Growing Champions: A new type of champion in agro-commodities

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An investment in agricultural commodities is not for everyone. It requires an ability to manage volatility, willingness to stay the course over the longer term, and comfort with regulatory shifts that you cannot control. Yet, gradual changes in the industry and several untapped segments are opening up new opportunities for fast-moving private equity (PE) players, especially in Southeast Asia.

The world will need to produce more food in the next 40 years than it did in the previous 10,000 years combined. With demand on the rise, so is the pressure to improve yield and a growing need for animal protein, especially in emerging markets.

Higher productivity will be driven by new technology, innovation and consolidation, but there are real commercial opportunities beyond the core crops, such as in life sciences, renewable energy, animal feed and organic chemicals. Outside the major capital cities, smaller cities and towns are presenting exciting opportunities in specialised storage and conversion capabilities.

With demand outstripping supply across most major categories in this sector, investments in agro-commodities will provide for underlying capital appreciation, annuity income streams, and more importantly, a fundamental certainty.

With 9 out of 10 agro-commodity businesses being family-owned, traditionally, the industry had been closed to capital markets. But the investment landscape is changing and there has been a gradual opening up of the sector. These trends have not gone unnoticed. Large strategic players have been aggressive in the merger and acquisition markets, with long-term capital commitments.

Meanwhile, a new type of player is emerging on the scene — PE companies, though their participation is still small. Agriculture-focused funds are still small in number compared with the many on infrastructure and real estate.

In Southeast Asia, PE players have a unique set of advantages. Fast-growing populations, increased urbanisation and affluence, nascent use of agri-technology, numerous smallholdings and relatively rudimentary farming practices — all these factors make this region very attractive.

First-mover PEs can quickly build an investment track record by gaining access to the best deals and position themselves strongly against newer entrants. If commodity prices rebound, PEs that enter the market first will also secure discounted assets.

Competing in a space different from strategic players, the PE player’s objective will be to source nimble assets, which can be flipped within a five-to-eight-year period. There are six sub-segments that are relatively untapped, which can be explored by funds looking to make the most of the shifting dynamics of agro-commodities.

Upstream plantations: Funds can look at acquiring and improving efficiency by introducing agri-technology, high-yield seeds and operational best practices. Rolling up smallholdings and achieving scale should not be too challenging either, and combined with the rebound of commodity prices and land value appreciation, this sub-sector will be a great place to start.

Palm oil bulking and storage: This sector has a high cost of entry and the need for deep technical expertise means that only a few firms currently dominate the scene, with extremely high margins (about 30% earnings before interest and tax). With the region rapidly growing into a palm oil export hub, there is room to expand reach and cater to the under-served plantation landbank, such as in Sabah and Sarawak.

Agriculture technology: There is also growing pressure for yield improvement in a region that is limited in its adoption of new and cutting-edge agriculture technology. This creates an opportunity to partner local distribution networks and gain access to unreached markets. As a first mover, ensuring continued use of these products will then translate into a significant advantage over later entrants.

Refrigerated distribution and storage capabilities: Growing demand for animal protein in the region has acted as a catalyst for some potentially high-return segments. The increasing presence of modern grocery shops in emerging markets means a growing need for refrigerated distribution and storage capabilities. However, the competitive landscape of this segment is still highly fragmented, leaving room to grow a robust market leader in this fast-growing industry.

Meat-based food processing: This is also a great opportunity for roll-up players to build a market leader with strong brand equity and capture market share in an industry which has significant long-term growth potential.

High-quality specialty aquaculture feed: In the longer term, a maturing aquaculture industry will likely drive the demand for high-quality specialty aquaculture feed in the region. Expertise is a key barrier to entry in this segment, so there is opportunity to acquire and regionalise an aquaculture feed player with proprietary know-how in specialty aquaculture feed production.

Of course, there are challenges. One of the main hurdles will be to navigate politically complex markets with rapid regulatory changes. It might also be difficult to convince prospective investors to put their money in a segment where there is no real track record of PE returns. However, the size of the opportunity is too large to ignore.

In the end, it may well be the case of the one who dares wins.

Zarif Munir is a partner and managing director at The Boston Consulting Group, Kuala Lumpur

This article first appeared in Forum, The Edge Malaysia Weekly, on May 11-17, 2015.