Deep roots: A diverse production mix offers opportunities to rebuild the sector

Despite some challenging circumstances, the South African agricultural sector continues to perform robustly. While uncertainty over land tenure, labour unrest and the current economic environment have created some difficulties, they have not cast a shadow over the future of the industry. As the country continues to struggle with the post-apartheid quest for transformation of the sector, employment generation and rural development, the industry produces standout commercial success stories. Indeed, despite the uncertain investment environment and economic gloom on the global stage, investors have many reasons to look favourably on South African agriculture.

Unati Speirs, the director of Agro-processing in the Industrial Development division at the Department of Trade and Industry, told OBG, “In terms of food, South Africa is still the gateway to Africa.”

Economic Contribution

The agriculture, forestry and fisheries sector in the first quarter of 2013 accounted for 2.2% of real GDP, as per Statistics South Africa (Stats SA). This is down from 2.5% in 2010 and 7.1% in 1970, according to the Department of Agriculture, Forestry and Fisheries. However, the industry has shown positive signs of bucking this trend. In the first quarter of 2012 growth hit 3.4%, while in the second quarter it reached 5.8%. This figure was above the GDP figure for the second quarter, which stood at 3.4%, according to Bloomberg. With greater stability, there could be substantial potential for growth and development in the industry. In the 12 months before June 30, 2012 gross farming income in South Africa increased by 21.9% to R161.1bn ($19.63bn). Field crops saw the biggest rise at 63.1%, while horticultural products (9.2%) and animal products (11.6%) also grew, according to the Department of Agriculture, Forestry and Fisheries.

Much of this increase was the result of high commodity prices. The weighted average price of field crops rose by 31.7% in the same period. Horticultural products were up by an average of 5.9%. The price paid to farmers for products jumped by an average of 15.5%, while the price paid by farmers for inputs rose by 13.8% in the same period, according to the Department of Agriculture, Forestry and Fisheries. In total, net farming income grew by 55.8% to R51.5bn ($6.27bn) in the 12 months to the end of June 2012.

Big Business

Beyond these positive tendrils of recovery, the sector continues to offer significant opportunities for investors. According to Bloomberg, 10 of the top 20 agribusinesses by turnover come from South Africa. Particularly in the secondary agriculture sector, the industry has produced a number of heavyweight companies that rank strongly on the Johannesburg Stock Exchange (JSE), a legacy of the sector’s central position to the South African economy.

Indeed, Tiger Brands, a fast-moving consumer goods company largely focused on food, ranks in the top 40 companies on the JSE with a market capitalisation of R58.94bn ($7.18bn) in mid July 2013, according to Bloomberg. Despite a difficult domestic and global operating environment, including weak consumer demand and volatile commodity prices, the company has performed strongly in the 12 months preceding September of 2012. The company reported an 11% increase in revenue to R22.7bn ($2.77bn) for the year.

Tiger Brands is also expanding, with two investments in the last two years. In February 2011 the company bought Davita Trading, a local powdered food company with a presence in 28 African countries, for R1.34bn ($163.3m). Then in July 2012 the company acquired a 63.4% stake in the Nigerian company Dangote Flour Mills.

Such acquisitions not only show the ambition of South African firms in the African market, but also point to potential benefits for the domestic agriculture and processing industry. Avior Research equity analyst Jiten Bechoo told the local press, “The Davita acquisition was a good one… Just by the nature of the Davita business, which is one that uses a South African manufacturing base to export products widely into Africa – that kind of approach has proved to achieve better margins quicker, compared to going in and buying companies on the continent, refurbishing equipment and trying to build brands from within.”

The Dangote deal could also provide opportunities for local grain farmers. South Africa has become a net importer of wheat, importing approximately one-third of its requirements, according to Absa Bank; over the past three years, this percentage had been between 40-55%. This change is largely the result of relatively low wheat prices (which range from R3000-3500 [$365.70-426.65] per tonne) and the lack of the development of new hybrids. Aart-Jan Verschoor, a senior manager at the Agricultural Research Council (ARC), told OBG, “Wheat certainly constitutes an economic opportunity for farmers here in South Africa.” According to Verschoor, the milling industry is looking for locally sourced wheat to blend with imported wheat, a mix that is appropriate for baking. The ARC is focused on its breeding programme, to fulfil local requirements, given that most private breeders focus on maize.

Other food and agriculture-related companies on the JSE include Clover, Illovo Sugar, Pioneer Food Group and Tongaat Hulett. In the poultry segment, listed companies include Country Bird Holdings, Astral Foods, Rainbow Chicken and Sovereign Food Investment. In January 2011 Schalk Louw, the CEO and strategist at Contego Asset Management, told Fin24, a local business and stock market publication, that the earnings of food producers on the JSE show a 60% correlation with food inflation, suggesting that tracking global commodity trends, there could be some good opportunities to invest in South African food companies.

Major Products

South Africa’s key production mix has changed little over the past 12 months. The country’s primary farming segments (by value produced) include cattle, dairy, poultry, sugar and maize. Indeed, in 2011 indigenous cattle meat was the country’s biggest product by value, according to the UN’s Food and Agriculture Organisation (FAO). Chicken meat had the second highest production value, with the top five products rounded out by cow milk, maize and grapes, all of which also featured in the most valuable products in 2010, according to the FAO.

Many of South Africa’s most valuable crops and products are threatened to some degree by strong international competition. This is particularly the case with regard to poultry. South Africa has had a long and ongoing disagreement with Brazil over the cost of the latter’s poultry imports. Between February and August of 2012, South Africa imposed an additional anti-dumping duty of 6%, increasing the tariff to 63% on certain chicken cuts imported from Brazil. The South American country responded with a complaint to the World Trade Organisation (WTO). However, the South African government has decided not to impose definitive anti-dumping duties on Brazil and the South American country, in a departure from its previous practice, has not sought to push for an adjudication panel from the WTO.

While this may have avoided a trade war between two close BRICS allies, it has angered many within South Africa’s domestic poultry industry. The South African Poultry Association, for example, has been a vocal proponent of anti-dumping measures. The body estimates that R3.5bn ($426.6m) worth of chicken entered the South African market at artificially low prices in 2012. This was the equivalent of 5m chickens each week. According to the association, substituting these imports for local production could create 20,000 jobs. The government argues that the problem is more extensive than the issue of Brazilian imports and that a general tariff rise on poultry products may be required. However, with little sign of a new tariff regime, the Food and Allied Workers Union staged a protest in April 2013 calling for new tariffs on chicken imports from the EU and Brazil.

Consumption & Costs

Beyond the income growth and large migration towards the middle class within South Africa, the local industry is well placed to take advantage of the growing African market. The population of the continent is expected to more than triple from 1bn people in 2011 to 3.6bn by 2100. Several large South African firms have already been looking northwards to take advantage of this growing market.

However, the domestic market is becoming increasingly difficult. According to Tiger Brands’ annual report, growth in consumer spending was expected to fall from a high of 5% in 2011, down to 3.3% in 2012 and 3.7% in 2013. At the same time, however, spending on food continues to show considerable growth. According to the Department of Agriculture, Forestry and Fisheries, consumption expenditure on food reached R428.5bn ($52.23bn) at the end of 2012, an increase of 11.4% compared to the same period of 2011. Bread and grains showed the biggest rise at 14.6%, followed by milk products and eggs. Expenditure on meat and potatoes grew by 9.4%, while expenditure on fruit and vegetables was up by 9.9%. This is the result of inflation in food prices, to some extent. According to Stats SA, the annual rise in the food and non-alcoholic beverage index was 6.9% in December 2012. For that month, fruit, dairy products, and breads and cereals all showed a consumer price rise. This is the upshot of growing price pressure on the farming and agricultural sector. The producer price index saw an annual increase of 9.2% for food at manufacturing and 3.2% for agriculture in 2012, compared to a jump of 5.2% for the index as a whole (for domestic output), according to Stats SA.

John Purchase, the chief executive of the Agricultural Business Chamber, told OBG, “It is very expensive to farm commercially. Fuel, electricity, water, fertiliser and seed costs are all increasing considerably and quite a bit faster than inflation. Commodity prices have also increased in the past year, but perhaps not to the same extent as input costs. What is driving food prices up are input costs and costs, for example, agro-logistics costs, further down the value chain.”

Power Prices

Between June 2006 and the end of 2012, consumers have had to absorb electricity tariff increases of more than 142%. Eskom, the country’s primary electricity generation, transmission and distribution company, is seeking a further 16% annual raise in the tariff over the next five years. Such raises will be particularly challenging for the secondary sector and for those with products in the cold chain.

However, for many farmers in the primary sector a larger concern is the fertiliser price. According to the National Agricultural Marketing Council, fertiliser constitutes between 30% and 50% of overall input costs for South African farmers. Between September 2011 and September 2012, monoammonium phosphate, urea and potassium chloride all saw substantial local price hikes (by 7.2%, 4.2% and 7.7%, respectively). Farmers also had to contend with fuel price inflation, with petrol and diesel both up by 17.6% in the same period.

As such, farmers are being squeezed by both administered regulated costs, such as fuel and electricity prices, but also by market-determined costs such as fertiliser. Indeed, question marks remain about the viability of government intervention to ease the burden on farmers. In February 2013 Tony Ehrenreich, the Western Cape provincial secretary of the Congress of South African Trade Unions, called for electricity subsidies for farmers, arguing that local farmers are at a disadvantage given the habitual subsidies for farmers in other international markets. However, Frans Cronje, the deputy chief executive of the South African InstiTop agricultural products by value, 2011 tute for Race Relations, responded by suggesting that subsidies would have little impact in the longer term. “The problem with subsidies is that they are not a solution … With subsidies you are taking money out of the same pot farmers are putting money into [through tax]… The only solution is to reduce the costs of doing business in South Africa,” he said.

Wages

The cost burden on commercial farmers is becoming an increasingly emotive issue and one that has come to the fore through labour unrest in the country. A series of strikes by farm workers in the Western Cape, which turned violent in January 2013, have pushed labour issues in the agricultural sector to the top of the agenda. Purchase told OBG, “Labour unrest has remained isolated in the Western Cape because it is mainly a seasonal migrant labour issue. There is such an oversupply of migrant workers entering the region from across Africa, but also from the Eastern Cape.” These workers have been calling for an increase in the minimum wage, a call that was heeded by the Department of Labour in February 2013. Indeed, in that month the minimum wage in the farming sector was raised by more than 50% from R69 ($8.41) to R105 ($12.80), a regulation that will take effect from April 2013.

Land

Land tenure and land reform are also major issues. According to Purchase, “It is the factor that is causing the most uncertainty in agriculture, and because of that it is inhibiting investment the most.” In the early 1990s when land reform was first touted over 80% of farms were white-owned. The African National Congress-led government set the target of transferring 30% of these to black owners by 2014.

However, thus far, only 8% of this land has been transferred and approximately 90% of farms transferred to black farmers under the policy are no longer productive. In the last six months, the issue has returned towards the top of the national agenda. The government is striving for a new push on land reform in 2013, the centenary of the 1913 Native Land Act, legislation that played a considerable role in dispossessing the black community in the country.

In October 2012 President Jacob Zuma announced new plans for land reform, suggesting the establishment of district land reform committees that would be responsible for identifying 20% of the commercial agricultural land at the local level for redistribution. The emphasis would be placed on land where the farmer was under financial distress, or where there was an absentee landlord or it was part of a deceased’s estate. As such, the government believes that this would minimise the impact on the commercial sector.

Outlook

With demand somewhat stymied and rising costs of operation for a number of farmers and agro-processing businesses, not to mention key labour issues and land reform, the agricultural sector faces some pressing challenges. These notwithstanding, farming income levels are rising and South Africa’s large-scale firms operating in the secondary sector continue to perform robustly. As domestic demand looks likely to pick up and new markets steadily open across the continent, the medium-term prospects are looking stronger.