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Why is big, beautiful in Agriculture chemicals?

George Clapham – Industrial and Agriculture Analyst

According to the World Bank, arable land per person has almost halved since 1961, from 0.37 hectares per person to 0.20 hectares per person. Over the same period, farms have become more productive with average cereal yields per hectare increasing 270% from 1.42 tonnes per hectare to 3.89 tonnes per hectare. The fact that the world has been able to feed its growing population (currently 7.4 billion and expected to grow to 11.2 billion by 2100) using a static arable land base of about 1,400 million hectares, is quite an achievement. The improvement in agricultural productivity is due to a combination of better farming practices, adoption of new seeds and traits, better weed, disease and pest control, improving fertility rates and lifting water efficiency.

Big agricultural seeds and chemicals companies (“Big Ag”), like Monsanto, Bayer, Syngenta, Dow, DuPont, Agrium and Potash, have led these technological developments. In recent times, we have seen a significant number of transactions that might potentially consolidate this industry. Monsanto, the world’s largest seed company, has agreed to a US$57 billion takeover offer from German pharmaceutical and agricultural chemicals giant, Bayer AG. The leading pesticide and herbicide company Syngenta, based in Switzerland, has agreed to sell itself to China National Chemical Corp for US$43 billion, having knocked back an offer earlier in 2016 from Monsanto. Dow Chemical and DuPont decided to merge in late 2015, a US$115 billion deal which would be followed by a spin-off of their seeds and agricultural chemicals business. And last but not least the two largest Canadian fertiliser giants, Agrium and Potash agreed to a merger, creating a US$27 billion business.

The consolidation of these agricultural seeds, chemicals and fertiliser giants is not just about extracting cost savings, but more about gaining scale economies in R&D, particularly in the seeds and agricultural chemical technologies which take longer to come to the market due to tougher regulation. New crops and chemicals that can take around a decade and cost hundreds of millions of dollars to bring to market. “This is an industry that desperately needs to invest more,” said Robert Fraley, Monsanto’s chief technology officer, who estimated that Monsanto spends about $1.5 billion annually developing new products. When combined with Bayer’s R&D spend, should regulators approve the merger with Monsanto, the total spend by these two companies will be around US$2.5 billion or over 10% of combined revenues. Monsanto’s aim has been to double yields of key crops – corn, soybeans, cotton and canola – by 2030 from year 2000. The company has delivered yield improvements of approximately 25% to date.
Source: Monsanto, Bayer
Clearly, there will be push back from farmers and consumers about the impact of these mergers on the cost of crop inputs. Seeds represent about 30% of the cost for corn production, fertiliser 40% and chemicals (pesticides, herbicides) 10%. Farmers, will no doubt think they will pay more for these inputs. And Big Ag will have to do a good job selling the potential benefits of their marriages.
We believe these mergers will substantially improve industry structure, thus industry returns. However, given that Monsanto’s share price is sitting at a 20% discount to Bayer’s offer price, the market is not convinced the regulators will allow the bid to proceed. We believe the long term prospects of this industry are sound and that leading seed technology companies in particular, have a bright future. Arnhem retains a holding in Monsanto.
Crop yield gains since 2000

Source: Monsanto

This article has been prepared by Arnhem Investment Management Pty Limited ABN 17 129 606 775, AFSL 332484. It pays no regard to the specific investment objectives, financial position or particular needs of any specific recipient. You should seek your own professional advice in relation to any financial product referred to. You should also obtain the product disclosure statement relating to any financial product referred to and consider the statement before making any decision about whether to acquire the financial product. This article, including the information contained herein, may only be copied, reproduced, republished, or posted if done so in whole with original disclaimer included. © Arnhem Investment Management, 2016