Opportunities ripe for Chinese produce consolidation, says NAB
Relatively low company valuations and uncertain macroeconomic conditions make for good acquisition options in China's produce industry, according to a Hong Kong-based expert with the National Australia Bank (NAB).
While speaking at the Produce Marketing Association's (PMA) Fresh Summit event in New Orleans, NAB's Patrick Vizzone said while demand fundamentals were strong for fruit and vegetables in China, a wide range of factors meant businesses in the sector were not too expensive.
"Fresh produce has experienced really strong revenue growth in the past couple of years, in fact 18% annual growth, which puts it about fourth in all the sectors you see here [in the food and agriculture category]," said Vizzone, who heads up the bank's business development, consumer sectors and institutional banking in the Asian region.
"With a profit margin of 23% this puts fresh produce at the top. What's really interesting is that these industry margins and healthy growth rates do not translate to high returns on equity, and in fact at 8.5%, fresh produce in China is right near the bottom of the pack.
"But here's a final insight - China’s fresh produce industry actually has the lowest valuation within food and agri, so if you want to buy into Chinese fresh produce companies, they are at the moment relatively cheap."
He said there were two main reasons for this. Firstly, investors from outside the produce industry find it hard to "get their head around" the risks of horticulture like weather, perishable products and the nature of inventories.
"Secondly, fresh produce in China has seen more than its share of scandals, be they real or perceived. This creates opportunity, and continued low valuations on both sides of the Pacific provide the impetus for several transactions."
He added that current uncertain macroeconomic conditions, prompted by the Federal Reserve tapering and concerns about the debt ceiling, also contributed to lower valuations of businesses in Asia that investors could take advantage of.
On the other hand, figures presented by Vizzone show that Chinese produce businesses are much more cashed up than their western counterparts.
"Higher debt in a company basically means a higher return on equity; in fact, Chinese fresh produce companies are really flush with cash. For every $1 of debt, a Chinese fresh produce company has $1.60 in cash," Vizzone said.
"Now, that may not sound too out of the ordinary, but just reflect that in Europe and in the U.S., that’s closer to 11 cents. So basically, for every $1 of debt, a Chinese company has 16 times the amount of cash.
"Consolidation also remains a key investment driver, and one of the reasons for this really is the pressing need for scale in the produce industry."
He mentioned the average retail chain in Asia as a whole was 28 times the size of the average fresh produce company, while retailers on a global scale were 11 times the size of produce businesses.
This changing retail environment combines with robus liquidity to bring strong potential for outbound Chinese investment in global and domestic supply chains.
"So the opportunity here is to develop and acquire the know-how required to build efficient scale in fresh produce businesses in China, and as China’s retail sector continues to evolve along western lines, so too will the supply chains.
"The industry really needs to keep pace and service this growing retail trend – this was part of the business case for Hong Kong’s Chevalier International to acquire Australia's Moraitis Group in April this year, specifically making use of Moraitis’ know-how and expertise in farm management and retail supply chain solutions.
"So China will not only import product but it will import the intellectual property required to service a growing industry."
On a broader level, Vizzone pointed to strong demand forecasts for food in Asia and what this would imply for growers and holders of arable land.
"Here are some staggering numbers. The incremental demand growth in Asia is forecast to be 2.5 times the rest of the world combined, and China should comprise about two thirds of this, so if you look at that another way, the incremental increase in food demand in China is going to be 1.6 times the world estimation.
"This is why I love fresh produce. The largest increase in agri-food demand should come from fruit and vegetables, and this will comprise one third of the increase and will be a US$1.9 trillion industry by 2050. So the demand, particularly for fresh produce in China, looks very bright indeed.
"The most important sentence I could probably make in this presentation is that China is going to rely on the world more and more, and countries like Australia, New Zealand, the U.S. - with clean and safe supply and good biosecurity - they are really the best placed to supply China."
He said this led to a sound investment strategy.
"We at National Australia Bank see this and are very active in connecting cash-rich Asian companies with world class business that may not have the same access to liquidity but do have access to supply.
"Another driver of outbound Asian investment is what we call ‘international cost convergence’ – whilst Asia, particularly China, has enjoyed a strong cost leadership position, higher costs and inflation have chipped away at this comparative advantage, and it means that imports are more competitive.
"In Asia, particularly in China, this creates the opportunity to create cross-border vertically integrated businesses of supply...bringing this back to fresh produce, a case in point is Joyvio, which recently partnered with Subsole in Chile to do exactly this."
However, while there is a strong business case for investment in China, Vizzone warned potential investors "not to leave good business sense at the airport".