March 7, 2019

This article will be featured along with other articles addressing investment opportunities in agriculture and surrounding themes in the GAI Gazette, Volume 6, Issue 1, which will be distributed in conjunction with the 11th annual flagship Global AgInvesting event, held in New York City on April 1-3, 2019. Join us in New York to hear valuable insight and best practices for investment strategy from the expert speaking faculty. Learn more and register.

By Philippe de Lapérouse and Mark Zavodnyik, HighQuest Consulting

While the consensus is that agriculture has emerged as a distinct asset class, it nevertheless continues to be viewed as a challenging allocation for institutional investors. Lower crop prices following three successive bumper crops of soybeans and corn in the Western Hemisphere and the impact of the current trade war with China – which resulted in an erosion of farm income and a softening of land prices in the U.S. Corn Belt – may dissuade investors from committing capital to agriculture. Yet, like most things in life, timing is everything.

While returns on portfolios invested in row cropland prior to, or during the peak in farmland prices four to five years ago are likely to be down, due to lower commodity prices and cash rents, the current weakness in U.S. farmland values represents an attractive opportunity to acquire farmland at reasonable values. This would be done in anticipation of a rebound in commodity prices, which will be driven by the strong secular trend in global agriculture (rising GDP and populations in developing economies leading to growing demand for food during a period of increasing resource constraints).

Despite the headwinds noted above, farmland, along with other sectors across the agricultural value chain such as:

• crop inputs and services;
• robotics in the field;
• aquaculture; and
• indoor agriculture

represent attractive investment opportunities to pursue over the next 12 to 18 months for both strategic and financial investors seeking attractive returns and exposure in the agricultural asset class.

Farmland

Institutional investment in farmland ranges between US$28-35 billion.¹ Given that the estimated size of the “investable” universe of farmland globally is US$1 trillion,² less than 3.5 percent of the investable universe is owned by financial investors. We are clearly still in the early stages of the financialization of the farmland asset class.

While average farmland values in the U.S. Corn Belt have fallen 20 to 25 percent from peak levels realized in the 2012-14 period, farmland values in the region have stabilized within the past 12 months. Media coverage of the U.S. farm economy paints a bleak view based on a misleading comparison of current financial performance with that of the “golden age” of 2012-2014, when in fact current financial returns have reverted to the historical mean. Total U.S. farmland generated a return of 6.74 percent in 2018 with annual cropland in the Central Corn Belt generating a return of 2.64 percent, which approximates the rate for the 10-year U.S. Treasury note.³ The financial performance of the asset class is not as dire as depicted in the press.

Productive annual cropland in the U.S. continues to remain in short supply and is increasingly subject to water constraints. In addition, there is increased competition for leases driven by younger growers seeking to expand the acreage they operate in order to maximize their productivity. In many cases these growers, who are strapped for capital, depend on “non-operators”, including individual investors, family offices, and large institutions, to provide the necessary liquidity in the farmland market which enables them to access this acreage.

Therefore, despite a number of challenges (eroding farm incomes, an increase in farm debt, questions regarding future demand for renewable fuels, and the ongoing trade war), U.S. farmland continues to offer investors an attractive investment option that:

1. Protects against inflation;
2. Is negatively correlated with other financial assets;
3. Reduces the volatility of returns in a diversified portfolio; and,
4. Provides wealth preservation in a flat yield curve environment with expectations of long-term growth in global demand for food.

Farmland prices and returns vary across regions and different crop systems within the U.S. For example, farmland in the Pacific Northwest region, where a highly diversified range of crops are grown, generated an average return of 8.86 percent in 2018.⁴ Thus, as we have pointed out over the past two years, institutional investors are shifting the weight of their farmland portfolios away from annual row cropland in favor of specialty and permanent crops. In January 2019, the Alaska Permanent Fund Corporation announced its intention to reconfigure the target allocation for its $852 million farmland portfolio from 80 percent/20 percent row crops/permanent crops to 60 percent/40 percent due to the expected higher returns for permanent crops. Similarly, the Teachers’ Retirement System of Louisiana recently announced that it has established a $100 million separate account to be managed by Boston-based AgIS Capital for investment in permanent crops and related infrastructure.⁵

Disruptions in trade flows caused by tariff wars are likely to create opportunities for farmland investment outside the U.S. in countries located closer to major destination markets that are not embroiled in trade disputes. As countries dependent on food imports seek to diversify their sourcing of ag commodities, we expect that new players are likely to emerge, creating opportunities for farmland investing in non-traditional regions.

Crop Inputs and Services

Consumer concerns over food provenance and safety – where food comes from and how its produced (i.e. organic, non-GMO, sustainable production methods, etc.) – has emerged as a major trend in developed markets. As a consequence, consumers are playing an increasingly influential role in how food is handled and processed across the supply chain (production, processing, packaging, and distribution, etc.).

To stay ahead of this trend, retailers and distributors are requiring their suppliers to meet strict protocols that are radically upending established practices throughout the supply chain, and changing the range of crop inputs and services deemed acceptable for use in the field. This trend has opened the door for new players to develop and offer novel products, services, and technologies requiring a high level of sophistication to sell and support. This is disrupting the legacy ag retail and wholesale distribution sector in the U.S., with 100 of the largest ag retailers generating US$30.5 billion in revenue in 2019, according to CropLife magazine.⁶

The rapid adoption of new products and technologies (biologicals used for pesticides, fungicides and root development, and other precision ag technologies) has increased the options available to growers, which many legacy ag retailers find difficult to sell and support due to a lack of technological sophistication amongst their salesforce. There is clearly a shortage of skilled crop management advisors with the requisite technical expertise to advise growers responding to the changing requirements of the marketplace. Furthermore, with increased interest in “locally grown” agriculture and the growth of indoor agriculture, certain regions of the U.S. such as the Northeast, where agricultural production has largely been absent since the end of the 19th century, are experiencing an acute shortage of crop management advisors with the requisite technological skills.

“To succeed in the future, ag retailers will need to be generalists and broaden the depth of their expertise and technological knowledge as newer products such as advanced crop protection and agricultural bio-inputs come into the market,” said Chris Grallert, an industry expert and HighQuest Consulting affiliate.

New independent retailers (often not brick-and-mortar) have entered the market offering product knowledge and expertise, as well as a wave of new services such as product bundling, customized growing services, equipment, and data analytics. This is a sector where nimble new players and legacy crop input suppliers will have opportunities to acquire new capabilities and expand geographically by targeted acquisitions. For example, in January 2019, Wilbur-Ellis invested in Crop Enhancement Inc., a California-based producer of sustainable crop protection and agrochemical products for enhancing yields.⁷ The rationale given for the investment was “the powerful market force of hundreds of millions of consumers who demand sustainably produced foods.”⁸

Robotics in the Field

In response to a shrinking and more expensive labor force, the adoption of robotics in agriculture is increasing. The global market for ag robotics has been estimated by various industry analysts to be ~ US$3 billion and is expected to increase to US$12 to US$13 billion over the next seven years.

Increasingly stringent U.S. immigration laws are complicating the ability to hire competent and qualified labor in agriculture. While the national median annual cost of a U.S. farm worker in 2017 was $23,730 (or $11.41 per hour)⁹, the median cost for farm labor in California, where adoption of robots is the fastest in the U.S., is $20 per hour.¹⁰ According to a California Farm Bureau Federation survey conducted in 2017, 55 percent of responding growers have experienced labor shortages in recent years. Given that a majority are growing high-value crops, such as berries and grapes which have proven difficult to harvest mechanically, the labor shortage is particularly challenging.¹¹

Adoption of robots as an integral part of farm production provides labor cost savings and generates increased operating efficiencies. For example, the Harvest CROO Computerized Robotic Optimized Obtainer can pick a single strawberry plant in 8 seconds and cover 8 acres of strawberry fields in a single day, replacing the labor of 30 human pickers.¹²

The following are examples of recent investments in ag robotics:

• Blue River Technology’s (acquired in 2017 by John Deere for US$305 million) See & Spray devices combine machine learning with robots to identify exactly where the use of herbicides is required, thereby enabling them to significantly reduce overall usage.¹³

• Yamaha Motor Co. of Japan announced in 2018 that it had invested US$8 million in Robotics Plus, a New Zealand-based producer of robotics technologies used to grow and harvest fruits such as apples and kiwifruit.¹⁴ Yamaha’s interest in ag robotic technology is driven by persistent labor shortages in Japan.

With growing global demand for high-value specialty crops, the adoption of robots across the agricultural supply chain is expected to continue increasing, providing attractive investment opportunities.

Aquaculture

Global demand for seafood has increased 3.2 percent annually since 1960, outpacing the growth in the world’s population, with per capita consumption during the period increasing from 10 kg to more than 20 kg.¹⁵ Demand for seafood is driven by developing markets in Asia where fish has historically been a traditional source of protein, and by the trend toward healthy diets in developed markets. Given the growing demand and restrictions on wild catch fisheries, seafood production in farmed systems has increased dramatically over the past decade, growing at 8 percent annually since 2010.

While investment in integrated aquaculture production continues to attract capital, most investments in aquaculture have focused on developing alternative proteins (derived from insects, algae, and single cell proteins) to produce less expensive analogues for fish meal protein and fish oil (DHA) traditionally fed to carnivorous species such as salmon. This is due to the perception that investing in nutrition is a less risky proposition than investing in other sectors that support the aquaculture industry.

New gene editing techniques such as TALENs and CRISPR/Cas9, which act as “molecular scissors” to precisely cut into DNA to remove genes which are replaced with optimal genes from the same species, offer the opportunity to boost productivity of aquaculture production by reducing stress, and increasing disease tolerance while avoiding concerns over the use of gene transfer between organisms.

Finally, given estimates that 90 percent of seafood consumed in the U.S. is imported and 50 percent of that is farm-raised, guaranteeing the origin and the way a fish was raised is likely to become the accepted standard for the industry. Novel technologies, including digital infrastructure, that support traceability in the seafood supply chain will offer attractive opportunities for investors willing to spend time analyzing the sector.

Indoor Ag

Indoor agriculture has been one of the fastest growing agricultural sectors in the U.S. This method of “farming” can be undertaken in both urban and rural areas, reduces the water and carbon footprint of crops grown, and provides an opportunity to grow high-value crops year-round in inhospitable climates. It also reduces the distance required to ship products to urban areas with high population densities.

In 2017, the industry was comprised of 40,000 farms, operating more than 1 billion square feet of surface area, and produced crops with an approximate market value of US$15 billion.¹⁶

Labor costs, which are estimated to account for 49 percent of production costs for hydroponic farms and as much as 79 percent for aquaponic farms, are the primary factor limiting the industry’s ability to continue growing and attract capital.¹⁷ To reduce labor costs while increasing operating efficiencies, operators are seeking to integrate new automation technologies. Given that vertical farms require more labor than greenhouses (which typically operate at ground level), automation will be the critical factor determining the ability of vertical farms to achieve optimal scale.

Recent investments in indoor agriculture have focused on increasing automation. In January 2019, 80 Acres Farms, an indoor vertical farming startup based in Ohio, announced that it had raised US$40 million from Virgo Investment Group to build the first fully automated indoor farm.¹⁸ “The advantages of integrating a higher level of automation in indoor agricultural operations are too numerous to ignore: 24/7 availability, harvesting multiple crops with minimal change-over, germ-free, and one worker per machine vs. multiple pickers,” said Graham Mitchell, industry expert and HighQuest Consulting affiliate. “The indoor growing and vertical farm sector is going to be a first mover in adopting labor-saving automation and robotics technologies because the environments are controlled and predictable.”

Industry experts expect operators and investors to focus on the adoption of increased automation not only to decrease labor costs, but also to enable them to diversify the number of crops grown. This provides an opportunity to upgrade existing farms as well as build greenfield projects.

Other Opportunities Abound

Attractive investment opportunities are not limited to the sectors highlighted above. Another area to monitor is the market for products and technologies addressing animal health. Merck’s recently announced acquisition of Antelliq – a digital livestock tech company focused on digital animal identification, traceability, and monitoring solutions – from BC Partners for US$2.37 billion, marks the largest investment in ag technology to date.¹⁹ This sector will undoubtedly provide further investment opportunities as advances in IoT converge with big data and new technology solutions to redefine animal health and management in order to meet growing global demand for animal protein, and address consumer and regulatory concerns regarding traceability and food safety.

ABOUT THE AUTHORS

Philippe de Lapérouse is a managing director at HighQuest Partners, a leading global strategy advisory and consulting firm. HighQuest advises strategic players operating in and financial investors allocating capital to the global food and agricultural value chains on making informed decisions on strategy and resource allocation. Lapérouse chairs the Global AgInvesting conference series. He can be reached in St. Louis at +1 314.960.1632 or via email at pdelaperouse@highquestpartners.com.

Mark Zavodnyik is project manager for HighQuest Partners where he leads the day-to-day execution of consulting projects, advising clients on strategy and investment decisions across the global agricultural value chain. Previously, he was the lead tropical oils trader at AAK USA with responsibility for all sourcing, trading, and risk management in the United States. Zavodnyik has spoken at industry conferences on the efforts the industry has undertaken to make palm oil more environmentally sustainable. He can be reached at +1.574.274.3099 or via email at mzavodnyik@highquestpartners.com.

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DISCLAIMER: All views, data, opinions and declarations expressed are solely those of the author(s) and not of Global AgInvesting, GAI News, GAI Gazette, or parent company HighQuest Group.

^{1. Wheaton, Bradley and Kiernan, William. “Preqin Natural Resources Online” and “Farmland: An Untapped Asset Class? Quantifying the Opportunity to Invest in Agriculture”. Macquarie Agricultural Funds Management and HighQuest Partners. December 2012. (accessed February 15, 2019).↩}

^{2. Wheaton, Bradley and Kiernan, William. “Farmland: An Untapped Asset Class? Quantifying the Opportunity to Invest in Agriculture”. Macquarie Agricultural Funds Management and HighQuest Partners. December 2012. http://www.macquarie.com/dafiles/Internet/mgl/com/agriculture/docs/food-for-thought/food-for-thought-dec2012-us.pdf (accessed February 15, 2019).↩}

^{3. NCREIF Farmland Property Index – 4th Quarter 2018↩}

^{4. NCREIF Farmland Property Index – 4th Quarter 2018↩}

^{5. Kiernan, Lynda. “Teachers’ Retirement System of Louisiana Creates $100M Separate Account with AgIs”. GAI News. January 23, 2019. https://www.globalaginvesting.com/teachers-retirement-system-louisiana-creates-100m-separate-account-agis/ (accessed February 15, 2019).↩}

^{6. Hopkins, Matt. “CropLife Magazine Unveils Annual List of Top 100 U.S. Ag Retailers”. CropLife. December 3, 2018. https://www.croplife.com/croplife-top-100/croplife-magazine-unveils-annual-list-top-100-u-s-ag-retailers/ (accessed February 13, 2019).↩}

^{7. “Cavallo Ventures Makes Strategic Investment in Crop Enhancement to Advance Sustainable Agriculture”. Press Release. January 22, 2019. http://crop-enhancement.com/2019/01/cavallo-ventures-makes-strategic-investment-in-crop-enhancement-to-advance-sustainable-agriculture/ (accessed February 13, 2019).↩}

^{8. Ibid.↩}

^{9. Occupational Outlook Handbook. Bureau of Labor Statistics. https://www.bls.gov/ooh/farming-fishing-and-forestry/agricultural-workers.htm#tab-1 (accessed February 12, 2019).↩}

^{10. Larkin, Michael. “Labor Terminators: Farming Robots Are About to Take Over Our Farms”. Investor’s Business Daily. August 10, 2018. https://www.investors.com/news/farming-robot-agriculture-technology/ (accessed February 12, 2019).↩}

^{11. “Searching for Solutions: California Farmers Continue to Struggle with Employee Shortages”. California Farm Bureau Federation. 2017 Agricultural Labor Availability Survey. http://www.cfbf.us/wp-content/uploads/2017/10/CFBF-Ag-Labor-Availability-Report-2017.pdf (accessed February 13, 2019).↩}

^{12. “Harvest CROO (Computerized Robotic Optimized Obtainer) – Creating a Robotic Solution to the Declining Labor Force in Agriculture”. Harvest CROO Robotics. https://harvestcroo.com/about/ (accessed February 13, 2019).↩}

^{13. Kiernan, Lynda. Pontifax Exits Precision Ag Company Blue River Through $305M Deal with John Deere”. GAI News. September 7, 2017. https://www.globalaginvesting.com/pontifax-exits-precision-ag-company-blue-river-305m-deal-john-deere/ (accessed February 13, 2019).↩}

^{14. Kiernan, Lynda. “Yamaha Returns to Invest Another $8M in New Zealand Agtech Startup Robotics Plus”. GAI News. November 21, 2018. https://www.globalaginvesting.com/yamaha-returns-invest-another-8m-new-zealand-agtech-startup-robotics-plus/ (accessed February 13, 2019).↩}

^{15. “The State of World Fisheries and Aquaculture 2014”. Food and Agriculture Organization of the United Nations (FAO). http://www.fao.org/3/a-i3720e.pdf (accessed February 11, 2019).↩}

^{16. Kopf, Allison. “Let’s Talk About Market Size”. Agrilyst. May 19, 2017. https://medium.com/agrilyst/lets-talk-about-market-size-316842f1ab27 (accessed February 13, 2019).↩}

^{17. “State of Indoor Farming 2017”. Agrilyst. https://www.agrilyst.com/stateofindoorfarming2017/ (accessed February 11, 2019).↩}

^{18. Kiernan, Lynda. “80 Acres Raises ‘Significant Investment’ for First Fully Automated Vertical Farm. GAI News. January 23, 2019. https://www.globalaginvesting.com/80-acres-raises-significant-investment-first-fully-automated-vertical-farm/ (accessed February 14, 2019).↩}

^{19. Kiernan, Lynda. “Merck Makes Largest AgTech Acquisition on Record –Acquires Digital Livestock Tech Compnay Antelliq for $2.37B. GAI News. December 19, 2018. https://www.globalaginvesting.com/merck-makes-largest-agtech-acquisition-record-acquires-digital-livestock-tech-company-antelliq-2-37b/ (accessed February 13, 2019).↩}