April 30, 2020

In January of this year, GAI News featured Tim McGavin, CEO and founder of Laguna Bay of Australia, which was founded in 2010, in a 15 Minutes With… profile. McGavin provided a more detailed look at Laguna’s sale of the largest almond portfolio in Australia to Canadian pension fund giant Public Sector Pension Investment Board (PSP Investments) for over A$350 million (~US$240 million).

With the postponement of Global AgInvesting in New York this month due to COVID-19 and the world economy and markets upended with changes from this, we asked McGavin, who has been investing in agriculture since the 1990s and offers a lifetime of perspective experiencing the ups and downs of this sector, to provide some insight.

We note that in his January interview, McGavin warned investors saying “Asset prices globally have had a strong run for a decade or so, and off the back of that we feel like it’s time for caution. There are a few sectors that feel fully or over-priced. It’s a totally different market to what it was just five or six years ago. We’re focusing mainly on investments where value can be added and progressing them with conservative debt levels and a margin of safety in the assumptions to protect from downside risk. While entry price is a big determinator of returns, great businesses with strong, reliable cash flows will prosper long term.”

1). What are your initial thoughts on the effects of COVID-19 on the ag investing sector?

First and foremost, the suffering in the world right now is absolutely horrible to witness. COVID-19 and its risks to our health are upending our way of life and causing economic destruction, which is a human tragedy beyond what any of us could have predicted even a few months ago. This time at home with my family has allowed me to think about what is important in life and to reflect on our business strategy in the months and years ahead.

At a time when people are seeing their superannuation balances plummet through stock market declines, we are fortunate to be in a position to help protect and build on the savings of millions of public service employees, and other investors, who put their trust in us via their LP’s. It’s humbling, and we take this obligation seriously, especially now. We’re in regular communication with investors about the impact of COVID-19 on the Australian agricultural landscape and our investments. For LP’s, I cannot think of a better time to be invested in agriculture and food.

The best thing we can do for our investors is to stay the course and do what we do best – which is diligently allocate capital to the opportunities that offer the best risk reward. As Warren Buffett says “you pay a high price for certainty”. This being the case, the current uncertainty is sure to offer up bargains to those who can hold their heads. I have seen droughts, floods, fires, commodity crashes, and subsidy disasters. I remember the 1990/91 recession well. It coincided with the Australian government floor price in wool being removed which caused enormous financial and emotional stress in farming communities. My family and many close friends were heavily impacted – as operations were pulled back and livestock culled, the strain on the communities, relationships, and everyone’s individual mental health took its toll. Experiences like this have shaped my thinking in times of uncertainty and I feel these lived experiences etched in our memory stand our business in good stead.

2). How has Laguna Bay shifted its operations to accommodate these changes? 

Every one of our dedicated team members has ownership in Laguna Bay, which really sets us apart as a firm. We are personally invested in our funds and aligned with the performance of investments.

It is an exciting time for us. We recently realised a $370 million almond portfolio, locking in a 2.3x return for investors. We are nearly 75 percent deployed in Laguna Bay Agricultural Fund 1 with an exciting pipeline of investments to close out this fund. We are paying distributions to our investors and feel well-positioned for the current volatility. We should come out of this better than we went in.

As I mentioned in our January interview, it has been challenging to find value over the last couple of years. Our investors appreciate the patient approach and have a long-term mindset themselves, which suits our disciplined deployment program. We foresee being pretty close to fully deployed soon and that we will be back in the market raising capital in the second half of 2020. We have a short list of investors we’d like to work with for our next fund.

From a portfolio perspective, our investments have performed well. All our operators are very low-cost producers with leverage utilised cautiously. Save for some minor climatic impacts, which are par for the course in agriculture, we have had limited disruptions from COVID-19 at this stage. Agriculture has been declared an essential service and we have worked hard to put in place processes and training to ensure our people are continually kept informed, and their work environments are safe.

In times of crisis and disruption there are five immediate actions that our asset managers are focused on:

1: People – Ensure the health and safety of employees is managed appropriately and in line with advice from governing bodies.

2: Inputs – Secure critical inputs: seed, fertiliser, chemicals, feed, plant & equipment, fuel, and spares, for instance.

3: Supply – Work with our customers to ensure efficient and continuous supply. Our most sensitive operation in this regard is dairy. Our processors are very proactive and have plans in place that isolate teams and minimise human contact.

4: Costs – Trim any unnecessary costs/capex and manage forward budgeting with COVID-19 in mind.

5: Funding – Liaise with our credit providers to ensure lines of credit are secure. Preserve cash and prepare to act on opportunities.

3). What impact do you see on future opportunities?

With regards to the pipeline, the investment team’s objective is to keep a keen eye on agricultural opportunities and carefully assess any impacts that we start to see in particular sectors under stress. Opportunities are likely to arise in areas affected by flow on effects of the pandemic, whether it’s logistics, labour or otherwise, and where traditional capital sources dry up.

We are already seeing more contact from agents, advisors, vendors, and investee organisations as increasing levels of uncertainty creep into strategic planning and heighten counterparty risk plays into funding decisions. We have arrangements with several top operators in a few sectors that are “investment ready” but we are not yet at a point where asset prices are generally attractive enough to seed an investment. This may change quickly, so our aim is to be positioned to deploy efficiently.

4). What takeaways can you offer to those considering investments in agriculture? 

Agriculture Proves a Defensive Asset Class

The most important lesson for all of us is how resilient agriculture is as an investment class. Demand for food has increased in the last few months as everything else has collapsed.

At the forefront of people’s minds right now is security of supply of nutrition. Western society has not had to worry about food security in peacetime, and the sight of empty supermarket shelves has bred further panic buying. Securing the supply chains for food in nations which are not self-sufficient will continue to pose challenges as nationalistic tendencies take hold and border restrictions limit trade.

Farming, food supply, and logistics is rightly deemed an essential industry and hence is one of the few sectors not impacted by further lockdowns. It is worth noting that during the last two world wars, farmers were not conscripted to fight in the war as agriculture has and always will be a critical industry. This is a war of a very different kind, but many of the societal implications are quite like those created by conflict.

Australia and New Zealand enjoy large exportable surpluses of agricultural products. Some nations may implement export controls or taxes due to shortages or food price inflation so perhaps, in places with surpluses like Australia, experience lower risk than others in this regard.

Liquidity and Correlations

Public markets have been hit much harder than private markets and nearly all public markets have been positively correlated. We need to rethink the risks around too much liquidity. I feel safer being invested in private markets with less risk of speculative driven panic.

Agricultural land as an asset is tangible and not just another financial contract like so many other asset classes. I feel that investors generally put too much confidence in financial products like stocks and bonds and the thousands of derivatives around these, and not enough emphasis on real assets. There has never been a more important time to understand what you actually own and how you will get a return on your money.

Private markets can often be tainted with an illiquidity stigma, but in light of current circumstances, this might ease. Liquidity is important but can tend to be overallocated in many portfolios. Of course, you must consider the objectives of each portfolio, but we question how much liquidity is truly needed. What we have learnt in the past month is that with higher liquidity comes higher volatility and higher correlation. We need to update our risk models as correlations and volatility of liquid markets is exacerbating risk. Even gold has been correlated with every other asset class in the last month. There was talk of closing stock markets, and asset allocators need to consider this risk.

5). Where do you see the market once this crisis passes? 

After this crisis passes, inflation may be a much higher risk than it has been in our lifetimes. Any moral hazard policy makers had on fiscal constraints, no longer exists. Unlike the GFC, this crisis is not about bailing out large banking institutions. This crisis goes to the heart of the global economies, employment, and consumption. We are all in this one together and policy makers are going all out to stimulate all parts of the economy. How long can this continue for? What happens if there is another exogenous shock after we recover from this one?

Global synchronised zero (or near zero) interest rates and monetization of debt on a scale we have not seen in generations dramatically increases our risk of inflation. History tells us that deflationary scares set up inflation, we just never quite know when. QE (Quantitative Easing) as experienced after the GFC was mainly central banks buying existing assets, so it was not overly inflationary.

The policy response we are seeing now is MMT (Modern Monetary Theory), which is financing government deficits by unapologetically printing money to finance deficits and pushing money into the economy which, you have to assume is going to be inflationary at some stage, particularly if the quantities are large enough. History indicates that inflation is equal parts financial and psychological. Just like when we wake up one day and we cannot buy toilet paper and other goods – if investors get worried about inflation then it is too late – it has already happened. Investors need to allocate to inflation sensitives now in a steady manner so as not to cause the inflation we are looking to guard against. The current disruption should create an opportunity to get invested into inflation sensitive assets.

Agriculture is like an inflation protected, positively yielding bond without the liquidity. The yield is also real as it is linked to staple soft commodities. The yield on agriculture is also highly versatile in times of crisis.

Currency debasement/replacement

Currency debasement is becoming a real risk with nations prioritising weaker currencies to help exports and global mass monetisation of debt to fund stimulus.

Farmland is largely unaffected by currency debasement. Our farmland does not care if it grows wheat for the Italian consumer, or for flour mills in Asia. It will still be consumed as a staple and should hold its value on supply and demand fundamentals. That same land can produce malting barley for beer, or canola for oil or sheep meat or beef, regardless of currency. It is much less risky than a bond that can lose all of its purchasing power if we see currency debasement or even modest inflation.

The U.S. deficit could be $3 trillion soon. At what point do investors lose confidence in the U.S. dollar? Another good case for investing in farmland.

6). Any thoughts on what a recovery might look like? 

When will the pandemic pass and what will the economy look like on the other side? Nobody quite knows. The reason nobody knows is that the answer is reflexive on how participants (consumers and policy makers) react, and that is predicated on mass psychology and therefore is unpredictable.

How and when will our policy makers respond and how effective will policy be? What will the consequences of this policy be? How will billions of people act not only from a hygiene and responsibility perspective to contain infection rates, but also with regards to consumption?

US GDP is around 70 percent consumption and there are three broad categories of consumer spending:

1: Consumption now – food consumed at home, communication services, and equipment including mobile phones has seen demand increase

2: Delayed consumption – new cars and computers, consumables, homes, future travel, etc.

3: Lost spending (that will never be recovered) – travel, restaurant spending, income from delayed construction projects, fuel for cars not consumed

History shows that it takes about 20 months for a pandemic to pass. Hopefully COVID-19 will be quicker, as it is a global issue which has the human and economic resources of the world deployed to create a vaccine and rapid testing options.

How quickly will we re-open businesses, borders and travel? Who will be game to make the call “it’s all safe, please come out”, and put their political career on the line in doing so?

After 9/11, President George Bush urged people to “take your rebate cheque and go on a plane, go down to Disney World”. It might not be as easy to get consumers back into crowded public spaces too quickly this time.

Tourism is 10 percent of global GDP or around 320 million jobs. It is very discretionary and might be slow to recover. People might be more frugal and timid this time. Borders may be slow to open.

At Laguna Bay, we think in terms of possible outcomes and assess, then debate, probabilities on those outcomes occurring and keep an eye on it over time – this situation is very dynamic. There is no doubt that we will recover from this, but how that unfolds will only be known in time. Will it be a:

– V-shaped recovery – maybe a third of the population are immune to COVID-19 and many more people have already had it than we think and so the acute symptom rates may not be as bad as thought? Extensive testing is needed. Maybe an existing drug such as chloroquine sulphate proves to effectively treat it in the near-term reducing fatality rates? Maybe the significant government stimulus packages support effective labour transitions and together with lower oil prices creates a pick-up in consumer spending and business investment and maybe asset prices inflate?

– W-shaped recovery – a bumpier and longer version of a V-shaped recovery where we recover but COVID-19 infection rates break out again and market and consumer confidence ebbs and flows. This scenario destroyed a lot of wealth in the early 1930s as many investors bought false bottoms.

– L-shaped recovery – such as happened in Japan, which could take decades as the overhang of debt, over capacity, increased savings, and high unemployment cause deflation.

7). What possible disruptions will remain after recovery? 

The world will not be the same after COVID-19 passes. What might change?

– People will most likely keep more dry good supplies at home.

– Nations may build up strategic reserves of staple products, including pharmaceuticals and food.

– After the GFC, “too big to fail” financial institutions had special regulations mandated on them. Maybe essential companies such as some pharmaceutical, food, and manufacturers of medical equipment, might also see new regulations, including local manufacturing and higher inventories. This could lead to slightly lower ROA’s but lower risks for society.

– There might be a push towards nationalism in consumption and a further push to buy locally.

– Increased reliance on technology, from changing consumers’ habits – the obvious one being an increased reliance on sourcing goods and services online – and likely reduction of in-person meetings which saves time, money, and reduces our carbon footprint. Can you imagine the tens of millions of dollars (maybe hundreds of millions) of savings if the G20 meeting was held online? No private jets, accommodation, meals, and security for the thousands of support staff and media.

– Food distributors will be facing large defaults as a result of failing restaurants. Some will not recover. It may take longer for them to ramp up again. Perhaps the consumer wants to get closer to the producer after the pandemic. This could see the development of new distribution models that bypass traditional distribution models and would be a positive for the primary producer.

– Travel got a lot harder after 9/11 and this crisis won’t be any different. I doubt you will be allowed on a plane whilst having a temperature for years. This will reduce an individual’s travel reliability. If we wake the morning of a flight with a temperature, we will not be boarding a flight.

– Lots of full-time employees will now be part-time to give more flexibility to business, and employees from structurally affected industries (e.g. travel and tourism) will need to find new roles in the economy; this transition will be challenging.

– There should be a boom in automation – zero human touch robotics in manufacturing and facilitating touch-free shopping centres and public amenities.

– Education evolving into a semi-decentralised model with more pupil-free, online days. I did ‘school of the air’ on our family farm for first grade via two-way radio.

– Civil liberties will be unlikely to revert to what they were. Phone tracking and border security measures will probably stay in place and be enhanced; Singapore sets an interesting example.

– Mistrust between nations will most likely continue, which is very dangerous given the rise in populist politics.

– The debts accumulated by stimulus packages will take generations to pay off and will cause future generations to have to make sacrifices.

– Food security will become important and we may see a lot of interest in agriculture asset purchases and supply agreements. Foreign investment scrutiny may get worse.

In summary, we may see a fundamental shift in consumer patterns. We will continue to see fundamental shifts in debt monetisation, volatility, and correlation of public markets, and this may see a shift in asset allocations towards defensive private markets in assets that produce essential consumer staples. I received an unnamed quote last week that resonated with me. It said “Maybe the world just sent us to our rooms to think about what we have done”. When we come through this pandemic, it might be back to basics for consumers and investors. It doesn’t get any more basic than making sound, uncorrelated, real returns from producing food from good farmland.

ABOUT TIM McGAVIN

Tim McGavin is founder and chief executive officer of Laguna Bay. Laguna Bay is an agricultural fund manager that has around $700 million of committed and managed funds in Australian agricultural spanning many sectors and operating strategies.