dominant force today is security of food supplies.” Food prices reflect this crimp in supply.
The mainstream press focuses on issues such as population, dietary shifts, and the impact of biofuels. One thing that doesn't get talked about much may be the most important thing of all: a growing shortage of quality topsoil. Call it the topsoil crisis.
Quality soil is loose, clumpy, filled with air pockets, and teeming with life. It's a complex micro-ecosystem all its own. On average, the planet has little more than three feet of topsoil spread over its surface. The Seattle Post-Intelligencer calls it “the shallow skin of nutrient-rich matter that sustains most of our food.”
The problem is that we're losing it faster than we can replace it. And replacing it isn't easy. It grows back an inch or two over hundreds of years.
This is not lost on certain far-seeing investors. Jeremy Grantham, the curmudgeonly head of the money manager GMO, wrote about soil depletion in a recent quarterly letter. “Our farmers are in the mining business! Yes, the soil is incredibly deep, but it is still finite.” For every bushel of wheat produced, we lose two bushels of topsoil.
Erosion, development, and desertification eat away our topsoil. “Globally, it's clear we are eroding soils at a rate much faster than they can form,” notes John Reganold, a soils scientist at Washington State University. Estimates vary. In the United States, the National Academy of Sciences says we're losing it 10 times faster than it's being replaced. The United Nations says that on a global basis, the rate of loss is 10 to 100 times faster than that of replacement.
In any case, it seems safe to say that good dirt is in short supply. The obvious investment conclusion: Buy farmland.
A firm called Agcapita prepared this little graphic (Figure 12.3) that summarizes where we are in terms of arable land per person. For the first time, we're in danger of slipping below one acre per person.
We don't need 2.8 acres per person anymore because of advancements in agriculture over time. Over the past 40 years, we've increased the yield per acre by 2.1 percent percent per year. But the pace of those gains is slowing. Since 2000, the increase in yields per acre has averaged less than 1 percent per year.
We may see new innovations in seeds or other technology that we can scarcely imagine. But it seems that any solution would take some time and money to implement. Meanwhile, the world's agriculture markets get tighter and tighter.
In 1974, the cereal crop consumption was about 1,500 bushels per second. Today, it's 2,600 bushels per second. So, we have a double effect here. We have increasing population with an increasing amount of consumption per person. Agcapita estimates that cereal crop consumption will double again over the next 20 years. The pressure on the global food supply network is enormous. This again is a reflection of people eating better and eating more meat, which requires exponentially more grains to produce.
There is another wrinkle to the story. And that is that most every oil-consuming country has put in place biofuel targets. These nations include the United States, the European Union, Canada, Japan, Brazil, India, and China. To meet their targets, according to work by Agcapita, we'll have to commit some 240 million acres to biofuel production. That represents about 50 percent of the arable land in North America. Or you can look at it as 6 percent of all arable land in the world. The biofuel craze puts further pressures on farmland demand.
Outpace Inflation with Farmland Investing
The other appealing aspect of farmland is how well it did in the inflationary environment of the 1970s (see Figure 12.4). If you believe that we will continue to feel the bane of inflation, as I do, then farmland's performance in the 1970s will give you some comfort.
So you see that while you lost half of your money in the S&P 500, your farmland kept its value nicely. Again, I think that's rooted in the fact that farmland is intrinsically useful.
Now imagine what farmland might do in today's climate. We have not only the likely prospect of inflation, but a tightening supply of farmland and rising demand for its crops. I imagine you'll do quite a bit better than the 1970s vintage.
There's another way to reap the value of good soil: Own farming assets in grain-exporting countries. We'll explore a couple of ideas in a bit, but first, let's tackle another big challenge in expanding crop production.
Yet another obstacle to increased food production has to do with water restraints. Some of the largest cities and population centers happen to be in areas with little water, like China's urban north.
This creates water-based food bubbles. A water-based food bubble forms when farmers tap into more and aquifers and food production rises. But the rate of water extraction exceeds the aquifers' ability to recharge. So you have a water-based food bubble, meaning production is unsustainable and will collapse at some point as water supplies run out.
The best example of this dynamic is Saudi Arabia. For years, pumping water from aquifers allowed Saudi Arabia to be self-sufficient in food. But wheat production is collapsing as the aquifers run dry. The Saudis will soon import all of their grain needs.
According to Lester Brown at the Earth Policy Institute, Saudi Arabia is one of 18 countries with water-based food bubbles:
Altogether, more than half the world's people live in countries where water tables are falling. The politically troubled Arab Middle East is the first geographic region where grain production has peaked and begun to decline because of water shortages, even as populations continue to grow. Grain production is going down in Syria and Iraq and may soon decline in Yemen. But the largest food bubbles are in India and China.
The World Bank estimates some 175 million Indians and 130 million Chinese are fed by water-based food bubbles. That's a lot of mouths, nearly equal to the population of the United States. What happens when the aquifers run dry in China and India as they did in Saudi Arabia? I am sure you can guess the answer.
The simple fact is that we have to change some things about how we produce food, where we produce it, and the mix of what we produce. One particular crop in great shape to benefit is a group called pulses.
Pulses are crops harvested for the dry seed. They include lentils, chickpeas, peas, and a variety of beans. They are an efficient source of protein by weight, giving you almost as much protein as chicken and more than beef (Figure 12.5).
Most importantly, pulses require far less water. It takes only about 40 gallons of water to produce one pound of pulses. Compare that to the nearly 2,000 gallons of water to produce one pound of beef. Agriculture is the single-biggest user of water on the planet, accounting for about three-quarters of all water drawn from rivers, lakes, and aquifers. And across large swathes of the Earth, like China, South Asia, the Middle East and North Africa, current water extraction rates are unsustainable, as I noted above.
So this is a big deal and a giant plumed feather in pulses' humble cap.
Pulses are much cheaper than meat. It's no surprise that pulse crops are becoming a growing source of protein in emerging markets, especially those in dry regions or in places where water is problematic, such as the Middle East, India, and China.
The World Bank projects demand from emerging markets will grow to 45 million tons by 2030. Major importers such as India, Turkey, and Egypt will only import more. And China, which has been an exporter, will soon flip to a net importer of pulses. We know what happens when China becomes a net importer of something. It really juices the market. We're only in the beginning of that wave for pulses.
There is another great benefit to pulses' key to the investment thesis. Pulses have nitrogen-fixing properties. They fit well as part of a crop rotation system. By alternating pulses with wheat and canola, farmers don't have to leave the land fallow in the summer. Pulses naturally replenish nitrogen in the soil, and they thrive in the dry prairies of Saskatchewan. This reduces your need for nitrogen fertilizers. Since nitrogen fertilizers make up half the energy costs of most North American farms, planting pulses makes good sense. I would not be surprised to see the practice spread in developing countries.
So I like the long-term story on pulses. And I've found a keeper, a great way to play the pulses.
Bringing Crops from the Producer to the World
I sat down in a quiet Italian restaurant (owned by Persians) in Regina, Saskatchewan. At the table were Murad Al-Katib, the president and CEO of Alliance Grain Traders, and his older brother Omer, head of investor relations. Both were born and raised in a little town in Saskatchewan, from a family of Turkish descent. What I learned made me respect Alliance Grain Traders all the more.
The Al-Katibs are passionate about their business. I felt we could talk all day about the world of lentils, peas, chickpeas, and beans. They love this stuff, which is a good sign. They are owners. Insiders and employees own about 35 percent of the company, which I love to see as an investor. In fact, Murad started it all 10 years ago with a simple idea.
He saw that Saskatchewan farmers harvested their lentils and shipped them out raw and unprocessed, bugs, dirt, everything. Somewhere else the crop was processed, cleaned, peeled, split, polished, sorted, and so on. These activities add value.
So, Murad thought, why not process the crops here, close to the source, sell the byproduct to the feed markets, and maximize the value of the product? He wanted to capture more of that value, control the logistics, and manage those relationships with farmers and buyers.
AGT grew out of that kernel of an idea. Today, AGT is one of the largest lentil- and pea-splitting companies in the world. Its 26 facilities occupy the best pulse-growing regions in the world, primarily Canada and Turkey, but also the United States, China, and Australia. It ships pulses to 85 countries. The company's slogan captures it all: “From producer to the world.”
AGT continues to grow, both organically and by making neat-fitting acquisitions. “It's like I see what the completed puzzle looks like,” Murad said. “And now I just have to fit in the pieces.” While I was there, AGT announced picking up another pulse processer in Australia.
I have a greater appreciation for how AGT's business works and fits together as a result of the tours and time spent with the Al-Katibs. Let me try to explain it simply.
You can imagine a raw crop that comes right off the farm. It's a long way from landing on your table. So let's look at how AGT gets more value from lentils.
AGT cleans them, peels them, and sorts them. It can sort them by size, for instance. Different-sized lentils command different prices. If you just bag them all without sorting them, you lose some value there. AGT can sort them by color and reject bad lentils. I saw this process firsthand, and I can tell you it is amazing. Imagine a machine with a carpet of lentils flying down a screen in a blur. Yet there is this optical computer sorting them, rejecting individual lentils, looking for sizes, colors, faster than you can see. In this way, AGT can “grade” its lentils, selling premium lentils in one bag and a lower grade in another, and make more money than if it just sold the bag unsorted.
AGT can split the lentils. Split lentils are easier to cook, and they command a higher price. AGT can polish them to varying degrees, which adds more value, so they can charge more. AGT even bags them. There are different kinds of bags. If you want a certain premium bag, AGT charges more. This is something the Al-Katibs hammered home: AGT performs lots of services, and for each, it charges something. This is what they mean by “value added.” The term gets thrown around a lot, I know. It's kind of lost its meaning, but here you can see what it means. The things AGT does are not easy to imitate, and, clearly, alter the product.
First, you just can't buy these machines off the rack. AGT's lentil-splitting operation is proprietary. While I was there, they wouldn't let me take pictures of certain aspects of the production. Even if you could replicate the machinery, you'd need people, and this business is as much art as science. There is a need for skilled labor, of which there is something of a shortage in the province. AGT hand-picked some dozen Turkish technicians and brought them to Saskatchewan.
This is because AGT merged some time ago with Arbel (a Turkish pulse processor) and has a strong connection to that country. (The family that owned Arbel remains big investors in AGT.) The Arbel Group, operating within the AGT fold, produces pulses as well as rice, semolina, bulgur, wheat, and wheat flour. Through Arbel, AGT picked up Arbella Pasta, the third-largest-selling brand of pasta in Turkey, which is sold in 50 countries worldwide (though not in the United States). This is a natural extension of processing and milling and fits well with what AGT does. The Al-Katibs gave me some samples of the pasta, which my wife and I prepared when I got home. It was good pasta, and the kids loved it.
In short, once product leaves AGT's plant, it's ready to be used as food. This is why Murad told me AGT was “more a food story than a commodity story.” And when I asked him what he thought the biggest opportunity ahead was, he didn't hesitate. It was transitioning more and more to a food ingredients company.
Remember, this is a key part of the attraction of pulses. They are low in fat, high in protein, and provide a low glycemic index; they are a good source of fiber, complex carbohydrates, vitamins, and minerals (especially potassium, phosphorous, calcium, magnesium, copper, iron, and zinc). They are relatively inexpensive and use less water to grow.
These attributes encourage food companies to add lentil flour to cereals, breads, cakes, and baby foods to bolster the nutritional value of their products. They do this to satisfy increasingly health-conscious consumers and to get a leg up on competitors. This is a trend that is only starting, and it's a huge opportunity for AGT!
These food companies are not just going to buy from anybody. You don't mess around with food ingredients. AGT provides that confidence with its top-of-the-line facilities and track record. I saw machines that would pick out pieces of metal smaller than the tip of a pencil. I watched AGT's inspectors work. They track everything, and they know the chemical composition of everything that leaves their plants down to every shipment. It's an impressive operation.
Beyond this, I want to say a few more words about AGT's informational advantage. The market for pulses is global, and accurate pricing information is a competitive asset. It's not as if there is a liquid exchange with price quotes for split lentils of a certain grade. AGT has a network that extends the world over. It uses this information to its advantage.
I asked Murad how the company makes decisions about which lentils to sell or split, for instance. The company has a lot of trading decisions it could make. It can move around in this value chain of pulses to maximize returns. Murad told me all the decisions are made centrally. So, all the information captured every day by its processors around the world feeds back up to Regina. There, with this worldly window, AGT can decide how to buy and how to sell.
Importantly, AGT is not speculating on pulse prices. It's always covered, and it holds minimal inventory. It's more a business about capturing a spread between a raw product and a finished good.
This is not a quarterly earnings story; this is about long-term wealth creation. Murad is not going to manage this business to produce a quarterly earnings number. In fact, Murad doesn't even provide quarterly earnings guidance or any guidance at all. He doesn't play Wall Street's dumb game. And thank goodness for that. He'll manage the business as an owner because he is an owner himself. I can't stress the importance of this kind of orientation enough.
Recently, two family-owned processors of pulses and other crops merged. They merged with the idea that they would go public and use the proceeds to build a new canola-crushing plant in the United States.
According to AgCanada.com:
On Monday, Roy Legumex of St. Jean Baptiste, Manitoba, and Walker Seeds of Tisdale, Saskatchewan, announced their merger under the name Legumex Walker Inc. (LWI) and their filing of a preliminary prospectus for an initial public offering (IPO).
The combined LWI becomes what's billed as “one of the largest processors of pulses and other special crops in Canada,” combining Roy Legumex's plants at St. Jean, Morden and Plum Coulee, Manitoba, and Regina with Walker's processing and packaging facilities at Regina, Saskatoon, Brooksby, and Runciman, Saskatchewan, plus, a stake in a plant at Avonlea, Saskatchewan.
Brad sent me the following note on the Legumex Walker IPO:
I see this merger-IPO as being driven by the success of Alliance Grain Traders. AGT has been able to gobble up plants all over the world and become a dominant player because it had access to capital from the public markets. We're going to see a lot more of this as many agricultural enterprises scale beyond the ability of their founders to bootstrap them, coupled with the need of the founders to find liquidity for family and estate-planning purposes.
I agree. And Alliance Grain Traders has a big leg up on the competition.(Legumex-Walker went public in the summer of 2011 and now trades on the Toronto Stock Exchange.)
Another long-term grain play I like is Viterra. The name is new, perhaps some amalgamation of “vital” and “terra,” but that is only a guess. The old name, Saskatchewan Wheat Pool, reflected its old-world trade.
Viterra is in the grain moving, storing, processing, and cleaning business. But, Viterra is not a straight-up commodity play in the sense of selling grains. You would do better to imagine a toll road. Volume is the name of the game. Volume and efficiency, not grain prices, dictate the profit profile here.
Its largest business is grain handling, chipping in 65 percent of sales. Viterra has lots of those tall grain elevators you may have seen in grain country. About two-thirds of Viterra's grains eventually head west by rail and ultimately wind up in the Asia Pacific region. So it's a fine back-door play on the booming demand in Asia and its people's rapidly evolving diets. A falling Baltic Dry Index, which measures shipping costs, bodes well for Viterra. Cheaper shipping costs make Western Canadian grain cheaper for Asian buyers.
Viterra's second-largest business is selling agricultural products, such as fertilizer, seeds, and crop protection products, as a retailer and distributor. The company has 276 retail locations across the Canadian prairies. Like any other retail business, the drivers here are volume and margin. In these two lines, Viterra is the biggest dog on the block, with 45 percent market share in Western Canada.
In the big-picture sense, Viterra's profits tie more closely with seeded acreage and the mix of crops so planted. These tend to be stable variables over time.
And just to juice up the mix a bit, Viterra has a 34 percent interest in Canadian Fertilizers Ltd. (CFL), a nitrogen fertilizer plant in Medicine Hat, Alberta. Here CFL earns a spread on the difference between fertilizer prices and natural gas. This business is not particularly significant at the moment, but it is an interesting asset, nonetheless.
Viterra has numerous options in how it uses its cash and balance sheet. These could include acquisitions, which, in a market where cash and credit are hard to come by, and may lead to some bargains among smaller, less-financed operations.
Though it has little bearing on the share price, Viterra may be the only publicly traded enterprise run by a former NFL wide receiver. Mayo Schmidt, CEO of Viterra, played wide out for the Miami Dolphins in a brief stint. More importantly, though, Schmidt deserves credit for making many great moves, such as the acquisition of Agricore in 2007. He's proving a savvy chieftain.
There are more moving parts here, but I'll simplify for the sake of brevity. The bigger picture is what I want you to focus on. In Viterra, we have a well-financed and well-managed company. It's expanded globally with a large presence in Australia and a growing presence in New Zealand and the United States. The company has big winds in its sails. The best way to think about Viterra is, again, to think of it as owning the global toll road for grains. I don't see any decline in the traffic on that toll road over the next several years.
Of Course, There's More to Canada than Saskatchewan
There is more to Canada than Saskatchewan. But as this book draws from my own personal travels and interests, Saskatchewan is where I've focused this chapter, since I think it's a story you don't hear much about.
More broadly, I think Canada will be fine in a world turned right side up. Saskatchewan is emblematic of why. It has loads of coveted natural resources, and the trend is toward unlocking that wealth. Canada has become a leading producer of a long list of commodities. (See Figure 12.6.) For investors, there are many opportunities.
Figure 12.6 Canada's Natural Resource Wealth
Source: EIA, Global Insight, U.S. Geological Survey, EU Energy, USDA.
Canadian companies make up an increasingly large portion of my portfolios, as Canadian markets have seeded a number of companies in oil, gas, and mining that offer compelling rewards for shareholders. What's more, Canada has produced a stable of large, globally significant players: Cameco in uranium, PotashCorp in potash, and several others.
I'd like to end the chapter with two favorites of mine, Canadian Natural Resources and Brookfield Asset Management.
Canadian Natural Resources (CNQ:nyse) is one to keep. As I write, it is a $40 billion enterprise, a behemoth in oil and gas. It is one of the largest producers of heavy oil in Western Canada and the second-largest producer of natural gas. It has a long history of boosting production and reserves. It has an enormous asset base to continue on such a path for many years to come. Canadian Natural's operations are low-cost and long-lived. Every quarter, the team gives a detailed view of the business that should satisfy the great stickler for disclosure.
However, there is something else special here. Its management team owns a good stake in the business. That's important. They act like owners because they are owners. Figure 12.7 makes the point.
All things being equal, you should always prefer to invest with owners, rather than management teams that own token amounts of the companies they manage. The decisions owners make are better over time.
In a similar vein, I like Brookfield Asset Management for the long-term investment. It is quite a different company. It is focused on real estate, hydropower assets, and infrastructure. Brookfield manages over $150 billion in assets for clients. Its real estate is only high-quality property in big cities like New York and Toronto. Its hydropower portfolio is one of the largest in the world, high-quality, long-lived assets that produce free cash flow and are hard to replicate. Its infrastructure assets are the key components of trade: ports, rail, pipelines, and transmission lines.
Management has a 19 percent stake in the business. Led by CEO Bruce Flatt, it is a talented group with an exceptionally good track record, reflected in Brookfield's market-beating share price. The company is conservative, carrying lots of cash to buy when things get ugly. It's frequently made its best purchases by picking over the carcasses of busted competitors. Canadian Business once featured Brookfield in a memorable profile titled “A Perfect Predator.” It is.
I view these two as core positions, and this chapter rich in those sorts of ideas. One could do well over the next decade by building core positions in my favorites: Alliance Grain Traders, Viterra, Canadian Natural Resources, and Brookfield, to say nothing of a position in Saskatchewan farmland.
The countries poised to grow and prosper in the next decades need all the things Canada has and does well. Canada and Saskatchewan will have great market share from MENA, China, and beyond.
Five Key Takeaways
For more on farmland investing in Saskatchewan and lots of other good related information, visit Assiniboia's website: www.farmlandinvestor.ca/.
Agcapita is another firm offering a wealth of information on farmland in Saskatchewan. Visit the website at www.farmlandinvestmentpartnership.com/.
Alliance Grain Traders is a great way to play the world's need for more food as it is the leading processor of pulses: lentils, chickpeas, peas, beans, and more.
Viterra is another leading grain processor of commodities such as wheat and has a worldwide reach.
Two long-term core Canadian holdings to check out: Canadian Natural Resources and Brookfield Asset Management.