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Brazilian Farmland – Is the Risk Worth the Reward?

By Michael DeSa, Founder of AGD Consulting, and Monica Ganley, Principal at Quarterra

Click here to view the article on Global AgInvesting’s website

In recent years, Brazil has solidified its role as a global agricultural powerhouse. It has become the world’s largest exporter of soybeans, coffee, and sugar, as well as the second largest overall food producer on the planet. Over the past 15 years, Brazil has increased agricultural production by 156 percent with overall Gross Domestic Product (GDP) from agriculture reaching an all-time high in the first quarter of 2017.¹ The agricultural sector as a whole accounts for nearly 6 percent of Brazil’s total GDP and employs nearly 16 percent of their total labor force.² It is also the only sector that has continued to grow despite the current recession.³

Is this enough, however, to draw investors into a country and an economy in the midst of economic and political discourse? The economic crisis, which began in early 2015, coupled with the ongoing political turmoil, have forced Brazil into difficult times. In 2015 and 2016 Brazil’s GDP declined – the first time since 1931 that the country’s GDP has fallen for two consecutive years.

Figure 1: Brazil’s GDP (2010 – 2016)

However, the World Bank expects Brazil to slowly emerge from the recession by the end of 2017; restoring investor confidence and recovering lost ground could take much longer.

Brazilian Farmland – Is it Still for Sale?

While Brazil has begun in earnest to develop its frontier farming regions, there still remains millions of hectares left to be developed. Brazil’s total arable land area nears 600 million acres with only 170 million acres presently cultivated. One side of this coin seems to indicate that there is more than ample room for the development of viable agricultural land to meet a growing demand. With the world’s population expected to reach nearly 10 billion people by 2050, Brazil’s millions of hectares of undeveloped land could become the southern hemisphere’s next bread basket.

Farmland prices are also an attractive part of this equation, and is the primary reason for foreign investment by groups such as the Brazil Farmland Development Fund. According to Matthew Kruse, President of the fund, their land appreciated at nearly 3x within a ten-year timeframe in their previous investment. According to Kruse, “we can purchase land at less than U$1,000 per acre. That is a fraction of comparable land costs in parts of the Midwestern United States. We are confident that we are purchasing land with the same productivity potential but at one-tenth the cost.” Given that the average price for an acre of U.S. farmland is US$7,183, according to the 2016 Iowa Land Value Survey Results, farmland in Brazil is presently some of the most affordable in the world.

The other side of the coin begs the question – if land is so plentiful and affordable, and it’s the only sector in Brazil’s economy that is presently growing, why hasn’t this development happened yet?

Financing in Brazil is neither common nor readily available, thereby limiting the average Brazilian’s ability to purchase and develop raw land. There are no government subsidies for agriculture in Brazil either. Land development can be very expensive, requiring either independent wealth, foreign investment, or debt financing to accomplish, the latter of which is largely not an option. Wealthy Brazilians do not account for a sizable enough population to make a substantial impact in development statistics.

These factors have resulted in a much smaller pool of available capital capable of developing Brazilian farmland, leaving foreign investment as a significant source of land development capital in Brazil. This pool of capital has been growing during the last couple of years, making Brazil the world’s eighth largest destination for Foreign Direct Investment (FDI) in 2015,⁴ and could indicate that investors are again ready to take the plunge.

In spite of a growing agricultural sector, attractive farmland prices and increasing foreign investment flowing into the sector, the decision to invest in Brazilian farmland is still very much a risk versus reward consideration.

Understanding the Risks

While Brazil offers a compelling opportunity for agricultural investors, operating within the country carries unique challenges. To be successful, investors must be cognizant of these risks and become either comfortable with the potential impacts, or confident that they have a robust mitigation strategy in place. Although agricultural investments worldwide are subject to volatility stemming from a variety of sources, including weather and fickle commodity markets, investments in Brazil are subject to unique idiosyncratic risk as well, particularly due to the political environment, foreign exchange fluctuations, and liquidity issues.

Brazil’s chaotic political machine has been thrust into the international spotlight repeatedly in recent years as widespread corruption scandals have led to the indictment of one former president, the impeachment of another, and have left the current president with dismal approval ratings. Just a decade ago, Brazil was the darling of Latin America, posting GDP growth that frequently topped 5 percent. However, the prevailing concern, given the country’s poor economic performance during the last couple of years, is that these ongoing political scandals will inhibit the country’s recovery, thus impacting investment performance.⁵

In addition to impeding overall economic performance, an unstable political system can introduce additional risks that must be considered with any potential investment in Brazil. One poignant example is the regulation of foreign land ownership – an issue that carries particular socioeconomic sensitivities throughout resource-rich Latin America. In 2010, over concerns that land purchases by international investors were leading to disproportionate foreign control of Brazil’s agricultural resources, then President Luiz Ignacio Lula da Silva restricted purchases of farmland by foreigners. This move resulted in the area of agricultural land bought or leased by foreigners not being able to account for more than 25 percent of the overall land area in a given municipal district, according to the National Land Reform and Settlement Institute (INCRA). Additionally, no more than 10 percent of agricultural land in any given district may be owned or leased by foreign nationals from the same country.⁶

While the rules still allowed access after clearing a number of bureaucratic hurdles, this greatly increased transaction costs associated with these investments. Although these rules have since been adjusted, smart investment managers have developed ways to overcome these hurdles, such as the Brazil Farmland Development Fund (www.brazilfarmlandfund.com), who have developed a strategy to allow for foreign investment into Brazilian farmland. However, the political risk here still goes to the heart of the viability of these investments. If the political winds shift, it could affect a factor as fundamental as an investor’s legal claim to their asset.

Political risk also can manifest at a more granular level. Many of Brazil’s institutions are weak by Western standards and it is no secret corruption exists in many corners of the country. For a reminder, one needs to look no further than the ‘Weak Flesh’ sting that devastated the country’s meat packing industry in March 2017. This police investigation into the industry found widespread food safety offenses and bribery, resulting in the indictment of 60 individuals and the loss of an estimated $1.5 billion USD in export revenue for the beef and poultry sectors.⁷ Understanding that these risks are pervasive and having the ability to build operational mechanisms to prevent them where possible, and implement strategies to identify and address them where not, will be critical for investor success in Brazil.

Closely tied to political and economic evolution, and a critical factor in calculating investor returns, is the value of the Brazilian real. The real, as we know it today, was introduced in the mid 1990s and since then has fluctuated with the fiscal and monetary policies of the government.

While the currency had been experiencing a period of relative strength in late 2016, the resurgent corruption issues led to its rapid devaluation in June 2017.

Currency movements can impact investments in a number of ways, which can be either favorable or unfavorable to investors. Most obviously is that the relationship between the real and an investor’s base currency can influence the value of an investment. Currency risk comes into play when its change affects the underlying price of the asset in the period between the initiation and the retirement of the investment.

Currency risk plays another role, especially with respect to agricultural investments. In many cases agricultural investments are attractive, not only for the underlying asset, but also for the operating income that the asset creates. For example, in the case of a farm that produces soybeans, not only is the value of underlying farmland important, but also the value of the annual soybean crop. In this case, the value of the Brazilian real has an important impact on the value of the annual soybean crop. Since many agricultural goods are traded on global markets, they are denominated in U.S. dollars. As a result, a weak Brazilian real will encourage additional export demand as the crop will be artificially inexpensive in global terms. A strong real will have the opposite effect. Depending on the nature of their investment, investors may be able to manage some currency risk using financial tools such as those available through futures markets.

While many investors who choose agricultural investments are looking for long-term opportunities, sooner or later they may want to exit the investment. At this point, liquidity concerns with farmland assets can come into play. An asset is only worth as much as someone is willing to pay for it, and particularly in the case of larger farms, the pool of potential investors may be limited. To limit the impact of this risk, investors will be wise to maintain the value of their investment by performing necessary maintenance and making improvements to protect the operation. In addition, for an investor with flexibility of timing, staying close to the market can help identify the ideal moment to sell.

Is Now the Time?

The decision to invest in Brazil’s agricultural sector requires investors to strike a balance between opportunity and risk. While Brazilian farmland prices are more attractive now than they’ve been in years, owning land as a foreign investor in Brazil is still difficult and highly regulated. The agricultural sector as a whole has seen continued growth in spite of an economic downturn, but a continued slide toward slower growth or further political turmoil will inevitably begin to affect the sector. There are currency factors at play that can be either a hindrance or a help, depending on your base currency and the type of investment. For every positive, there is a direct counter-point that must be considered.

The rewards are promising for bold, first movers, but every investor must carefully weigh each risk before jumping into the murky agricultural investment waters of Brazil.

ABOUT THE AUTHORS:

Michael DeSa is the founder and CEO of AGD Consulting, a U.S.-based, veteran-owned firm offering strategic advisory services and customized due diligence trips for investors seeking exposure to Latin American agriculture. DeSa is an experienced LatAm land owner, former Marine Corps Officer, and family farmer. He has years of technical management experience with the Marine Corps from his assignments in Djibouti, Jordan, Afghanistan, and throughout Latin America. DeSa can be reached at michael@desaconsultingllc.com.

Monica Ganley is the principal at Quarterra, a boutique consulting firm offering international strategic planning, research and business development services to organizations and individuals in the agriculture and food space. Ganley is passionate about the food and agricultural industries and has pursued a dynamic career with experiences ranging from agricultural production to consumer products spanning many geographies. She holds an MBA from the University of Chicago Booth School of Business and currently resides in Buenos Aires. Ganley can be reached at monica.ganley@quarterra.com.

SOURCES:

¹Yara International. “Agriculture in Brazil – Vast Resources.” YouTube. 13 June 2014. 28 August 2017. https://www.youtube.com/watch?v=KlI2JwhI1JU.

²World Bank. “Global Economic Prospects – A Fragile Recovery.” World Bank. June 2017. 28 August 2017.

³“Brazil Farmland Development Fund Pitchbook, (www.brazilfarmlandfund.com) 01 August 2017.

⁴Export.gov. “Brazil – 1- Openness to and Restriction on Foreign Investment.” State Department’s Office of Investment Affairs’ Investment Climate Statement. 31 July 2017. https://www.export.gov/article?id=Brazil-openness-to-foreign-investment. 28 August 2017.

⁵“How to Cope with Brazil’s Political Crisis.” The Economist. 25 May 2017.

⁶Ibid.
⁷Welshans, Krissa. “JBS SA Resuming Operations as 60 Indicted in Brazilian Meat Scandal.” Feedstuffs. 21 Apr 2017.

Our most recent article for Global AgInvesting. Enjoy an abbreviated version of the article below. You can find the full article here

As always, don’t hesitate to contact us if you can help.

Best Wishes,

Michael

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Potash — it’s a key component to feeding the world’s growing population, yet many don’t even understand what it is or why it is important. In the broadest sense, potash refers to a variety of mined and manufactured salts that contain potassium in water-soluble form. Before the industrial era, ash burners (workers who collected or produced wood ash) would soak wood ash in water, then evaporate the water from the mixture in large iron pots leaving behind a concentrated, white residue called pot ash. The name pot ash literally means plant ashes soaked in water in a pot.

Today, potash is more widely associated with naturally occurring potassium salts. Coincidentally, the name potassium comes from the word potash. Global potash production capacity was approximately 51 million metric tons in 2016, with the majority of it used in fertilizers. These fertilizer applications constitute the single largest industrial use of the potassium element in the world, making it an invaluable and irreplaceable part of feeding the world’s growing population, which grows by 80 million people every year – a number equal to the population of Turkey, according to the UN.

The potassium in potash fertilizer is used to encourage water retention in plants, increase yields, improve taste, and even help plants fight disease. Potassium is also an important mineral for keeping humans healthy and must be regularly replaced in our bodies by consuming potassium-rich foods. Since potassium doesn’t exist in elemental form in nature (it reacts violently with water), it has to be combined with other elements, either naturally or mechanically, before it can be used by plants. The naturally occurring union happens as a result of a very long geological process, so, in order to be applied as a fertilizer on our rapidly expanding fields, it has to be mined and processed.

Economic and middle class growth in places like Asia and Latin America have contributed greatly to the increased use of potash-based fertilizer. With increased cash in the pockets of middle class families, the more they’re willing to spend on more and higher quality meat and dairy products. This new and more expensive diet will require more acres to be planted, more fertilizer to be applied, and more animals to be fed – all good news for potash.

The industrial applications for potassium span a variety of necessary human functions. Potassium chloride is used in aluminum recycling, oil-well drilling fluids, snow and ice melting applications, and even in water softening. Potassium carbonate is used to produce animal feed supplements, cement, fire extinguishers, and is an integral component in beer brewing. These non-fertilizer uses historically account for about 15 percent of the annual potash consumption in the United States.

They Don’t Always See Eye to Eye

Most of the world’s potassium reserves were deposited as sea water in ancient inland oceans. After the water evaporated, the potassium salts crystallized into beds of potash ore. These crystallized beds formed thousands of feet below the surface area where most of the world’s potash is being mined today.

Canada possesses the world’s largest potash reserve and is also its largest producer, mining nearly 11.2 million metric tons in 2015. Following closely behind are Russia, Belarus, and Germany to round out the top four.

It should come as no surprise that these countries don’t always see eye to eye when it comes to potash production. In 2013, a trade pact between Russian and Belarusian producers collapsed when Russia pulled out of the agreement, claiming Belarus had been selling potash outside of their pact. Russian producers then quickly announced a policy of heavier production, sending the potash market into a slump from which it has yet to fully recover.

Recent talks between the two governments could signal that the cartel is ready to rise from the ashes once again. Belarusian president Alexander Lukashenko has been suggesting that an agreement between Belaruskali (Belarus’s main producer) and Russia-based Uralkali could allow them to divide up the markets again and agree on production limits. While this could be positive for the overall potash price and the market’s largest producers, the competition is not very happy.

With the state of the former cartel uncertain, competition was allowed to soar along with unregulated production. Many new producers from around the world began to build new mines and ramp up production. The German company, K+S AG, officially opened a new mine in May 2017 while Sirius Minerals is nearing a final plan to begin building the second deepest mine in Europe beneath a national park in Britain.

If cooperation is ultimately restored between Russia and Belarus, it could spell trouble for smaller potash producers. This could, however, be good news for the potash price, which is already up over 20 percent since last July, mostly on the rumor.

Meanwhile, Canada’s potash producers were off to an uncertain start to 2016 as well, with negotiations between key Chinese buyers and Canadian producers dragging on well past their usual wrap-up window of January-March. With market prices sitting around US$230/metric ton in July 2016, the Chinese continued to play hardball, asking for prices below US$200/metric ton. Low potash prices have instead placed the bargaining chips squarely in the hands of the world’s largest potash buyers (China and India included), forcing negotiation at every turn.

Are Low Prices a Cure of Low Potash Prices?

The potash market has had a strong dose of low prices over the last several years, but has this forced the supply and demand equation back into alignment? Is the market poised for a bull run or will the recent price uptick be just another dead cat bounce?

From the supply side, sustained low potash prices have forced many companies to trim excess fat, closing high cost operations and delaying new ones. Shutting down or delaying these operations has had a slight impact on the overall supply, but these production cuts are unlikely to result in a net shortage. Global potash production capacity is forecasted to reach 64.5 million metric tons by 2020, a 22 percent increase compared to 2016’s production capacity of 50.8 million metric tons. How does this stack up against global demand and consumption?

World potash consumption was approximately 35.4 million metric tons in 2016. A comparison with 2016’s production capacity highlights a 15.4 million metric ton supply surplus that isn’t likely to shrink significantly in the next five years. Global consumption is expected to rise (39.0 million metric tons by 2020), but if production capacity hits expectations, the supply surplus will nearly double during that time period.

Between 2015 and 2020, global potash supply is expected to grow by 17 percent with demand increasing by only 11 percent. Barring some major black swan event that could drastically affect global potash supply, this will be a hard gap to close. As the world’s largest potash producer, a look at Canada’s supply/demand forecasts says it all.

Foreign currency exchange rates also will play a role in the potash price of the future. The U.S. imports the majority of its potash from Canada and Russia in U.S. dollars, so a strong Canadian dollar and Russian ruble could support higher potash prices as outside producers attempt to maintain their margins. The Canadian dollar is up more than 10 percent since the start of the year while the Russian ruble has held steady.

However, the U.S. is not the only consumer of potash, and being forced to purchase this necessary component in U.S. dollars is severely affecting some agricultural powerhouses. Brazilian farmers, for example, have been the recipients of the wrong end of the currency exchange stick for years, being forced to convert their reals into dollars to purchase potash at nearly a three to one premium.

The combined effect of long-term low prices and strong demand may not be enough to overcome an increasing supply surplus and mixed buyer currency exchange rates. If the Russians and Belarusians never work collaboratively with potash production again – bringing production back under control – smaller producers will continue to drive new growth, only widening the gap between supply and demand. Meanwhile, China, India, and other major buyers will continue to play coy with their bottom line price, making is easier to negotiate a lower price and harder for markets to predict annual prices. While this is certainly an area to watch going forward, I wouldn’t bet the farm on it.

SOURCES:

Heffer, Patrick and Prud’Homme, Michael. “Fertilizer Outlook 2016 – 2020.” International Fertilizer Industry Association. 84th Annual IFA Annual Conference. 30 May 2016. Web. 20 August 2017. http://www.fertilizer.org/imis20/images/Library_Downloads/2016_IFa_Moscow_Summary.pdf?WebsiteKey=411e9724-4bda-422f-abfc-8152ed74f306&=404%3bhttp%3a%2f%2fwww.fertilizer.org%3a80%2fen%2fimages%2fLibrary_Downloads%2f2016_IFa_Moscow_Summary.pdf
Ibid.