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Volatile Markets? Look for Real Assets

Global listed technology companies saw their valuations plummet in January, amid fears of rising interest rates and higher than expected inflation rates.


Why the sell off in tech stocks?

A large proportion of tech stocks are cash flow negative, and they have relied on cheap debt and raising capital easily.

With the rising concerns around the increased cost of debt and capital, this has seen tech stock multiples compress, as their ability to raise cheap equity diminishes.

Ytd the Australian information technology index (ASX:XIJ) has decreased ~22%, compared to the ASX 200 only decreasing ~5%.


US based Ark Investment Management is a fund that solely focusses on the high-tech side of the market. It has seven listed ETF's covering all facets of tech from 3D printing to Fintech.



On a long term view, ARK's ETF's have outperformed the market, however, in the last six months they have underperformed with the average decrease across their seven ETF's being ~32% as of the 10th of February 2022.



With interest rate increases still to come, the thematic of tech stocks multiples normalising appears a trend set to continue.


We have also seen Meta platforms formally known as Facebook get de-rated by close to 30%. This was because their revenue growth rate in the December quarter was well below analysts expectations. Going forward, as the cost of additional equity and debt increases, tech companies are likely to change their focus from buying market share and look to generate earnings. Higher growth is likely to become harder to obtain and multiples could continue to descend if revenue growth falls.


Further to this, a significant portion of tech stocks are valued on an EV/Revenue multiple type basis. If we saw tighter capital management and slower growth at the top-line, there could be further de-ratings in the tech sector.


What are the inflationary impacts on tech and agriculture sector?


In a high inflationary environment we are looking for companies with the ability to pass through cost increases, which in-turn favours the agriculture sector. During the December quarter the Australian consumer price index (CPI) rose 1.3%, making the 12-month inflationary rate 3.5%. During the December quarter, dairy and related products rose 1.7% due to price rises for cheese, milk and yoghurt. We believe the agriculture sector is in a strong position, as they have the advantage of quick price resets. We should see commodities prices such as dairy, protein and grain products rise with inflation. Woolworths, Coles and Aldi all increased their price of their branded milk by 10c per litre in December 2021, with most ag products price inelastic.


In the December quarter we only saw telecommunication products and services rise 0.1%, and over the past 12-months it fell 0.5%. This affirms our notion that tech companies may not be poised to benefit from inflation. The majority of tech companies are focussed on growing their revenue and market share, therefore, they cannot afford to increase their prices. Only groups with differentiators, loyal customers and market leading technology such as Apple have pricing power and should be able to perform well in periods of increasing inflation.


What is the opportunity in the consumer staples and agriculture sector?


The AgFood fund consumer staples index (see below in references) has decreased 7% ytd, this is mainly due to Woolworths, Coles and Treasury Wines who are down ~12%, ~8% and ~14% respectively. Excluding these three stocks, on a market cap weighted basis, the rest of sector is only down 3%.

A key factor in this market is having a large asset base relative to the valuation, or a high net tangible asset (NTA) compared to valuation. This is represented by the Share Price / NTA per share ratio. A negative ratio implies the company has more liabilities than tangible assets. A stock with a ratio of below 1.0x is trading below its net tangible assets.

For this ratio:


Woolworths, Coles and Treasury Wines either trade at a negative NTA or at ratio above 2.2x which is higher than the median in the AgFood consumer staples index.


This indicates they have less net real assets relative to the consumer staples sector median of 2.2x.

Groups like Ricegrowers and Tassal have a strong Share Price / NTA per share ratio of 1.1x respectively. Ytd they have shown more resilience during this period with Ricegrowers down 1% and Tassal up 4%. We believe having a high NTA provides a floor for the share price and having an installed capital base helps act as a barrier to new entrants.

How is the AgFood fund set to benefit from evolving economic environment?

Our investments are leveraged to inflation as a majority of our investments are tied to commodity prices in the dairy, poultry, grain and nut industries. Our largest listed investment TasFoods has dairy and poultry divisions, we have already seen price rises in dairy at the supermarket and wholesale level. TasFoods needs to show its pricing power which should improve its margins, that have been historically lower than usual due to higher input and logistics costs.

Our cornerstone investments, TasFoods, Health Plant Protein, Wingara Ag and Yumbah have a Share Price / NTA per share ratio of 1.1x, 1.2x, 1.0x and 1.5x respectively, which makes them defensive in a volatile market.


Steady Growth in the Ag Sector


The Australian Bureau of Agricultural and Resource Economics (ABARES) forecasted in 2020 the long term outlook for the value of production in the agriculture sector would reach 100bn. In 2020 this amount was 67bn and in 2021 it was 78bn, a 14% increase due to higher than expected crop and meat prices and favourable growing conditions.

Assuming a 10-year outlook the agriculture sector could grow at 4% CAGR on the basis of ABARES forecasts. This could be higher given the significant increase in 2021.


AgFood Fund believes aquaculture, plant based protein and strong brands can grow significantly above 4%pa as we think livestock grows more conservatively and is heavily weighted. Our investments concentrates along the higher growth sub-sectors sectors, and avoids livestock.

We are looking for AgTech investments with short path to cash flow, and are close to making investments in the area and will update you shortly.


References


Reserve Bank of Australia, 2022, Cash Rate Target

Available at: https://www.rba.gov.au/statistics/cash-rate/


ARK Invest, 2022, Our ETF's

Available at: https://ark-invest.com/

Australian Bureau of Statistics, 2022, Consumer Price Index, Australia:

Available at: https://www.abs.gov.au/statistics/economy/price-indexes-and-inflation/consumer-price-index-australia/latest-release#main-contributors-to-change


ABC News, 2021, Days of dollar milk are long gone as supermarkets increase cheap milk prices further

Available at: https://www.abc.net.au/news/rural/2021-12-02/days-of-dollar-homebrand-milk-are-long-gone/100664658


ABC News, 2022, Facebook parent company Meta plummets 26 percent, loses $332 billion in worst one-day company drop

Available at: https://www.abc.net.au/news/2022-02-04/facebook-meta-25-per-cent-stock-market-plummet/100803976


https://www.awe.gov.au/abares/news/media-releases/2020/long-term-view-key-100-billion-target


AgFood Fund consumer staples index

ASX:A2M ASX:AAC ASX:AHX ASX:AVG ASX:BGA ASX:BKL ASX:BUB ASX:BWX ASX:CAN ASX:CBO ASX:CSS ASX:E33 ASX:ELD ASX:FSF ASX:GDA ASX:GNC ASX:HLF ASX:HPP ASX:ING ASX:LGL ASX:LRK ASX:MBH ASX:MCA ASX:MCP ASX:NOU ASX:NUC ASX:NUF ASX:NZK ASX:PBP ASX:PFT ASX:PTL ASX:RFF ASX:RIC ASX:S66 ASX:SGLLV ASX:SHV ASX:SM1 ASX:TFL ASX:TGR ASX:TSI ASX:TWE ASX:UMG ASX:WNR ASX:WOA ASX:MWY ASX:WOW ASX:COL ASX:EDV ASX:MTS ASX:CGC


Weighted average market for the consumer staples sector







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