China Finance: Big agriculture stocks worth a look long term

• Agriculture reform in China is likely to see move towards larger scale food producers
• This means growth opportunities for many listed Chinese companies in the sector
• Opportunities related to the government always means connections will be in play, so looking at board structures etc. to help unlock the opportunities down the road
• Generally the rules of the game appear to be that efficiency and scale will be the winners, with marginal advantage being given to sustainable solutions.

Amid all the speculation around the SEC/PCAOB issues among US stocks it’s easy to lose sight of other aspects that will drive the future value of Chinese equities in the long run. One such aspect is the current drive towards larger scale and more efficiency in the agricultural space.

The industry has long been struggling with increasing the yield from the limited land resources in China, and part of this has been the establishment of growing larger scale agriculture companies. While this trend may increase, it’s not the main political goal going forward.

There are new goals and political initiatives in play to drive the sector towards the goal of China achieving food self-sufficiency. This is no mean feat, and it will require large-scale reform of how agriculture works in the country.

Most farmland now used by small-scale agriculture

Take for instance, the fact that a majority of Chinese farmland is being used by small-scale agriculture. Most of these farmers have trouble getting enough margins for their produce. This makes it difficult to make the investments necessary to increase yield due to systemic inadequacies with middle-men and transport issues. This is a problem for a country looking to supply food for a population the size of China’s. Small-scale farming lacks the ability to fully utilise the land in the long run.

As such we're likely to see larger players being given more importance, as they can afford to make the necessary investments now. Many of these are listed companies, who, if they manage to position themselves well, will reap many benefits and increased growth potential from these reforms. As always with government reforms it'll be a game of economics and connections, which means detailed analysis of board structures etc. will help unlock the winners down the road. But if we look at more general data, we can get guidance on how to analyse the potential of our companies.

Efficiency will trump scale

There are a few factors that look likely to be rewarded in this drive to maximise agricultural land usage in China. Efficiency is likely to trump scale as it’s politically better to leave the land in the hands of more people rather than re-enforce the widening wealth and power gap in the country. But efficiency must increase and if this can best be achieved by allowing for larger-scale industrialised farming, than that is where this process will lead us.

There is also some talk about sustainability becoming a larger part of the mix, which could be beneficial for food production companies geared towards such ends. However, there is often talk of sustainability and more organic solutions, but actual implementation of the steps does not necessarily follow. So while we might find a comparative advantage for sustainable solutions and companies, I doubt this will be given enough weight to truly factor into a judgement.

If we look at the Saxo Stock Screener for agriculture and food production companies we get a list of 20 companies trading on a number of different exchanges. These should all be reviewed carefully before making a final investment decision, but a lot of them are trading below book value, which means there could be some real steals in there.

As always, investors need to be cautious when it comes to investing in Chinese stocks. Precautions should be taken as the sector has shown a higher propensity towards fraud than normal. But with some good research there is certainly money to be made in the sector.

For investors who don’t feel the risk of a mass-delisting of Chinese shares in the US is too much to avoid the sphere altogether, Zhongpin (NASDAQ: HOGS) is worth a look. It’s shown pretty good growth numbers and operates in the pork industry, which is very important in Chinas. There’s also a reasonably steady cash flow from operations to go with a P/B of 0.63, according to data from Saxo equity research.

If you want to stay away from the US-listed firms, you have a good number of options in Hong Kong and Singapore as well. Want Want China Holding (SEHK: 00151) could be worth a look for instance, or Dachan Food (SEHK: 03999) currently trading at a P/B of 0.55 for those not averse to a riskier bet.

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Fredrik Oqvist writes regularly about Chinese equities, mainly those listed on foreign exchanges. If you'd like to comment on this story or be notified by email whenever a new China Finance story is published, become a member - it's free, and you can use your Twitter, Facebook, Google or LinkedIn login - and "follow" the China Finance blog during the signup process. You can also bookmark the China Finance blog page.