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I maintain that the underlying impetus driving the coup in Cairo relates principally to the price of food and specifically to that of wheat (Egypt is the world’s biggest importer); while certainly the littany of grievances in Egypt touched upon poverty, unemployment, cronyism, corruption and an overall lack of legitimate political opposition, as The Economist noted back in 2005 “Egyptians have tended to shrug off electoral shenanigans and police hooliganism as part of their lot. [Decades] of one-party rule, mostly under martial law, have left the country socially atomised and sceptical of even the possibility of effecting change.” Wheat price volatility, by contrast, is a fairly new but increasingly sinister phenomenon (the rolling standard deviation of percentage changes in the price over twelve months has trended up from about 5% during the 1980s and 1990s to about 15% today; see chart left), especially for a government whose fiscal deficit as a % of GDP has consistently widened over the past few years in an effort to subsidize costs and thus somewhat neutralize per capita inflationary effects on the average citizen who devotes roughly forty percent of his income to food (bottom right).
With shrinking world food supplies in the near-term, increasingly unpredictable weather patterns and the expected secular rise in Asian food (and specifically meat) consumption one may question to what degree this dynamic is priced into budget projections (i.e. for Arab policy makers set on further subsidies), the yields demanded by creditors or even sovereign default protection. Barclays wrote today for instance that Egypt credit spreads “rallied following the announcement of President Mubarak stepping down, with 5y CDS tightening to about 320, a level not seen since the beginning of the protests on 25 January. Investor perceptions of a potentially improved longer-term outlook for Egypt (in terms of social stability) in a post-Mubarak era may continue to support momentum for Egyptian spreads to tighten at this stage.” The contention here, however, is that social stability and fiscal/food policy is hopelessly intertwined, in Egypt and elsewhere. Yet even putting aside the vexing conundrum of who or what exactly will now follow in Mubarak’s footsteps, the interim period is not likely to be kind for fiscal prudence (increased spending is correlated with social unrest) and thus inflation, which at 10.8% y/y already trumped consensus. Barclays, for one, advises clients to “scale back into short credit positions” on any further spread tightening.
Per the FT’s recent insert on world food, “the prevalence of hunger in developing countries has fallen but is stuck at 16 percent, and there will not be enough time or money, according to many experts, to hit the 10 percent target by 2015.” Solutions are as varied as they are complex, though for certain there is room for “improving agriculatural yields, especially in Africa, where the sector has lacked investment. Only 4 percent of sub-Saharhan African cropland was irrigated in 2002, up from 2 percent in 1962, compared with almost 40 percent in South Asia.” Analysts note that every step of the production process must be targeted–from farming techniques themselves that educate about pesticide use, cutting waste, and improving quality through using best practices such as better seeds, soil testing, and planting and harvesting techniques, to increasing access to customers not only be removing costly intermediaries, but also by improving substandard roads and communication networks that, coupled with increasingly volatile commodity market prices (due in part to climate change as well as protectionism abroad), is particularly devestating to the vert supply chains most abundant in poorer countries that tend also to be more reliant on vulnerable smallholders. To that end, better access to credit and more transparent and credible land rights are crucial to production as well, experts note.
Finally, an underlying issue may not just be sufficient production of quality food, but also sufficient variance in terms of quality of nutrition. Per the UN’s Food and Agricultural Organization (FAO), for instance, ” at a global level, the world already has enough food . . . but if diets are not sufficiently varied, they may lack vitamin A, iron, zinc and iodine, causing infants and young children irreparable harm.” Couple the need for properly diversified nutrition (which in turn is linked not only to fortification of staple foods, but also to sanitation and, most importantly, antenatal care and education of, and perhaps direct transfer-payments to mothers) with Nicholas Kristof’s latest piece in The New York Times on just how crucial the role of the uterine environment is to a given individual and thus, society’s welfare in the aggregate, and it is to easy to argue that the quality and supply of the global food chain is the single most important issue facing developing (and developed?) countries today in terms of their long-term evolution.
That said, I continue to maintain that an even more basic issue–the supply and suitability of water–is even more crucial, in that it lays the groundwork essential to efficiently meeting demand. Admittedly, the topic of usable water goes hand in hand with ‘best practice’ farming techniques and more pointedly, irrigation (agriculture accounts for roughly 70 percent of water consumption). For example the FT cites Daniel Wild, an equity analyst with Sustainable Asset Management in Switzerland, who points out that “with conventional food irrigation, the efficiency level is often well below 50 percent, and important nutrients or corp protection agents are [thus] washed away in the process.” This and other measures, such as horizontal ploughing and preventing farmers from tapping underground sources without limit (if usable water is a scarce commodity, isn’t there a moral hazard to not effectively pricing and treasting it as such?) may in turn boost crop yields by up to 150 percent or more. The FT points out that several emerging market companies–most notably Jain Irrigation Systems in India amd Israel’s Netafim–are experiencing rapid growth in micro irrigation systems (MISs), which include drip systems, sprinklers, valves, water filters and plant tissue products and help to enhance the productivity of seeds and fertilizer while conserving water. Additionally, said firms are exploring solar water pumps, a sort of leapfrog technology in a sense that could be used by farmers even in power-deficit states (of which they are plenty in frontier regions). Ultimately, “[Jain] plans to enhance its distribution by adding new dealers and distributors to penetrate [frontier markets] in Africa and the Middle East,” per Anil Jain, its managing director. Analysts and investors alike, including asset managers and private equity funds, would be wise to keep a watchful eye on this growing sub-sector of agribusiness.
It’s one thing to hear a money manager, whose fund’s thesis rests on African growth, tout the continent’s impending demographic dividend and accelerating consumption habits; it’s quite another when the world’s biggest retailer takes a punt and sinks its own teeth into the game. Last week’s Economist noted, for instance, that Wal-Mart’s recent $4.1bn acquisition of South African-based Massmart (the top wholesaler and low-cost distributor of basic foods and consumer goods, as well as the leading retailer of general merchanise, liquor and home improvement equipment and supplies with 288 stores in 14 countries spread across sub-Saharan Africa) is proof that “Africa is near the top of the agenda for the world’s leading businesses . . . as [its] middle class and urban working class expand rapidly, food consumption is expected to grow strongly, along with sales of other consumer products.” That said, as the article points out by referencing the firm’s travails in Germany, the rewards from such global expansions are never for certain, and hence why the $4bn expenditure should perhaps be thought of more as a cheap call option on the region rather than a definitive, global macro paradigm shift in consumption habits.
Mumias Sugar Co., Kenya’s biggest sugar producer and the stock of which has risen 99 percent this year (almost triple the 35 percent advance in the country’s benchmark stock index) is in the midst of diversifying its revenue sources by reducing its reliance on its core business of sugar production as final selling prices of the commodity will be negatively impacted beginning this December by the expiry of regional trade concessions that will give way to a flood of duty free, imported stocks that sell at a discount due to their lower production costs. In addition to increasing the amount of branded sugar to 70 percent from 30 percent, the company will launch a 120 million litre per year ethanol manufacturing plant in December 2011 (in late August it secured debt-financing amounting to $20 million (Sh1.6 billion) from a consortium of banks led by Ecobank Kenya to fund the plant), produce bottled drinking water from co-generation, a process whereby plants generate electricity from industrial waste or by-products such as gases, and refine its own sugar. The newfound stable electricity supply from the co-generation project would already boost output of its sweetener by 15 percent this year, management touted back in April.
London-based Silk Invest, which recently won the Africa investor Agribusiness Investment Initiative of the Year in Durban for its African Food Fund, underscores in its latest blog post exactly what it envisions to be the driving catalysts behind the private equity vehicle it launched earlier this year.
First, the food industry is a principal pillar underpinning African consumption, and it should only continue to grow both in size and scope as output grows to service increasing demand. “There will be 500 million new consumers in Africa in the next 15 years and…even today, already 50-60% of disposable household income in many African countries is spent on food,” the group notes. Moreover, as incomes and tastes rise, one can expect a convergence between Sub-Saharhan countries and the rest of the continent in terms of food sales channels and specifically the supermarket penetration rate (see graph, right). That in turn is likely to fuel the continuing acceleration of branded and packaged products. “Moving to packaged sugar, milk or flour is a big driver of growth. In most African countries, food is still pre-dominantly sold through non-branded items,” chief executive Zin Bekkali told Reuters in April.
Second, many African food companies cannot obtain financing in spite of high ROE which theoretically would indicate efficiency, creating a bevy of opportunities for investors. Per Silk, “the smaller, privately owned food companies are equally benefitting from strong demand dynamics but are faced with challenges of obtaining the capital needed to effect the capital expenditure required to grow in line with demand. The banks are not lending the capital needed to grow, probably because they are also mostly focused on capturing the growth of the consumer by targeting more retail customers, at the expense of not fully developing their corporate banking activities.”
Saudi-based Savola’s “expansion drive” was temporarily halted after the Middle East’s largest sugar refiner announced that it would not bid for the six sugar beet processing mills being sold by the Turkish government, as previously expected. In October the firm said that, along with farmers’ union Turkey Tarim Kredi and the Nesma Holding Company, it would set up a joint venture in order to increase production at the plants from 300K to 500k tons/year, while “orient[ing] some of the output to foreign markets,” per one Savola executive. Yet there are other options [for expansion] on the table, reiterated its chief executive, Sami Baroum, including “options in Sudan and Egypt.” And according to at least one analyst at Shuaa Capital in October, “expanding outside of the Gulf Arab region is part of Savola’s stated expansion strategy in the food sector, where its sugar business is a major component alongside edible oil.”
The missed opportunity should be an opportune time to beginning ramping into shares of Savola for our mock frontier fund. The firm is an attractive long-term investment on multiple fronts: one, its highly diversified business operations involve the firm not only in the production of edible oil and sugar, but also in retail and real estate. Savola Foods, however, can be considered part of the bedrock of its identity: in addition to being the world’s largest manufacturer of branded cooking oil, its total sugar refining capacity of 2 million tons/year is nearly double that of its closest regional competitor, UAE-based al-Khaleej Sugar Co. That said, at the end of 2008 the company’s retail segment (highlighted by Panda, the largest retail food chain in the Middle East) was the major revenue generator, accounting for 43.8% of the total company’s revenue followed by edible oil and sugar segments with a share of 32.6% and 17.6% respectively. The company is also targeting expansion for this latter segment; per a report issued in mid-October by Global Investment House, a Kuwaiti investment firm, “expansion in the company’s retail segment is based on two types of strategies: (i) acquisition of other retail chains (e.g. Giant and Geant stores); and (ii) adding new hyper and super-Panda stores. This is expected to increase company’s overall retail stores to 110-116 in 2012, out of which 15-20 will be hypermarkets and remainder will be supermarkets.”
EFG-Hermes, a Cairo-based investment bank, noted to investors last week that it expects the Egyptian pound to fall to LE 5.70 by the end of 2009 and LE 5.90 by the end of June 2010 relative to the U.S. dollar. The pound has strengthened by 2.2% against the dollar since March, hurting exports and in-turn stalling GDP growth–which is set to fall to 3.1% in 2009-2010 from 4.1% in the year prior, the firm posited. “With credit growth slow and low loan-to-deposit ratios, exchange rates are a more effective channel than bank lending for supporting growth, by improving export competitiveness. The Nominal Effective Exchange Rate (NEER) has been stable since June, but we think that the [Central Bank of Egypt (CBE)] will encourage some trade-weighted EGP depreciation before the end of 2009,” speculated EFG economist Simon Kitchen to investors. Yet while Kitchen’s theory makes sound economic sense, it may not pass muster with authorities. One risk of currency devaluation is that by increasing the price of imports and stimulating greater demand for domestic products, devaluation can lead to inflation, which in turn might require the CBE to raise interest rates–a prospect most central banks will balk at until a bona fide global recovery is indeed upon us. Moreover, inflationary pressures could wreak havoc with habitually volatile food prices that will already be tied to increased and impending consumption and preparations for post-Ramadan festivities.
Abu Dhabi-based Agthia Group, a holding company with three subsidiaries operating in the distribution and bottling of mineral water; the production of flour, animal feed and frozen and canned vegetables and the distribution of baby food, tea, juices and jam, reported strong growth (group sales up 18.7%; gross profit margin up 11.4%; and net profits doubled) for the first six months of 2009. Per its Chairman, Rashid Mubarak Al Hajeri, the results are a “testament to the defensive nature of the food and beverage sector. The growth registered this quarter builds upon the strong first quarter performance and sets a positive scene for the rest of the year. Agthia’s performance for the first half of 2009 demonstrates the strength of the company’s core businesses and the effective implementation of management’s strategic and financial initiatives.” According to analysts, the increase in revenue was predominantly driven by sales volumes, with flour and feed up 7.6% (16.6% volume growth), and water and beverages up 42.8% compared to same period last year.
JGW
Frontier Markets 
