GLOBAL_AGRIBUSINESS：LATIN_AMERICA_PRODUCES_ASIA_CONSUMES-2012-09-18.ppt

consumer & retail agricultural products,september 2012,in the spotlight.,global agribusiness,latin america produces, asia consumes,by pedro herrera, diego t. maia, ravi jain, and,thilan wickramasinghe,disclosures and disclaimer this report must be read with the disclosures and analyst certications in the disclosure appendix, and with the disclaimer, which forms part of it,consumer & retail agricultural products september 2012 in the spotlight. hsbc latam spotlight publications focus on countries or industries and provide comprehensive quantitative and qualitative analyses of trends, value drivers, and competitive landscapes to enable our clients to formulate a longer-term view of risks and rewards. why you should read this report we show how grain consumption around the world, primarily in asia, is ballooning. incomes are increasing, meat consumption is booming, and grains are increasingly used for nonfood purposes such as renewable fuels and starch. we demonstrate that grain supplies and inventories are down and increasingly not meeting growth in consumption, a trend that should continue. planted acreage per capita is down, yield improvements are slowing, and frequent extreme climate conditions are further affecting supplies. we discuss grain price trends and dynamics, both short- and long-term, and conclude that the upward shift in grain prices to todays levels is essentially here to stay, a new normal. we quantify the evolution of latin america as an agricultural powerhouse, as the region has become the main supplier of agricultural commodities to satisfy asian and global consumption. asian economies are strong, urbanization continues, and planted acreage is falling, while meat consumption is growing. we conclude with an explanation of why we believe latin america will continue to be the main beneficiary of these trends and is positioned to exploit evolving global food dynamics. we expand on latin american competitive advantages, huge availability of fertile land, an abundance of water, and ideal climatic conditions to meet future food demands of the world. we provide detailed company discussions and our favorite ideas for investment in latin american agribusiness companies engaged in production of grains and development of farmland and in the brazilian sugarcane-based ethanol segment. we like adecoagro, cosan, tereos internacional, and olam international. 2,abc,consumer & retail agricultural products,abc,september 2012 food for thought: metrics to make you think grain consumption: the 50-year cagr is 2.7%, far higher than the 1.7% population growth cagr (chart 5). grain production: average grain surpluses of the past 25 years were only 0.2% of consumption versus 1.5% in the previous 25 years (chart 17). grain prices: the 10-year cagr was 11.1%, more than seven times the 1.5% previous 40-year cagr. the price of a ton of grains averaged usd100-150 for 30 years. in the past 10 years, the average was about usd250 (chart 2). grain inventories have declined to 72 days versus the 94-day 50-year average (chart 4). us ethanol: about 39% of us corn today is used for renewable fuels versus 6% in 2000 (chart 14). meat consumption: per capita meat consumption had a 50-year cagr of 1.6%, triple the 0.6% cagr in per capita rice consumption. meat consumption in china grew at a 10-year cagr of 4.2% versus 0.3% in the us. despite that, chinese meat consumption is only 52kgs/year versus 110kgs in the us. it takes 2-9lbs of grains to produce one pound of meat (charts 11, 12, and 13). planted acreage per capita: fell at a 0.8% cagr the past 50 years versus 1% growth in grain demand. in the early 1960s, the world had 11,400 sq ft of planted area per capita, and today it is 7,500, or -34% (chart 16). yield improvements: dropped to a 1.2% cagr in the past 25 years versus 2.4% in the previous 25 years (chart 18). urbanization: in south and east asian countries, urbanization rates are 1.5-2% versus 0.2-0.5% in the us and europe, and at end-2010, only 30-50% of the population lived in urban areas versus 80-90% in the us and europe (chart 6). extreme poverty: population with incomes of less than usd1.25 per day in east asia and the pacific fell to 14% in 2008 from 77% in 1981, to 6% from 12% in latin america, and to 36% from 61% in south asia (charts 8 and 9). southeast asia (ex japan) imports: 36% of global grain imports versus 19% 50 years ago. middle east and north african imports increased to 25% from 9% in the same period (chart 29). latin american agricultural exports: today 41% of global grain exports versus only 7% 50 years ago (chart 28). global crop acreage: 11% is in latin america versus only 4% 50 years ago. the latin american acreage cagr in the past 50 years was 2.4%, four times the 0.6% global average (charts 50, 51, and 52). transportation of agricultural commodities: one gallon of fuel powers a barge with one ton of soybeans 576 miles versus 155 miles by truck. freight from mato grosso in brazil to the port of santos, 1,200 miles, costs about usd118 versus only usd38 from minneapolis to the us gulf, also 1,200 miles (charts 60 and 63). farmland needs: with yield improvements stable at current rates, we estimate that in the next 50 years the world will need 270m additional hectares to produce grains, 68% more than the acreage added in the past 50 years (chart 20). brazil: the only large country (by size) to have both a very low population density (23 persons per sq km) and solid rainfall levels (1,782mm/year), ideal conditions for agriculture (charts 56 and 57). farmland valuations: since 2005, cagr was 17.7% in the argentine corn belt, 11.6% in the us corn belt, and 11.3% in the state of parana, brazil. average farmland prices in brazil are usd3,700 per hectare versus usd11,000 in the us and usd11,500 in argentina (charts 64 and 72). us farms versus the s&p 500. the 50-year cagrs of us farm values and the s&p 500 are similar, slightly above 6%, yet s&p volatility was significantly higher, making the &p risk-adjusted returns substantially lower (charts 66 and 67). 3,92,5,96,104,24,27,33,123,48,58,137,65,consumer & retail agricultural products september 2012 contents global agribusiness:,adecoagro sa (agro),abc,investment thesis brasilagro sa (agro3) burgeoning demand for grains,has just begun climate change, weather events, and agriculture latin america produces, while asia consumes structural growth drives asian consumption latin americas competitive advantages our bullish case on land,10 40,bunge limited (bg) cresud sa (cresy) slc agrcola (slce3) cosan limited (czz), cosan sa (csan3) so martinho sa (smto3) tereos internacional (teri3) first resources (fr sp) olam international (olam sp),100 108 112 119 128 131,our views on short-term grain price trends sugar and ethanol: brazil,genting plantations (genp kl) 134 appendix: agribusiness,sweetens and powers the world,disclosure appendix,150,asian palm oil,82,disclaimer,153,younger, nimbler traders,stitching it together 4,87,consumer latin america has fertile soil, water, and good weather,abc,executive summary strong economic and consumption growth in asia during the past few years has driven equally strong agricultural production and sector expansion in latin america. we believe that demand for agricultural commodities, food, and alternative fuels produced from grains and other renewable sources will continue unabated, and that latin america is the better-positioned region of the world to provide these. in this report, we present our rationale for these views and discuss potential ways for investors to profit. we see investment opportunities in grain producers, farmland developers, and sugarcane-based ethanol. our 50-year analysis addresses soybeans, corn, and wheat as proxies for grains, as these three crops make up c70% of all field crops as defined by the us department of agriculture (which include barley, corn, cotton, millet, oats,peanuts, rapeseed, soybeans, sunflowers, rice, rye, sorghum, and wheat). the shift in prices seems here to stay for nearly three decades, grain prices remained relatively stable at levels near usd100-150 per ton on average. however, since 2005 prices have risen sharply. and, although we expect a correction from current levels once weather conditions normalize, we do not see grain prices returning to historical levels. higher prices should be a positive for farmer economics and should encourage further investments to expand planted acreage and generate yield improvements and increased uses of technology. we note that it is increasingly more expensive to bring new land into production, while wider uses of technology increase overall costs. thus, higher grain prices and strong farmer economics should support the investments necessary to increase productivity to,5,consumer & retail agricultural products september 2012 address increases in demand, while increasing the value of land currently under production. burgeoning demand should continue during the past decade, global demand for grains has risen significantly, driven by a variety of factors. the worlds population reached 7 billion in october 2011 and the un expects it will reach 10 billion by 2060. in addition, urbanization rates continue to increase in most emerging markets, especially east and south asia. income levels are increasing, with significant numbers of people now above extreme poverty levels (defined by the united nations as less than usd1.25 per day). consequently, per capita meat consumption has increased sharply in the past few years, much more than rice, for example. one pound of animal protein requires several pounds of grains to produce (2lbs for poultry and up to 9lbs for beef). in addition, grains are increasingly being used for nonfood purposes such as alternative fuels (ethanol) and industrial uses such as starch. these dynamics point to increasing demand for grains going forward. the growing asia-latin america connection there is a strong and growing link between asia, where consumption growth has been exceedingly strong in recent years, and latin america, which has expanded its agricultural production platform to address not only huge asian demand, but also domestic demand. fifty years ago, latin america accounted for 7% of global exports of the key grains corn, wheat, and soybeans. today, latin america accounts for 37% of the global grain trade, higher than that in north america (the us and canada). similarly, 50 years ago, asia accounted for 19% of global grain imports and today accounts for 37%. increasing trade between asia and latin america is what hsbc chief economist stephen king calls the “southern silk road.” 6,latin american competitive advantages the agricultural boom in latin america is a result of several competitive advantages in the region, in our view. first is availability of unused land to address acreage expansion requirements. second is abundance of water, including solid rainfall levels, and large renewable-water sources. brazil is one of the only large countries in the world that has both low population density and very high rainfall levels, ideal conditions for agricultural expansion. third are the fertile soils typical of the region, also extremely suitable for agriculture. the humid pampas region of argentina, for example, is one of the most fertile agricultural areas in the world, requiring minimal fertilizer usage and thus having significant low-cost advantages. we point out, however, that the region still lacks an efficient infrastructure and logistics system to support the growing production platform. the cost of transporting soybeans in brazil is almost three times that of transporting soybeans in the us, comparing farms equidistant from corresponding ports. for the region to realize its potential to become an agribusiness superpower, building an efficient infrastructure and logistics system is of paramount importance, we believe. our bullish case for investing in latin american farmland we remain very bullish on the potential for value appreciation of latin american farmland, given its competitive advantages and the burgeoning demand for grains. since 2005, land prices in the us corn belt and the state of parana in brazil have appreciated at an 11% cagr (in usd terms). land in the argentine corn belt appreciated even faster, at a 17.7% cagr, in the same period. we compared the appreciation of us farming real estate with the s&p 500 over 50 years and found that the appreciation was very similar. it is,abc,consumer & retail agricultural products september 2012 important to note, however, that the s&p volatility was significantly higher and thus reduced the risk-adjusted returns. we believe that land valuations should continue to outperform due to two factors. first, growing demand for grains is driving solid returns for farmers. and second, as it is increasingly more expensive to bring new land into production, the values of currently producing farms should continue to increase. argentina recently passed a law restricting foreign ownership of land, and brazil is in the process of formulating a similar law. however, while the restrictions in argentina are significant, a brazilian law should primarily limit foreign land ownership by sovereign entities, sovereign wealth funds, and nongovernmental organizations (ngos). because significant investments are required to continue to expand the brazilian agricultural platform, any brazilian legislation meant to address foreign ownership concerns should ensure an open and secure environment for corporate and commercial concerns, the mainstay of the industry, to continue investing and growing. asian palm oil medium-term structural price trends in palm oil appear likely to be influenced by demand, not supply. the demand situation globally remains strained, while supply growth seems unlikely to have bottlenecks going forward. of palm oil, 72% goes to food demand, where growth does not vary materially, despite the global macroeconomic cycle. industrial and biodiesel usage do follow the macro cycles. this is essentially the key driver for marginal demand for global edible oils and palm oil in particular, in our view. brazilian sugar and ethanol we expect the 2012-13 harvest to be another year of global sugar surplus, although lower than our previous expectation. we expect a surplus of 4- 5m tons from larger supplies in brazil, production,increases in thailand and australia, and india remaining a net sugar exporter. we are lowering our sugar surplus expectation as a result of weather issues in india and to some extent in brazil. we expect sugar prices to remain-range bound at usdc20-23/lb as a result of another year of sugar surpluses. the brazilian ethanol segment is experiencing several challenges. in the past few years, producers have diverted increasingly more sugarcane to producing sugar due to higher profitability. in addition, a lack of investments in the sugarcane crop and in additional ethanol productive capacity has hampered ethanol output. today, the segment is awaiting government support to foster private investments in ethanol and sugarcane. however, we remain bullish on the long-term potential for the brazilian sugarcane- based ethanol business, as it is by far the most cost-efficient and environmentally friendly renewable fuel today. ethanol produced from other grains is not competitive or sustainable long-term without government support, in our view. in addition, new technologies such as cellulosic ethanol, solar energy, and wind power have yet to be economic viable at the scale the world needs. our preferred plays adecoagro (agro us, usd10.43, overweight (v), target price usd14) we view adecoagros business and geographic diversification as very attractive, as it brings forth not only participation in a high-growth arena, but also relative stability of earnings. we are particularly bullish on the land transformation business, and we believe in strong potential for appreciation of farmland values in latin america. we like the adecoagro management team, which we view as highly experienced and technically impressive. the company is a cost leader in the,abc 7,consumer & retail agricultural products september 2012 farming business and a very efficient sugar and ethanol producer in brazil due to high mechanization levels and its own sugarcane, and has a proven track record adding value to land. we view adecoagros current valuation as compelling, as it is trading at a 0.79x price-to- nav. cosan ltd. (czz us, usd15.25, overweight, target price usd18) cosan sa (csan3 bz, brl36.25, overweight, target price brl43) cosan is our preferred play in the sugar and ethanol segment. we expect razen energia, cosans sugar and ethanol business unit, to expand crushing capacity 23% over the next four years to 80m tons via brownfield projects and acquisitions. given its scale, financial strength, strong brand awareness, higher exposure to premium products, and solid synergy extraction track record, razen combustveis, cosans downstream operations, should continue to outperform in fy13. cosan recently acquired comgs, a natural gas distribution monopoly in the southeastern region of the state of so paulo that is responsible for 27% of brazilian gdp. we view the acquisition favorably, as it is eps- accretive and fits well with cosans diversification strategy, and should result in a more-efficient capital structure. the companys rumo logistics platform also continues to grow at a solid pace. tereos internacional (teri3 bz, brl2.93, overweight, target price brl4.30) we strongly recommend tereos internacional as a value play. we see the shares as significantly undervalued, with the brazilian sugar and ethanol operations trading at usd63 ev/ton, a steep discount to its peers. the company recently 8,concluded a shareholder restruct