Strong Productivity And Asset Management Bode Well For SLC Agricola - SLC Agrícola S.A. (OTCMKTS:SLCJY)

It's been a while since I've written about SLC Agricola (OTCPK:SLCJY), and the shares have had quite a ride since then, trading up as much as 30% relative to the price at that last article before starting a downward slide that now has the shares trading about 20% below where they were last year. While they're all different companies, that net performance largely mirrors the disappointing performance at Adecoagro (AGRO) (which does some farming, but is predominantly a sugar/ethanol company), and significantly lags the performance of other Brazilian ag/sugar/ethanol players like Cosan (CZZ), Sao Martinho, and BrasilAgro (LND).

Commodity companies are difficult in general, and agricultural commodity companies are even more difficult given the significant impact local/regional weather can play (among other factors). At SLC, though, I think the company's consistent superior productivity must factor into the valuation as well as management's strategy to go asset-lighter and conduct more sale/leaseback transactions. I see fair value in the $5.25 to $6.25 range, though I would note the liquidity on the ADRs isn't great.

Maybe the biggest unknown for SLC Agricola in 2019 is where soybean prices will settle out. Soy accounts for around 40% of the company's revenue and EBITDA, so it definitely matters. In the first quarter earnings report, management revised its productivity guidance up about 6%, suggesting low single-digit productivity growth in 2019 after an incredibly strong 2018 (about a third above the long-term average in terms of kg/Ha). Management also disclosed that about 70% of the expected crop was hedged at $10.30/bushel (against a spot CBOT price of $8.78 as of this writing).

On the positive side, the tariff battle between the U.S. and China has led China to turn to Brazil to supply even more of its soy needs (China accounts for 30% of global demand, Brazil accounts for 32% of global supply and more than 50% of global exports). On the negative side, the outbreak of African Swine Fever has meaningfully decreased expectations for China's soy needs. Back on the positive side, U.S. soy plantings are at a 10-year low due to poor weather, with only 40% of the crop planted through June 1 and a shrinking window of opportunity to get the plantings done. Squarely, in the "some good, some bad" zone, while the premium for Brazilian soybeans is well off its $3/bu peak, it's been rebounding from the sub-$0.50/bu level.

Given the hedging position and SLC Agricola's improvements in operating efficiency, I think 2019 will be a good year for soy. Longer term, this remains a worthwhile business for the company, with long-term yields about 5% above the norms in Brazil and the U.S., and more recent yield advantages closer to 15% to 20%. Investors should also note that management has already hedged more than 40% of the 2020 crop (at around $9.80/bu).

I fully expect SLC Agricola management to continue to prioritize cotton in the future and look to increase its planted acreage. Cotton has grown from around 40% of the company's revenue to closer to 50% more recently, and cotton generates about 5x more EBITDA per Ha than soy. With yields comfortably above Brazilian norms (about 10% long-term) and well above U.S. norms, it seems like a no-brainer.

As far as the market goes, supply has been outrunning demand in recent years, and prices have fallen about 20% over the last year, 12% over the last two years, and 12% over the past three years. SLC Agricola revised its 2019 yield estimate higher by about 6% but still expects a year-over-year decline (in the low single-digits). Over 90% of the 2019 crop is hedged at around $0.80/lb, well above today's spot price of $0.61, but only about 20% of the 2020 crop is hedged (at around $0.79/lb).

SLC Agricola has always stood out to me for its superior technology/process-driven operations. SLC has been an aggressive adopter of modern machinery, seed technologies, and new technologies like RFID tagging and field monitoring. While there are still opportunities to add more digital technologies to the operation (including crop/field monitoring), and the company's soybean fields are just reaching maturity, I'm not sure how much more productivity the company can reasonably be expected to squeeze out of its fields - in both cotton and soy, the company's yields are exemplary.

While management does intend to continue increasing its planted acreage and will continue to invest in yield-enhancing/margin-improving technologies, I believe the biggest near-to-medium-term driver will be a change in the company's philosophy toward its asset base.

Brazilian farmland values have increased by more than 10% a year on average over the past decade, but the rate of appreciation has definitely slowed (up 3% in 2018 for SLC Agricola, down slightly for Adecoagro). Although Brazilian farmland still trades well below the value of Argentinian and U.S. farmland, there are also still meaningful logistical challenges in the market, including poor rail access, inadequate storage infrastructure, and long distances to ports (most of Brazil's corn and soy are grown 1,000km or more from ports).

Perhaps anticipating a slower pace of appreciation from here, and with minimal undeveloped acreage (versus BrasilAgro, whose land bank is almost one-third undeveloped), SLC Agricola is looking to increase its sale-leaseback activity, with a goal of boosting its leased acreage planting from about 40% of the mix to 60% or more over the next few years. With returns on leased land about 50% to 100% higher than those on owned land (on an ROIC basis) and strong EBITDA margins, this could be a meaningful driver of returns and capital returns, provided commodity prices don't decline significantly.

I model SLC Agricola using the company's planting and yield estimates coupled with the hedging details, current commodity futures data, and third-party projections for commodity prices. I'm expecting high single-digit revenue growth from SLC Agricola over the next decade, with more than half of that coming from increases in planted acreage. If commodity prices stay flat over the next decade, it would take about $0.50 to $1/ADR out of my fair value.

I'm expecting EBITDA margins to decline from the 30%-plus levels of recent years into the mid-20%s, and I expect the next few years of FCF to below recent years in terms of margin (FCF/revenue), but I do expect the sale/leaseback transition to support higher FCF yields over time, driving FCF growth into the low double digits.

I also value SLC Agricola on a forward EV/EBITDA basis. SLC Agricola's forward multiple can move around a lot but has generally been between 6.5x and 8.25x over the long term. Today, I'm comfortable with a 7x multiple (higher than the 6x I use for Adecoagro, as SLC Agricola has no sugar/ethanol exposure).

Between discounted cash flow and EV/EBITDA, I believe fair value is between $5.25 and $6.25 per ADR today. Whether that is enough of a discount to compensate for the risks and volatility inherent to an agricultural company, that's for readers to decide for themselves. I do believe SLC Agricola is one of the best-run agricultural companies out there, but the long-term performance numbers are what they are (not impressive on a five-year basis), and this is a tough sector in which to make money consistently.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: Seekingalpha.com

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