H&G High Conviction Fund - The Markets in Three Charts - February 2022

Updated: Mar 11



INTRODUCTION

We are back once again with another edition of The Markets in Three Charts.


For this edition, we have found some interesting environmental, economic, and share price charts in order to illuminate some of our investment ideas. This month we will be discussing the links (in our estimation) between rainfall patterns, agriculture, and land banking. Please note we are presenting general insights into our decision-making, not investment advice.



Chart 1 - I: Rainfall decile ranges over the past decade (1) & II: Effects of climate on farm profits (2)
HNG investment value since 2007

Rainfall in Australia is highly variable with low average annual rainfall over most of the continent and intense seasonal falls in the tropics.


The rainfall pattern is generally concentric around the extensive arid core of the continent, which in the west and along parts of the Great Australian Bight extends to the coast. Around this arid centre there is a broken margin of more humid conditions which increases the level of precipitation as it nears the coast, particularly in the east of the continent. (3)


In contrast to this year’s La Niña weather pattern, the past few decades have seen the southern half of the country experience lower than average levels of rainfall (Chart 1.I.). These areas also predominantly host some of the most prized agricultural lands in the country. Recent decades have also seen a trend towards lower average winter season rainfall in the southwest and southeast of Australia.


As shown in Chart 1.II., the areas of Australia with below-average rainfall over the past decade have also suffered from below-average farm profits between 2000 and 2019.


Australian Bureau of Agricultural and Resource Economics research found when controlling for non-climate factors since 2000 average annual broadacre farm profits have been reduced by 22% or around $18,600 per farm. These effects have been most pronounced in the cropping sector, reducing average profits by 35%, or $70,900 for a typical cropping farm.

The forecasts of changing climate, toward more extreme weather events, also mean that the country’s ‘goldilocks’ locales with long term stable rainfall and relatively stable temperatures are essential for agriculture.


(1) Sourced from: http://www.bom.gov.au/research/

(2) Sourced from: https://www.awe.gov.au

(3) Sourced from: https://www.ga.gov.au/


 

CHART 2 – I: Prices of farmland in Adelaide & Fleurieu area (4) II: Rainfall analysis of Adelaide & Fleurieu area (5)

Despite the global pandemic, Australian rural land prices showed resilience to the economic shock to agriculture and associated supply chains. This has been fueled by a mixture of low-interest rates and loose credit but also surging commodity and agricultural product prices.


One marker of exceptional transactions though was the value of historical rainfall for the associated properties. As seen on the prior page's charts, South Australia (so far) has been less harshly affected by extreme drought as a percentage of total agricultural land in the country.


Over the past year, the median price per hectare for farmland in the Adelaide and Fleurieu region increased by 23.3 per cent to $14,253 per hectare in 2020, a boost from the already high long-term trend of 7.3% p.a. over the last 20 years (Chart 2.I.).


At a municipality level, Kangaroo Island saw a 77% rise in the median price per hectare, which can largely be credited to a reduction in transaction volume of 17.1% following widespread bushfires across the region in late 2019 and early 2020.



Inset: rainfall in Kangaroo Island

Another factor that has kept Kangaroo Island agricultural land prices buoyant is the quality of land available and the fact that it also has historically over average levels of rainfall (Chart 2.II.).


Crucially, rainfall reliability maps for the past 30 years (1989–2018) show winter rainfall has been reliable across the region with less variability in the west than the east. Winter seasonal rainfall usually has about 70mm difference from one year to the next. Autumn rainfall is also moderately reliable from year to year across most of the region. (6)


This contrasts with the trend of less winter rainfall across most of southeastern and southwestern Australia that we saw in Chart 1.I. above.


(4) Sourced from: https://www.ruralbank.com.au

(5) Sourced from: https://www.waterconnect.sa.gov.au/

(6) Sourced from: http://www.bom.gov.au/


 

CHART 3 – 10-year share price of Kiland (ASX: KIL) (7)

H&G High Conviction Fund has 8% of its portfolio invested in Kiland, having held shares in the company for over a decade at an average cost base of $0.61 per share.


What does Kiland do?


Kiland owns 18,600 hectares of land on Kangaroo Island, which is reverting from forestry to agriculture. The company, originally named Ruralaus, has the biggest holding of timberland on the island. These trees were planted as part of tax-incentivised managed investment schemes over 20 years ago. However, without a port from which to ship harvested trees to major markets in Japan and China, forestry on the island was untenable. Despite a concerted effort by the company in 2016-20 to become the major timberland owner on the island and construct a port, the South Australian government refused to grant development approval. With 90% of Kiland’s trees fire-affected by the 2019-20 bushfires, the company’s board and management decided the most economic outcome was to revert the timberland into farmland.


What attracts us to Kiland?


Kiland’s current market capitalisation is $60m, compared to its stated net tangible asset backing of $75m. These assets comprise $17m in cash, $10m in receivables and $52m inland (as per an independent valuation in June 2021, accounting for remediation costs), minus short-term liabilities. The stock is currently trading at a 20% discount to Kiland’s net asset value, and we believe there is a significant upside to the land valuation considering the increasing demand for high-rainfall agricultural land. The majority of Kiland’s landholding is on the western side of Kangaroo Island, the area with the greatest annual rainfall (see Chart 2.II. above).


What does the future hold for Kiland?


In January 2022, Kiland announced it had appointed AAG Investment Management (AAGIM) as property manager of its estate. AAGIM, which made a takeover bid for Kiland’s assets in May 2021, will be responsible for removing trees and stumps and preparing the land for agricultural activities. Kiland will be in a position over the course of the reversion to determine the best use of the farmland. We believe a landholding of its size in high rainfall area would be unique in Australia and would be an attractive asset for a global pension fund looking to park money for the long-term in a safe jurisdiction.


(7) Sourced from: Reuters Refinitiv.



FUND INFORMATION

Fund name

H&G High Conviction Fund

Investment Manager

H&G Investment Management Limited

Fund inception

November 2007 (relaunched April 2021)

Fund pricing

Monthly

Fund type

Open-end unit trust

Investor eligibility

Wholesale and sophisticated investors

Trustee

Equity Trustees

Custodian and sub-custodian

Mainstream Fund Services and JP Morgan

Auditor

Ernst & Young

Management fee

1% plus GST p.a. + fund costs capped at 1% plus GST p.a.

Performance fee

20% of benchmark outperformance, with a high watermark

Benchmark

5% p.a.

Buy/sell spread

0.4%


DISCLAIMER

Equity Trustees Limited (“Equity Trustees”) (ABN 46 004 031 298), AFSL 240975, is the Trustee for H&G High Conviction Fund. Equity Trustees is a subsidiary of EQT Holdings Limited (ABN 22 607 797 615), a publicly listed company on the Australian Securities Exchange (ASX: EQT).

This monthly performance report has been prepared by H&G Investment Management Ltd (ACN: 125 580 305; AFSL: 317155) to provide you with general information only. In preparing this report, we did not take into account the investment objectives, financial situation or particular needs of any particular person. It is not intended to take the place of professional advice and you should not take action on specific issues in reliance on this information. Neither H&G Investment Management Ltd, Equity Trustees nor any of its related parties, their employees or directors, provide and warranty of accuracy or reliability in relation to such information or accepts any liability to any person who relies on it. Past performance should not be taken as an indicator of future performance. You should obtain a copy of the Information Memorandum before making a decision about whether to invest in this product.