Invest in other markets

Volatile markets and politics make SA farming particularly risky. In a two-part series, Nicolaas Hanekom from AngloRand Securities tells Glenneis Erasmus how diversification can reduce financial risks and generate wealth.
Issue date : 27 June 2008

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Since deregulation, increased risk has forced producers to diversify their financial portfolios. Most farmers are either adding value to their product (horizontal integration into the value chain) or expanding their product range (vertical integration). I n the Swartland, for example, farmers have started their own mills and bakeries to add value to their wheat. In the southern Cape, many wheat producers have incorporated a livestock component: by utilising rotation crops, livestock adds value to wheat production.

This diversification also makes producers less vulnerable to market fluctuations. If the price of one commodity is low, the other might still be profitable. Climatic risk is also reduced. A hailstorm might destroy a whole crop; animals under cover will just sleep through it. But Nicolaas Hanekom from AngloRand Securities, a member of the Johannesburg Stock Exchange (JSE), argues that this isn’t enough – farmers should learn from Warren Buffet about sound investments. he primary shareholder and CEO of Berkshire Hathaway, Buffet is one of the world’s greatest stock market investors. Forbes ranked him the wealthiest person in the world with an estimated net worth of around US billion in February 2008.

Buffet attributes his success to one principle – only invest in companies with a good chance of generating large profits, and a risk of making a loss once in every 10 years. Avoid investments that do the opposite. Farming: low profit, high risk Farming is in the low-profit, high-risk category.

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Hanekom explains that rising input costs and extreme market fluctuations strain farm profit margins enormously. SA farmers have to cope with these and climatic risks, as well as with a changing political environment. Crop farmers, for example, are essentially commodity, currency, weather and political speculators. they apply the same level of risk management, knowledge and skill needed to farm successfully to an investment on the JSE, Hanekom says they’d generate surprising returns. The agricultural sector receives the least government support in the world.

Investment is also hindered by the proposed Expropriation Bill and other policies – many farmers fear they’ll lose their land and are afraid of investing further in their farms. Farmers should be compensated for the increased risk of capital loss with higher profit margins, but in practice they generate a relatively low return on capital because their competitors in the US and Europe are heavily subsidised. Canny entrepreneurs wouldn’t invest more capital in a business with this skewed risk:reward profile.

“Our policy makers are economically illiterate and don’t understand the game the is playing with the international trade in agricultural products,” says Hanekom. “The world is in an energy crisis, and by increasing subsidies to their farmers and ethanol plants, the strengthens its stronghold and position on food and energy security by bankrupting producers in Africa.” He says the and EU are protecting their rural jobs by subsidising their farmers, while exporting produce and unemployment to Africa. The unemployment rate in the is 4%, compared to 40% in SA. However, this doesn’t mean farmers should stop farming.

They must take stock and decide exactly why they are farmers – there are two types, says Hanekom. Lifestyle farmers are born to farm. They reinvest all their profits back into the farm, either by buying better equipment or more and more land. These farmers, regardless of the value or size of their land, can resemble subsistence farmers because they never have a good cash flow or investments outside agriculture. They usually only see their money when the farm is sold – if it isn’t passed on to the next generation.

The other type of farmer sees farming as a business and income generator. Instead of buying more and more farming equipment that devalues over time, they seek ways to generate wealth with their profits. They’ll share a tractor with their neighbours and only make the minimum required investments to ensure farming profitability. The rest of their profits are invested in other areas to generate compound growth. Sound investment strategies The trick here is to find a sound investment. Some farmers buy into property syndicates or shop franchises or start selling their own products. Hanekom, however, warns that all of these carry high risks.

“It’s been found that 85% of new businesses are liquidated within three years. The risk is much lower if you buy shares in a listed company. You’ll share in the best companies’ profits, whereas you’d be dependent on your own success if you started your own business.” It’s much less risky to buy shares in the company that buys your wheat – for example, Pioneer – and share in its profit, than to start a new grain-trading company. Pioneer already has specialised and experienced staff as well as established infrastructure and clients. It’s unlikely that a new miller or baker would generate the profits of an established company in our competitive market.

As for property syndicates, Hanekom warns that investors must ensure they enter these agreements with financially sound partners. “What happens if your partners can’t pay their share or go bankrupt? Will you be able to buy them out or will you lose your share if the bank has to repossess the property?” He adds that property investment is no longer highly profitable. “Some people argue property prices haven’t stagnated, but the market has slowed to such an extent that it takes about eight months to sell a property.

Property shares have declined almost 30% since October 2007, which is an indication of the market conditions.” Managing a portfolio Hanekom explains that well-managed portfolios have been outperforming farming enterprises. The average Swartland farm, 30 years ago, was worth R220 000. This would have grown to R22 million if all profits were reinvested into buying more land. The original land alone is now worth R6 million. An investment in Absa would have generated similar returns to a farm over the last 20 years.

The long-term return for a farming enterprise in SA is about 3,5% per year, and Absa’s dividend yield is 4%. However, a farming income is taxable, and the income from shares is tax-free. Thus, with a farm, capital gains are 10% per annum, while with Absa shares they’re 19%. Thus, Hanekom jokes that the easiest way to get hold of your neighbours’ farms would be to buy shares in the bank where they have their overdraft or loan.

If you invested in the best available equity fund, the R220 000 investment might generate over R1 billion with 29% annual compound growth over 30 years. However, these are exceptional returns, not the average investment. In the long run, a managed investment in listed companies can generate good returns at an acceptable risk level.

Read more about ways to select shares to invest in next week’s issue. Contact Nicolaas Hanekom on (021) 975 4790 or e-mail [email protected]. Disclaimer: Any investments generating returns on the Stock Exchange Market in the past might not necessarily yield the same returns in the future. There are financial risks involved in trading in the stock market. Prospective investors should therefore first speak to their consultants before investing in a specific division. |fw