MONTHLY MUSINGS - JUNE 2023
PRIVATE DEBT FUNDING TO AGRICULTURE
Investment portfolios typically have minimal exposure to agriculture and primary production of food due to the S & P/ASX 200 equity index comprising less than 1% exposure to agricultural companies. Private Debt, such as the Roadnight Capital Natural Capital Fund, can provide sophisticated investors with access to an asset class not readily available.
What has driven private debt investment in Agriculture?
Roadnight Capital developed the Natural Capital Fund in 2021, and has produced strong risk adjusted returns of 10% per annum. Investment in Australian agriculture has been driven by the growing role of Australia as part of the global food supply chain due to its clean, green and high quality agricultural products; proximity to the world’s fastest growing populations in Asia; and complementary production systems to Europe and North America underpinned by free trade agreements. The underlying demand for agricultural real assets and food products continues to grow and this trend is likely to continue for years ahead.
During this time, the major banks have struggled to quickly process opportunistic growth funding requirements, often leading to farmers missing the opportunity. altogether. Some banks have decreased their risk appetite for the agriculture sector due to APRA concentration risk issues or a change in strategy, making It increasingly difficult for farm operators to access capital. These factors have led to a gap in the marketplace for private lenders such as Roadnight Capital to enter and grow. The sweet spot for Roadnight Capital has been providing debt facilities to borrowers looking to raise between $2m to $20m.
Why add agriculture to an investment portfolio?
Irrespective of short term commodity price movements, investing in Australian agriculture offers investors:
Natural hedge against inflation – agriculture typically benefits from higher inflation leading to increases in food prices, which in turn delivers a greater return to investors over the long term. The value of agricultural assets tends to increase during high inflation periods.
Low correlation and good diversification – agricultural investments offer a low correlation to other assets such as equities, property and bonds. When economic shocks, such as COVID 19 pandemic occur, agriculture remains largely unaffected, providing steady returns.
A conservative but stable investment – this asset class is considered a conservative investment that offers stable returns over the long term. The 20 year compound annual growth rate for Australian farmland value has been 7.5%.
Defensive characteristics in certain market cycles. During the GFC in 2008, agricultural trade data remained relatively stable at rates of 3-5% of GDP.
Attributes of a successful private debt financier in Agriculture
A deep understanding of agriculture requires a strong credit assessment process, a clear risk monitoring framework, and expertise to structure and manage loan assets. Agriculture managed well has a track record of producing competitive risk-adjusted returns with relatively low levels of volatility. Like many industries, however, operators in agriculture face multiple risks that can impact their profitability and viability, such as:
1. Climate risk - fire, droughts and floods
2. Commodity price risk - caused by market demand and supply
3. Currency risk - can impact the competitiveness of exports
The farm management practices of the operator can also vary, leading to differences in:
1. Crop yields or pasture biomass;
2. Daily weight gains in livestock production systems; and
3. Genetic quality impacting calving rates, milk production volumes and quality
Successful lenders to the agricultural sector have a deep understanding of the seasonality and variability in the sector and have the expertise and patience to manage the risks over time.
At Roadnight Capital, our successful investment strategy has been underpinned by seeking farm operators with the following characteristics:
• Character - Highly regarded, multi-generational families.
• Business Model - proven profitable business models over time operating at long-term scale. Operators are typically aggregators of land parcels, deeply committed to property improvement and sustainability initiatives.
• Management - Good management skills, sometimes complemented by software systems. Operators are adopters of technology that create farm efficiency and provide real-time intelligence.
• Production and Profitability – operators are focused on producing ‘better than average’ profitability per hectare and cost per hectare statistics compared to regional benchmark averages. This leads to a constant cycle of improvement and growth.
• Equity – established farm operators with strong equity levels > 70%.
We continue to receive investment opportunities from farmers with the above characteristics, keen to approach the private debt market to establish long-term relationships, seek a financier with the capacity to structure customized lending solutions and flexibility, and most importantly, act with speed.
It is evident that some major banks are unable to deliver anymore or have changed their risk appetite for the sector or promoted their best Relationship Managers to another part of the bank.
Roadnight Capital continues to see high-quality farming operators seeking growth capital to achieve their goals.
