September 29, 2008


Eastern Europe farms draw investors despite slowdown


Investment into Eastern European agriculture will continue to march along, despite a recent slowdown linked to a drop in grain prices and political uncertainties in the region, analysts and investors said.


Lured by the combination of cheap farm land and last season's record-high wheat, corn and oilseed prices, investors had been racing to Eastern Europe in droves over the past two years. While this has slowed, analysts say the long-term rationale for investing - rising food demand and limited land resources globally - remains in place.


The slowdown has come as Chicago Board of Trade nearby wheat, a global benchmark, tumbled this month to a 10-month low of US$6.86 a bushel, down as much as 52 percent from the record high set in early 2008. Pressure stems from a drop in crude oil prices and a historically large world wheat crop after farmers not only planted more but also benefited from nearly perfect growing conditions.


"Russian grain prices have fallen with the global drop, which along with the global financial crisis and the lack of cheap money, has slowed private investment by some companies in recent months," said Rudolf Bulavin, of Russian-based Coordinating Analytic Centre of Agroindustrial Sector


"There was a level of exuberance. And it's not a vast retreat, but it has softened a bit," said Rory Cullinan, co-head of Renaissance Partners, a merchant bank specializing in emerging markets, including land investment and food production in the Commonwealth of Independent States.


Cullinan manages a Ukraine farm started in 2005 that now includes about 300,000 hectares of crop land, half of which was planted for the 2008 season.


Like many others who have embarked on farming ventures in the region, Cullinan amassed all those hectares by snapping up a multitude of small private leases - more than 100,000 in his case - and is now restoring the soil to its former productive state after it had lain fallow since the end of the Soviet Union.


The CIS in particular continues to attract investors like Cullinan who hope the region can reclaim the prominence in global grain production it had during the Soviet era.


In Russia and Ukraine as much as 13 million hectares could still be returned to production, according to estimates by the European Bank for Reconstruction and Development and the UN's Food and Agriculture Organization. A shortage of both credit and such agricultural resources as tractors, fertilizers and seeds has kept the land fallow for nearly two decades.


Foreign investment in Russia's agriculture sector tripled in the two years through 2007 to nearly US$470 million, according to government statistics.


"Oftentimes the general agriculture market in Eastern Europe is rising faster than other parts of the world," said Jim Borel, group vice president of crop protection and seed for E.I. duPont de Nemours & Co. (DD).


Last month DuPont's seed business Pioneer Hi-Bred opened a new research facility in Hungary that cost between EUR1.5 million and EUR2 million. Borel described the investment as a continuation of interest, which picked up in the 1990s.


Huge production potential exists for the region by improving yields. Ukraine, for example, produces corn yields at only about 40 percent of the rate achieved in the US. Boosting yields to even half of those in the US would mean about another 1.5 million tonnes of corn, said Borel.


Also showing interest in the region is John Deere Ltd., the world's leading manufacturer of farm equipment. The Illinois-based company is investing US$80 million in a facility southwest of Moscow that will focus on distribution, replacement parts and training.


Deere CEO Robert Lane, who visited large farmers in Kazakhstan and Russia earlier this year, said the new facility is "evidence of our confidence in Russia."


Already in the 2008-09 season, aided by favourable growing weather, grain production in Russia and Ukraine is up 22 percent on the year at a combined 134 million tonnes, according to the International Grains Council.


"We will not see a crop like this one for another two to three years. We had excellent weather conditions," said Andrey Sizov Jr., managing director of Moscow-based consultancy Sovecon.


But longer-term, Sizov also expects Russia's average crop size to keep rising, because he looks for yields to start climbing closer to those in Western Europe. At about four to five tonnes per hectare, Western European yields are currently at least twice Russia's current average.


"Central, Eastern Europe will never have yields comparable to the high Western European levels achieved with the maritime climate," said Richard Warburton, head of Bidwells Agribusiness, a UK-based real-estate and farm business advisory service for institutions and funds.


However, he also said farm investment still makes sense fundamentally, adding that even if last season's spike in grain prices was weather-related, global food demand will continue to rise. This month Bidwells launched a EUR300 million pan-European farmland fund with Palmer Capital Investments.


Sovecon's Sizov said that last season, well-managed Russian farms achieved returns of 80 percent to 120 percent, but earnings will be lower this season.


Farmers won't be as eager to plant for the coming season because grain prices are sharply lower and input costs are up about 30 percent on the year, said Sizov.


Ian Bailey, researcher for UK-based real-estate company Savills, said investors are tracking land values in Central and Eastern Europe and South America to diversify portfolios.


"Wheat prices have come down, but stocks will be low for some time," he says. "The (longer-term) price trend is up rather than down."


Geneva-based Gaia World Agri Fund, launched in June, has set a goal to have the largest portion of its assets in listed and unlisted Ukrainian farming companies, focusing on the next three to five years.


J. Coast Sullenger, lead manager of the Gaia fund, said the drop in prices hasn't been surprising.


"Short-term, grain prices might have peaked but they remain at very low levels in real terms," he said. "Farm land in the Black Sea region costs about an eighth of that of similar land in Latin America."


Some farming operations have become public over the last two years, but prices for shares in those companies have fallen along with a general drop in the region's equities.


Black Earth Farming, a Swedish-run company farming in Russia and trading in Stockholm, is now trading at about 23 Swedish krona (US$3.51) a share, at least half of its value in June. Likewise, UK-based Landkom International, a farming operation in western Ukraine, was trading in London near GBP33 per share this week, down from an April high of GBP103.


This coincides with a drop in Russian stocks on the benchmark RTS index, which is now at its lowest level since the summer of 2006 and down just over 50 percent from values posted in mid-May.


Martin Sundman, Finland-based equity analyst for Kaupthing Bank, said while Black Earth had previously been overvalued at SEK55 a share, he now sees it as a good value.


In July, Black Earth's main shareholder, Vostok Nafta Investment Ltd., increased its holdings in the company to 24.81 percent from 21.45 percent.


Vostok CEO Per Brilioth said lower oil prices are bad news for the Russian equity market generally, but he looks for Black Earth to improve its margins as land becomes more conditioned and yields rise.


Black Earth seeded nearly 150,000 hectares in 2008, up nearly three times on the year. As of June, the company had built up a land bank of more than 330,000 hectares. Landkom more than doubled its land bank in the first five months of 2008 to just over 100,000 hectares.


Denmark-based Trigon Agri A/S (TAGR.SK) manages farm land and dairy farms in Russia, Ukraine and Estonia, with 120,600 hectares under its control. Since becoming listed in Stockholm in May 2007, the company traded higher than EUR2 a share as recently as March but is now closer to EUR0.70.


Still, Trigon Agri is now taking further steps into commodities trading and storage through a joint venture with United Grain subsidiary Ramburs Group.


Advisor Warburton warned that investment in land and farming operations will always be "more challenging" than investment in futures and equities, especially because it's more illiquid.


"There is a difference between making business models work on paper and executing them," he said. "Yields are sensitive to management and you have trouble finding enough calibre people to manage the large farms."

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