Adecoagro: Most Inexpensive And Speculative Farmland One Can Buy (NYSE:AGRO)

Farmland has become a hot commodity these days with rising food prices and inflation. In fact, The Federal Reserve Banks of Chicago and Kansas City have estimated a YoY appreciation in farmland value of 20%. That is eye popping performance and well above the average CAGR in farmland appreciation of 5.7%.

I love farmland. Not just as an investment. Farmland is enjoyable to view and a great place to spend time and grow (pun intended). But I hate overpaying for farmland. That’s why I do not own Gladstone Land (LAND) which I wrote about last month. Because farmland is uncorrelated with general equities, it is a strategic portfolio asset that I want to own.

The war in Ukraine is causing commodity prices to soar even further. Russia and Ukraine are responsible for approximately 25% of global wheat exports and 15% of global corn exports. Sorry, I meant to say ‘were responsible.’

The crisis is causing wheat and corn prices to go vertical. Wheat futures are up 50% since the beginning of the invasion. You can’t tell, but I look like I’ve just seen a ghost. About 20% of all calories consumed by the human race comes from wheat. This means that the cost of eating increased 10% over 2 weeks.

This is a great cause for concern. History shows that people are most desperate when they cannot afford to eat. Eventually high food prices cause social unrest. While I have hope that the war in Ukraine will end soon and food prices will stop rising, I don’t see “cheap” commodity prices for a long time. Ukraine and Russia will not ramp up food production quickly. We do not know the measure of destruction that will result from this war or how long it will take to rebuild.

This is why I’m taking another look at farmland investments. There are nine equities on my radar. One of them is really cheap, but unfortunately it comes with great risk. Higher commodity prices have risen the bottom line and geopolitical risk. That stock is Adecoagro S.A. (AGRO).

Let’s Meet The Contenders

I have a list of nine U.S. listed equities that own significant quantities of farmland with a market capitalization of at least $100 million. For this article, I’m interest in farmland first and foremost. Specifically, I’m referring to crop producing farmland. Several of the following companies own more than just crop producing land. For example, Cresud owns residential and commercial real estate in addition to their agricultural holdings. Fresh Del Monte and Mission Produce have processing and distribution infrastructure. Adecoagro has sugarcane and ethanol processing plants and also produce bio-electricity. This is considered in the overall valuation of the stocks, but the cropland is my primary focus. Now, let’s meet the contenders:

Land Packages

The land packages of each company are in the table below. I’m interested in how many farmland acres they own. I’m not interested in how many acres they lease. The location of the farmland is crucially important. I also want to know what they produce with that land.

The following information was derived from presentations and financial reports from each of the company’s websites. The information is the best estimation available at the time. Links to the company websites are above.

AGRO, LND, and CRESY have the largest land packages all located in South America. They grow the same types of crops, focusing on row crops that do not require irrigation. These companies own and operate their cropland. They are fully exposed to cost inflation and farming risks but also experience the full benefit from rising commodity prices.

FPI has row crop exposure in the United States. LAND, FDP, LMNR, and ALCO own mostly high value fruits and nuts in the U.S. that usually require irrigation and are costly to install. AVO grows avocados on their cropland in South America. Normally, higher value crops are a better investment. But with all things being equal, I would rather own farmland that produces staple crops like wheat, corn, and rice over expensive fruit and nut crops in this environment. That’s because I see consumers around the world suffering from inflation and needing to cut costs. They will cut back on luxury foods before staple foods.

LAND and FPI are the most well known to U.S. investors. They are REITs that own farmland across many States. They lease out their properties on a triple net lease basis. Therefore, they do not deal with farming operations and are less exposed to cost inflation. However, they are not immune to poor crop performance. If their tenants cannot make rent the REIT will suffer.

You can see how their property maps breakdown below. Many of their properties are in the same growing regions. The main difference between their exposure is the types of crops grown. About 70% of FPI’s portfolio produces row crops such as corn, soybeans, and wheat. Most of LAND’s properties produce berries, nuts, or tree fruit.

Financial Performance

The operations of each of these companies is unique and different from the others. Many companies own more than just farmland and several are involved in global marketing and distribution of food products. To evaluate each company I’m looking at the EV/EBITDA, P/CF, and ROTC to assess efficiency and value. I looked at Market Cap/Acre and Market Value/Acre to get a sense of how expensive the land is. The market value is the company’s stated value of the farmland, separate from the rest of the operation.

The following information was derived from presentations and financial reports from each of the company’s websites in addition to Seeking Alpha. The information is the best estimation available at the time. Links to the company websites are above.

AGRO has the cheapest cropland according to this information, which makes sense because they mostly grow low value crops. Farmland that grows high value crops are worth a lot more because suitable land is more uncommon, it often comes with irrigation rights, and perennial crops are expensive to plant. For example, is can cost more than $7,678 per acre just to plant an almond orchard, which does not include the cost to buy the land. This compares to the cost of planting wheat between $150-250 per acre, which is required annually.

For perspective, the average cost of cropland in the U.S. in 2021 was $4,420 per acre. About 93% of AGRO’s farmland is located across Argentina. The generalized cropping conditions of Argentina, including hardiness zone, precipitation, temperature, and soils, is similar to that of Texas. The value of non-irrigated cropland in Texas in 2021 was $2,090 per acre.

With a P/FFO of 46x and 44x I do not find LAND or FPI attractively valued, respectively. I’m not interested in ALCO, AVO, and LMNR due to niche crop markets in luxury foods. CRESY is too broadly invested and expensive for my taste. This leaves AGRO, LND, and FDP.

Between these three AGRO has the best Quant Grades. FDP has underperformed the group significantly. Cash flow from operations have been positive and consistent for AGRO while LND has suffered from volatile and often negative cash flow. The chart below has CFO for AGRO on the left and CFO for LND on the right. For these reasons, I want to take a closer look at AGRO which I believe to be the best performing farmland stock.

Company Outlook

AGRO is a sugar and ethanol company first. They are one of the lowest cost producers of sugarcane worldwide. They own and operate 3 sugar/ethanol mills and harvest over 180,000 hectares of sugarcane. These facilities have the ability to switch production between sugar and ethanol giving them the ability to adapt to changing market prices to maximize returns. Currently, they are running mostly ethanol because of attractive pricing.

AGRO produces hydrous and anhydrous ethanol which is primarily used for vehicle fuel. The company was optimistic about ethanol prices when oil was around $80 per barrel and it has risen 50% since. They also expect the Brazilian sugarcane crop to be lower than expected this year which will further support prices. Ethanol is an important fuel in South America. Ethanol accounts for more than 50% of gasoline use in Brazil compared to 8% in the U.S. In 2021, sugarcane production was down 27% due to poor weather conditions. The company expects sugarcane yields to return to normal in 2022.

In addition to sugarcane the company produces a variety of row crops on 262,000 hectares. Like sugarcane, they are also a low cost producer of crops like soybean, corn, and rice. Unfortunately, the cost of export taxes prevents AGRO crops from being competitive globally. According to an independent appraisal, company farmland appreciated by 2.4% in 2021.

This year they expect to plant 7.9% more acres than last year. They have secured their fertilizer needs for the current crop but if fertilizer prices continue climbing it will impact margins for next year. The farming enterprise recorded a 30% increase in EBITDA YoY for Q3 2021.

The company also produces dairy products and electricity, as a bi-product of their other operations, which helps to diversify the operation. Synergies from the vertical and horizontal integration of these enterprises leads to great efficiencies in company performance. This helps explain the steady rise in FCF and EBITDA per share over the past few years. EBITDA, in particular, has grown by 53% YoY while decreasing the shares outstanding. The company has achieved a reasonable Net Debt to Adj. EBITDA of 1.56x which is below the company goal of 2.

Several recent developments are appealing about the direction of AGRO:

• The company recently repurchased 5% of shares outstanding and plan to repurchase more in 2022.
• The company has announced the start of a dividend program of at least $30 million per year to be distributed semi-annually. This is about 2.5% at the current stock price.
• The company stored crops from the previous season, increasing their inventory by 2.3x, in an effort to sell at higher prices in Q4.
• The company is engaged in selling CBio carbon credits in the Brazilian marketplace.
• Management is focusing on new investments with 20-25% IRR. This includes value-added dairy products and biomethane production.

In 2020, about 74% of EBITDA came from the sugar/ethanol enterprise of the business. It has been the fastest growing segment of the company. It is advantageous for the company to have this enterprise because it helps to hedge the company’s exposure to energy costs on the farming side, but they can switch to producing sugar if energy prices are low.

Stock performance correlates with the prices of the commodities the company produces. Prices of these commodities has risen sharply since 2020.

Geopolitical Risk

So far we have seen a great company with bright future that provides investors with exposure to inexpensive farmland. Here comes the “but.”

Argentina is a terrible place to invest.

The Heritage Foundation ranks Argentina #144 in their Country Rankings for the 2022 Index of Economic Freedom, one rank above Haiti. Here is what they say about Argentina’s background:

Argentina, once one of the world’s wealthiest nations, is South America’s second-largest country. It has vast agricultural and mineral resources and a highly educated population, but it also has a long history of political and economic instability. Peronist President Alberto Fernández and Vice President Cristina Fernández de Kirchner, who preceded Fernández as president, began their four-year terms in 2019. Legislative elections in November 2021 weakened the strength of the Peronists in Congress. Popular disillusionment is widespread because of a weak economy and the country’s ninth sovereign debt default. To check inflation until after the election, the government imposed economically harmful price controls on hundreds of products. In September 2021, the government gained backing from creditors for a deal to resolve the default.

Argentina has a checkered history, at best, interfering with free market enterprises. Trade restrictions and regulations have impacted the competitiveness of commodity exports from the country. Consumer inflation, especially rising food and fuel prices, are going to pressure politicians in Argentina and Brazil to take drastic actions. They have demonstrated a willingness to engage in actions that harm businesses in the country in the name of the public good.

Just listen to what the company has to say on the issue. The following are excerpts from the Company’s 2013 Form 20-F filing:

The Argentine government has in the past set certain industry market conditions and prices. In March 2002, the Argentine government fixed the price for milk after a conflict among producers and the government. In 2005, the Argentine government adopted measures in order to increase the domestic availability of beef and reduce domestic prices.

Moreover, the Argentine government may increase its level of intervention in certain areas of the economy. For example, on April 16, 2012, the Argentine government sent a bill to the Argentine Congress to expropriate 51% of the Class D Shares of YPF, S.A. (“YPF”), the largest Argentine oil and gas company in Argentina. The expropriation law was passed by Congress on May 3, 2012 and provided for the expropriation of 51% of the share capital of YPF, represented by an identical stake of Class D shares owned, directly or indirectly, by Repsol YPF S.A., a Spanish integrated oil and gas company. The national government and the Argentine provinces that are members of the Federal Organization of Hydrocarbon Producing Provinces now own 51% and 49%, respectively, of the YPF shares subject to the seizure. This particular measure also sparked a strong international condemnation and had a significant negative impact on foreign direct investment in Argentina as well as restricted more the limited country’s access to international capital and debt markets. In response to the nationalization of YPF by the Argentine government, the European Union Commission threatened with the imposition of commercial sanctions (i.e. unilateral tariff preferences to Argentina). However, during February 2014, the Argentine government and Repsol YPF S.A. agreed to a compensation of $5,000 million payable in Argentine sovereign bonds to compensate Repsol YPF S.A. for the seizure of the YPF shares. This settlement was ratified by Repsol YPF S.A.’s shareholders and by the Argentine Congress through a law passed on April 24, 2014.

We cannot assure you that the Argentine government will not continue to interfere or increase its intervention by setting prices or regulating other market conditions. Accordingly, we cannot assure you that we will be able to freely negotiate the prices of all our Argentine products in the future or that the prices or other market conditions that the Argentine government might impose will allow us to freely negotiate the prices of our products, which could have a material and adverse effect on our business, results of operations and financial condition.

During the Argentine economic crisis in 2001 and 2002, Argentina experienced significant social and political turmoil, including civil unrest, riots, looting, nationwide protests, strikes and street demonstrations. Despite Argentina’s economic recovery and relative stabilization, social and political tension and high levels of poverty and unemployment continue. In 2008, Argentina faced nationwide strikes and protests from farmers due to increased export taxes on agricultural products, which disrupted economic activity and have heightened political tensions.

Future government policies to preempt, or in response to, social unrest may include expropriation, nationalization, forced renegotiation or modification of existing contracts, suspension of the enforcement of creditors’ rights, new taxation policies, including royalty and tax increases and retroactive tax claims, and changes in laws and policies affecting foreign trade and investment. Such policies could destabilize the country and adversely and materially affect the Argentine economy, and thereby our business, results of operations and financial condition.

The Argentine government may order salary increases to be paid to employees in the private sector, which would increase our operating costs.

The Brazilian government frequently intervenes in the Brazilian economy and occasionally makes significant changes in policy and regulations. The Brazilian government’s actions to control inflation and other policies and regulations have often involved, among other measures, increases in interest rates, changes in tax policies, price controls, currency devaluations, capital controls and limits on exports and imports. We may be adversely affected by changes in policy or regulations…

We are a Luxembourg corporation (“société anonyme”) and it may be difficult for you to obtain or enforce judgments against us or our executive officers and directors in the United States.

To make matters worse, Last year MSCI downgraded Argentina from “emerging market” to “standalone,” which caused AGRO stock price to take a 9% hit. AGRO will experience fewer capital inflows as a result of this downgrade.

On the bright side, Argentina and the IMF recently agreed to a credit facility extension. This measure is intended to stabilize the Argentinian financial situation. I suspect the agreement will change little in the way of economic prosperity and is likely another link in a long chain of economic failures by the country’s government. But at the very least there is some international pressure to take responsibility and additional nationalization will not be viewed favorably.

Best Case Scenario

Adecoagro is a quality farmland company that is performing well. In the best case scenario the Argentinian and Brazilian governments do not interfere with AGRO through debilitating taxes, tariffs, price controls, or expropriation. In that case I would expect the stock to perform well. It currently trades at an adjusted P/OCF of 4.09x which is below the 8Y average of 4.98x.

Using data from FAST Graphs I have created the following chart which illustrates the expected return over 1Y and 2Y time-frames at different price to cash from operations multiples. The size of the circles represents the probability of occurrence according to my judgement in the best case scenario. In that case, I expect total return CAGR of 20-40%.

Summary

AGRO is the epitome of “you get what you pay for.” The company is performing, the farmland is cheap, and current commodity markets are supporting strong cash flows. They have an ideal combination of diversification, integration, and low cost of production.

Enter, Atlas Shrugged.

If governments get involved investors will be lucky to breakeven. There is no limit to the amount the losses could be. Higher commodity prices lead to higher profits which lead to more scrutiny. The rising cost of food is alarming and social unrest should be expected. And with it, higher risk.

We should acknowledge that this geopolitical risk has existed for the entire 11 years since the company’s IPO and that has not prevented AGRO from outperforming the S&P 500 over the last three years, not an easy task. It’s also worth noting that 6 out of 9 farmland stocks we looked at have exposure to Argentina, Brazil, or other South American countries with similar geopolitical risk. Because of this, I’ve decided to start taking a closer look at ALCO.

I cannot disagree more with the SA Quant Ranking of “Strong Buy.” I’m really tempted to call this one a sell. The only reason I’m not is because I have yet to see signs of imminent government intervention. Therefore, I will hold onto my very small position in AGRO as a highly speculative part of my commodities portfolio. It is adrenaline-inducing to say “I own farmland in Argentina.”

I’ll be watching governments carefully with one finger on the sell button.