This week, Jamie discusses a solution to using return on capital employed when the capital employed part of the equation is missing. He does so through the lens of ARM Holdings, which became the third-largest UK company by market capitalisation last week.
You have to feel somewhat for whoever compiled and proofread the trading update from US-listed Lyft last week. In the morning, it was announced that the margin would increase by 500bps (5% for 2024). This amazing figure was rewarded with a 60% leap in the share price. Alas, later that day, the company had to correct the announcement. The margin would only increase by 50bps after all. Back down came the share price… Oops! One wonders whether that would constitute market manipulation. In the UK, we had two big moves from formally much more highly valued companies. Close Brothers lost >30% in the week following an announcement about how the company is dealing with the ongoing investigation into car financing – hint, not well. This takes the decline since the investigation began to >60%. The company is going to have to pay big, but at a 75% discount to the book value, one wonders if we are reaching the bottom. The other big faller is Genus, which is discussed further down.
Last week, I talked a lot about Renishaw. As part of this, I intimated that high-quality UK-listed businesses were much cheaper than equivalent quality businesses listed in the US for example. Apropos of this fact, last week ARM Holdings became the third-largest British company by market capitalisation. But it isn’t listed in the UK; it used to be but is now listed in the US having been owned by Softback entirely for a period in between its UK and US list. Since relisting on the NASDAQ just over a year ago, the shares have risen c. 125% and apparently, now trade on a forward PE ratio of 100x.
Years ago, on the UK stock market, ARM Holdings was rather a plodding little stock and had been for years following the end of the tech boom of the late ’90s. Things shifted with the advent, development and eventual ubiquity of the smartphone. Many of the chips that had been designed by ARM Holdings early on weren’t particularly feasible contemporaneously with their respective design but became so as Moore’s Law did its thing.
If using the Return on Capital Employed (ROCE) framework or CFOIC variant, you may have struggled to value the ARM Holdings. The reason being that, whilst this framework provides insights into a business that allows for a decent assessment of value, it doesn’t work with ARM because of the CE part of the equation in ROCE. The problem was that ROCE is determined by the formula:
In the case of ARM Holdings, the Capital Employed element was so minuscule that the ROCE number was absolutely enormous. More importantly, capital employed can change by huge relative values, owing to simple timing of cashflows, which in turn leads the ROCE figure to be so volatile as to be meaningless. That is to say, over a five-year stretch, the ROCE figure for ARM Holdings could be something like 233%, 1,189%, 7,707%, 816% and 516% – meaningless.
If one can’t get a feel for at least a rough idea of how much return is generated per unit of capital employed, it makes it very difficult to get a sense for the competitive advantage; the trends competitive advantage; and, the likely sustainability of the earnings stream. My style of investing sees loss-avoidance as the most important consideration for investment, a business such as ARM Holdings could pass me by. However, I have found a solution…
In order to better reflect ARM Holdings and other businesses with mercurial characteristics, I required a new ROCE (usually pronounced Rocky in the City) – I call it ROCE2, which is the film Adrian spends most of her time in a coma. In about early 2016, I had an idea of how to solve this problem. It was a lot of work but worth the process simply for the insight, not just into ARM Holdings but nearly all companies for which it was difficult to quantify value.
Essentially, it required rebuilding the accounting of a company from as early a date as possible but capitalising certain expenses. This means treating certain expenses as adding value to the business rather than simply as administrative expenses associated with the operation of a business. These capitalised costs still have a cash impact. That is to say that they represented a very real drain on resources, but rather than being considered operating expenses and therefore contained within cash flow from operations, they were instead moved to cash flow from investment. They were also removed from the Profit & Loss account entirely. In the case of ARM Holdings, the main expense I was reassessing as an investment was Research Costs.
The Process – ROCE2
Unfortunately for this type of analysis, there’s no easy way out. It requires a bit of leg work, Sharepad can assist here to make the process easier by using the ‘Financials’ tab on a company and the ‘Export data…’ section of the ‘Sharing’ sub tab and then manipulating it in Excel. When I perform this process in a professional setting however, I use company accounts to ensure I understand the business well enough. Going back as far as possible in the accounts, ARM Holdings reported how much it had spent on research during each financial year. I’d argue that research expenditure is in fact investment but that is not reflected by either IFRS accountancy rules or its UK precursor UK GAAP accountancy rules. For each year the operating profits are elevated by removal of the research expenditure e.g., if operating profits for a year were £25m and research expenditure was £5m, then the new operating profits were £30m, since £25m plus £5m equals £30m. This can be thought of as EBITR for Earnings Before Interest, Tax and Research.
However, the reality of UK tax law is that for tax purposes, regardless of how I think of research expenditure/investment, the company is allowed to claim a tax shield from research. Thus, the taxation line isn’t altered – effectively lowering the tax rate paid. Each year, this research investment is added to the balance sheet in both the fixed assets and the equity (accountancy rule number one; balance sheets must balance). It needs to be given its own separate line item, which I would typically call internally generated assets. As you move forward each year, treating the research expenditure as an asset, the internally generated assets are increased by that year’s research cost. Once this has been done for all years, you will have rebuilt the company to reflect its economic reality rather than accounting opinion.
This additional ‘internally generated assets’ line had the effect of taking a company like ARM Holding, which had little to no capital employed and created a much larger capital employed figure. This fixed the problem discussed above with the ROCE line since now the denominator in the equation was much larger. For ARM Holdings, the ROCE line having incredibly volatile and nonsensical morphed into a ROCE2 line. This newly created version (sequel) was incredibly stable with ROCE2 ranging from 19% in a bad year to 24% in a good year. From here, one can make the typical calculations one would make to get a sense for the competitive advantage of the business and derive a sensible valuation.
The only unfortunate thing about this was the timing. Philosophically, we (Patrick Barton, with whom I ran the strategy at the time, and I) see risk as best mitigated through a margin of safety. That is to say, focusing on not overpaying in the first place to account for the ‘what if I’m wrong’. At the conclusion of the work in Spring 2016, the shares were c. 800p per share and we felt that we would be comfortable building a position at <650p. Within months, the company was taken over by Softbank, the Japanese investment company with ties to the Saudi royal family, at a price of 1700p.
Last week’s article also talked about stocks to own and stocks to rent. ARM Holdings is definitely in the former category but the caveat about not falling in love with stocks applies – hence the reticence to even consider it at current valuations. Back in 2016 also, Softbank did bid a high price but the shares weren’t obviously good value at the time and so we never bought in the end. Was this a mistake? Not really; I’ve talked in the past about not beating oneself up over missed opportunities. One must always remember that decisions to buy or not should be viewed in the context of the portfolio construction of the time. As it happens, we concluded 2016 as a top-performing fund as our bias away from sterling earnings boosted the performance of the fund considerably in the fallout of the Brexit referendum.
Since developing this method of analysis, I have used it on a number of other businesses for which much of the valuation is derived from intangibles that aren’t easily quantified. It has never worked as perfectly as in the case of ARM Holding, where the stability of the ROCE2 calculation was stunning, but whenever I have performed the analysis, I have always derived an insight that otherwise would be missed. In a future article, I shall discuss the analysis I performed on Unilever about five years ago that indicated that it could be worth considerably less than the current share price if, the economic trends uncovered are accurate and, crucially, if the market catches. In the case of Unilever, I have a theory that branded fast-moving consumer goods are losing their value because the barriers to creating and marketing a new competitor brand is much smaller today than 25 years ago.
This week I have been thinking about food and the future as I looked into the travails of former stock market darling and now fallen angel, Genus. I then review the release from Agronomics, which is a fascinating quasi-venture capital firm that is very involved in innovation, particularly regarding food production and longevity.
Genus, trading update
History
Genus sells genetic material for beef and pork farming. Essentially, it sells the semen of bulls and pigs. Its breeding animals are selected for characteristics desirable to farmers such as feed efficiency, disease resistance, growth rate, fertility, and protein and fat content. It is a biotechnology business insofar that the company has R&D capabilities, which is used to analyse animal DNA. In pork, it is estimated that almost one-third of commercially raised pigs globally are produced using Genus genetic material. Technically, the firm reports three divisions but only two are profit-generating; that being ABS, the bovine business and PIC, the porcine business. The third division is Research & Development, which is further split into four areas; a third each in bovine research and porcine research and a sixth each in gene editing and other research.
The history is slightly difficult to pin down. The oldest part of the business appears to have been founded in 1933 as the Milk Marketing Board, but the current business does not seem highly related to its earlier endeavours. ABS, the bovine business was acquired in the late 90s and was formally called the American Breeders Service. This part of the business was founded in 1941. The PIC (which stands for the Pig Improvement Company) business was acquired in the mid-2000s via the takeover of Sygen. Sygen had been previously known as Dalgety Plc.
Trading update
The trading update was fairly short and, on the face of it, fine with revenue and profits described as in line. Nevertheless, PIC is a bifurcated market, that of China and ex-China. Outside of China, the company is doing okay and expected to deliver modest operating profit growth. Within China however, conditions are described as challenging with earlier outbreaks of swine flu still impacting the company. Nevertheless, management does expect that sales efforts in the interim have been positive and are expected to start delivering growth in China from FY2025 and beyond.
ABS is fairing slightly worse with a 6% reported decline in volumes. As with PIC, it is China that is the source of the worst weakness owing to a double-digit percentage decline in the Chinese dairy herd. The outlook here seems worse too with management undertaking what they refer to as a ‘Value Acceleration Program’ that includes:
‘changes in leadership structure’ aka firing managers.
‘integration and simplification of ABS’s supply chains’, which doesn’t sound good as it implies that there are unnecessary bureaucracies built into the present business.
‘targeted price initiatives’, i.e., they’re too expensive and have become uncompetitive – this usually means a medium-term margin hit.
‘cost efficiencies’, which is a slightly nebulous phrase meaning if they happen to find any excess costs, they will cut them – assuming they can.
Finally, there is a new product being developed for the US markets to deal with a nasty viral disease affecting pigs called Porcine Reproductive and Respiratory Syndrome (PRRS). PRRS has received the rather unfortunate moniker of Pig-AIDs in the past because of the timing of its emergence in the 80s. It represents one of the most significant infectious diseases affecting the swine industry. The new product developed is called PRRS Resistant Pig (PRP). It is currently going through the US Food and Drug Administration approval process, but as is so often the case, it has been delayed and will not be available until at least FY2025.
Opinion & Valuation
Genus was a darling stock for a number of years that had a valuation to go along with its popularity. Quite why the popularity became so high is a lesson in exuberance. In this case, the exuberance was driven by the emergent Chinese middle class and their insatiable appetite for animal proteins – or so the investment case went. As can be seen below the valuation hit its zenith in around 2018 at a frankly comical EV/EBIT valuation.
The problem today isn’t so much that the investment thesis is broken since through-the-cycle growth remains fairly good. Rather it has become a little too jam tomorrow, which for a stock that had traded at its previous highs is a big problem. As we saw above, a brave investor in 2016 could have bought ARM Holdings and done very well very quickly. But an investment in Genus at the wrong time shows the dangers of an insufficient margin of safety. It isn’t necessarily what you don’t know that gets you into trouble, it’s what you think you do know but just isn’t so.
As it happens, I think Genus was and remains a decent business. I’m in no rush to invest as I think that the valuation is still a little expensive but it is one to watch and if FY2025 turns out as promised, we may start seeing Genus on an upward trajectory once again.
Agronomics, interim results
History
Agronomics was founded by Jim Mellon in 2011 on the Isle of Mann, where he is the largest landowner. Mr Mellon has a bit of a Midas touch after selling his first business at 28 and becoming a millionaire, and since then he has had a string of successes leading to three more zeroes being added to his wealth. I first became aware of Agronomics because Mr Mellon is a fairly regular guest on some of the investment-related podcasts, such as Merryn Somerset-Webb’s Merryn Talks Money. The business exists to provide funding to businesses involved in developing new technologies in agriculture that address areas including sustainability, water pollution and antibiotic resistance. The portfolio is currently valued at c. £167m, including £22m in cash, and is made up of 23 companies. For more information, I urge readers to look at the Agronomics website to get a rounder understanding.
Interim results
The net asset value per share during the period was flat at just under 17p. Nevertheless, the share price continued its three-year relentless decline to 9.5p and thus the share price now represents a discount of >40% to the net asset value. As is usual, the outlook statement was optimistic from Mr Mellon with approvals from the US Food and Drug Administration expected in 2024 that will allow some of the portfolio businesses to achieve commercialisation during the years ahead.
Opinion
There is another lesson in exuberance and not overpaying displayed in Agronomics. A couple of years ago, when interest rates were rock bottom, investors were willing to value ‘pre-profit’ enterprises much higher than today. For a while, therefore, Agronomics traded on a decent premium to its net asset value – peaking at just under 2x. Since then, the shares have fallen almost 75% and the valuation has gone from a near 100% premium to a >40% discount.
I’m personally fascinated by agriculture and land management and Agronomics is trying to address current and coming challenges through investment. This sort of enterprise is always going to require a leap of faith because you are taking the value of the portfolio from the company. In reality, these sorts of assets are only worth what they are worth because the investment trust says so. Nevertheless, having been at a slightly silly valuation for a number of years, the shares are now demonstrating some semblance of a margin of safety. Furthermore, it only takes a couple of these businesses to do really well for the trust’s value to explode higher. I don’t own the shares yet but, as a diversifier with the potential to yield tremendous returns should things go well, Agronomics is becoming very tempting.
~
Jamie Ward
Note: owing to its small size and tightly held shares, the spread is typically around 5%. This is slightly offset by the fact it is Isle of Mann domiciled and therefore attracts no stamp duty.
Jamie owns shares in Renishaw
Got some thoughts on this week’s commentary from Jamie? Share these in the SharePad “Weekly Market Commentary” chat. Login to SharePad – click on the chat icon in the top right – select or search for “Weekly Market Commentary” chat.
Weekly Market Commentary | 20/02/2024 | GNS, ANIC | Yo Adrian, I did it
This week, Jamie discusses a solution to using return on capital employed when the capital employed part of the equation is missing. He does so through the lens of ARM Holdings, which became the third-largest UK company by market capitalisation last week.
You have to feel somewhat for whoever compiled and proofread the trading update from US-listed Lyft last week. In the morning, it was announced that the margin would increase by 500bps (5% for 2024). This amazing figure was rewarded with a 60% leap in the share price. Alas, later that day, the company had to correct the announcement. The margin would only increase by 50bps after all. Back down came the share price… Oops! One wonders whether that would constitute market manipulation. In the UK, we had two big moves from formally much more highly valued companies. Close Brothers lost >30% in the week following an announcement about how the company is dealing with the ongoing investigation into car financing – hint, not well. This takes the decline since the investigation began to >60%. The company is going to have to pay big, but at a 75% discount to the book value, one wonders if we are reaching the bottom. The other big faller is Genus, which is discussed further down.
Last week, I talked a lot about Renishaw. As part of this, I intimated that high-quality UK-listed businesses were much cheaper than equivalent quality businesses listed in the US for example. Apropos of this fact, last week ARM Holdings became the third-largest British company by market capitalisation. But it isn’t listed in the UK; it used to be but is now listed in the US having been owned by Softback entirely for a period in between its UK and US list. Since relisting on the NASDAQ just over a year ago, the shares have risen c. 125% and apparently, now trade on a forward PE ratio of 100x.
Years ago, on the UK stock market, ARM Holdings was rather a plodding little stock and had been for years following the end of the tech boom of the late ’90s. Things shifted with the advent, development and eventual ubiquity of the smartphone. Many of the chips that had been designed by ARM Holdings early on weren’t particularly feasible contemporaneously with their respective design but became so as Moore’s Law did its thing.
If using the Return on Capital Employed (ROCE) framework or CFOIC variant, you may have struggled to value the ARM Holdings. The reason being that, whilst this framework provides insights into a business that allows for a decent assessment of value, it doesn’t work with ARM because of the CE part of the equation in ROCE. The problem was that ROCE is determined by the formula:
In the case of ARM Holdings, the Capital Employed element was so minuscule that the ROCE number was absolutely enormous. More importantly, capital employed can change by huge relative values, owing to simple timing of cashflows, which in turn leads the ROCE figure to be so volatile as to be meaningless. That is to say, over a five-year stretch, the ROCE figure for ARM Holdings could be something like 233%, 1,189%, 7,707%, 816% and 516% – meaningless.
If one can’t get a feel for at least a rough idea of how much return is generated per unit of capital employed, it makes it very difficult to get a sense for the competitive advantage; the trends competitive advantage; and, the likely sustainability of the earnings stream. My style of investing sees loss-avoidance as the most important consideration for investment, a business such as ARM Holdings could pass me by. However, I have found a solution…
In order to better reflect ARM Holdings and other businesses with mercurial characteristics, I required a new ROCE (usually pronounced Rocky in the City) – I call it ROCE2, which is the film Adrian spends most of her time in a coma. In about early 2016, I had an idea of how to solve this problem. It was a lot of work but worth the process simply for the insight, not just into ARM Holdings but nearly all companies for which it was difficult to quantify value.
Essentially, it required rebuilding the accounting of a company from as early a date as possible but capitalising certain expenses. This means treating certain expenses as adding value to the business rather than simply as administrative expenses associated with the operation of a business. These capitalised costs still have a cash impact. That is to say that they represented a very real drain on resources, but rather than being considered operating expenses and therefore contained within cash flow from operations, they were instead moved to cash flow from investment. They were also removed from the Profit & Loss account entirely. In the case of ARM Holdings, the main expense I was reassessing as an investment was Research Costs.
The Process – ROCE2
Unfortunately for this type of analysis, there’s no easy way out. It requires a bit of leg work, Sharepad can assist here to make the process easier by using the ‘Financials’ tab on a company and the ‘Export data…’ section of the ‘Sharing’ sub tab and then manipulating it in Excel. When I perform this process in a professional setting however, I use company accounts to ensure I understand the business well enough. Going back as far as possible in the accounts, ARM Holdings reported how much it had spent on research during each financial year. I’d argue that research expenditure is in fact investment but that is not reflected by either IFRS accountancy rules or its UK precursor UK GAAP accountancy rules. For each year the operating profits are elevated by removal of the research expenditure e.g., if operating profits for a year were £25m and research expenditure was £5m, then the new operating profits were £30m, since £25m plus £5m equals £30m. This can be thought of as EBITR for Earnings Before Interest, Tax and Research.
However, the reality of UK tax law is that for tax purposes, regardless of how I think of research expenditure/investment, the company is allowed to claim a tax shield from research. Thus, the taxation line isn’t altered – effectively lowering the tax rate paid. Each year, this research investment is added to the balance sheet in both the fixed assets and the equity (accountancy rule number one; balance sheets must balance). It needs to be given its own separate line item, which I would typically call internally generated assets. As you move forward each year, treating the research expenditure as an asset, the internally generated assets are increased by that year’s research cost. Once this has been done for all years, you will have rebuilt the company to reflect its economic reality rather than accounting opinion.
This additional ‘internally generated assets’ line had the effect of taking a company like ARM Holding, which had little to no capital employed and created a much larger capital employed figure. This fixed the problem discussed above with the ROCE line since now the denominator in the equation was much larger. For ARM Holdings, the ROCE line having incredibly volatile and nonsensical morphed into a ROCE2 line. This newly created version (sequel) was incredibly stable with ROCE2 ranging from 19% in a bad year to 24% in a good year. From here, one can make the typical calculations one would make to get a sense for the competitive advantage of the business and derive a sensible valuation.
The only unfortunate thing about this was the timing. Philosophically, we (Patrick Barton, with whom I ran the strategy at the time, and I) see risk as best mitigated through a margin of safety. That is to say, focusing on not overpaying in the first place to account for the ‘what if I’m wrong’. At the conclusion of the work in Spring 2016, the shares were c. 800p per share and we felt that we would be comfortable building a position at <650p. Within months, the company was taken over by Softbank, the Japanese investment company with ties to the Saudi royal family, at a price of 1700p.
Last week’s article also talked about stocks to own and stocks to rent. ARM Holdings is definitely in the former category but the caveat about not falling in love with stocks applies – hence the reticence to even consider it at current valuations. Back in 2016 also, Softbank did bid a high price but the shares weren’t obviously good value at the time and so we never bought in the end. Was this a mistake? Not really; I’ve talked in the past about not beating oneself up over missed opportunities. One must always remember that decisions to buy or not should be viewed in the context of the portfolio construction of the time. As it happens, we concluded 2016 as a top-performing fund as our bias away from sterling earnings boosted the performance of the fund considerably in the fallout of the Brexit referendum.
Since developing this method of analysis, I have used it on a number of other businesses for which much of the valuation is derived from intangibles that aren’t easily quantified. It has never worked as perfectly as in the case of ARM Holding, where the stability of the ROCE2 calculation was stunning, but whenever I have performed the analysis, I have always derived an insight that otherwise would be missed. In a future article, I shall discuss the analysis I performed on Unilever about five years ago that indicated that it could be worth considerably less than the current share price if, the economic trends uncovered are accurate and, crucially, if the market catches. In the case of Unilever, I have a theory that branded fast-moving consumer goods are losing their value because the barriers to creating and marketing a new competitor brand is much smaller today than 25 years ago.
This week I have been thinking about food and the future as I looked into the travails of former stock market darling and now fallen angel, Genus. I then review the release from Agronomics, which is a fascinating quasi-venture capital firm that is very involved in innovation, particularly regarding food production and longevity.
Genus, trading update
History
Genus sells genetic material for beef and pork farming. Essentially, it sells the semen of bulls and pigs. Its breeding animals are selected for characteristics desirable to farmers such as feed efficiency, disease resistance, growth rate, fertility, and protein and fat content. It is a biotechnology business insofar that the company has R&D capabilities, which is used to analyse animal DNA. In pork, it is estimated that almost one-third of commercially raised pigs globally are produced using Genus genetic material. Technically, the firm reports three divisions but only two are profit-generating; that being ABS, the bovine business and PIC, the porcine business. The third division is Research & Development, which is further split into four areas; a third each in bovine research and porcine research and a sixth each in gene editing and other research.
The history is slightly difficult to pin down. The oldest part of the business appears to have been founded in 1933 as the Milk Marketing Board, but the current business does not seem highly related to its earlier endeavours. ABS, the bovine business was acquired in the late 90s and was formally called the American Breeders Service. This part of the business was founded in 1941. The PIC (which stands for the Pig Improvement Company) business was acquired in the mid-2000s via the takeover of Sygen. Sygen had been previously known as Dalgety Plc.
Trading update
The trading update was fairly short and, on the face of it, fine with revenue and profits described as in line. Nevertheless, PIC is a bifurcated market, that of China and ex-China. Outside of China, the company is doing okay and expected to deliver modest operating profit growth. Within China however, conditions are described as challenging with earlier outbreaks of swine flu still impacting the company. Nevertheless, management does expect that sales efforts in the interim have been positive and are expected to start delivering growth in China from FY2025 and beyond.
ABS is fairing slightly worse with a 6% reported decline in volumes. As with PIC, it is China that is the source of the worst weakness owing to a double-digit percentage decline in the Chinese dairy herd. The outlook here seems worse too with management undertaking what they refer to as a ‘Value Acceleration Program’ that includes:
Finally, there is a new product being developed for the US markets to deal with a nasty viral disease affecting pigs called Porcine Reproductive and Respiratory Syndrome (PRRS). PRRS has received the rather unfortunate moniker of Pig-AIDs in the past because of the timing of its emergence in the 80s. It represents one of the most significant infectious diseases affecting the swine industry. The new product developed is called PRRS Resistant Pig (PRP). It is currently going through the US Food and Drug Administration approval process, but as is so often the case, it has been delayed and will not be available until at least FY2025.
Opinion & Valuation
Genus was a darling stock for a number of years that had a valuation to go along with its popularity. Quite why the popularity became so high is a lesson in exuberance. In this case, the exuberance was driven by the emergent Chinese middle class and their insatiable appetite for animal proteins – or so the investment case went. As can be seen below the valuation hit its zenith in around 2018 at a frankly comical EV/EBIT valuation.
The problem today isn’t so much that the investment thesis is broken since through-the-cycle growth remains fairly good. Rather it has become a little too jam tomorrow, which for a stock that had traded at its previous highs is a big problem. As we saw above, a brave investor in 2016 could have bought ARM Holdings and done very well very quickly. But an investment in Genus at the wrong time shows the dangers of an insufficient margin of safety. It isn’t necessarily what you don’t know that gets you into trouble, it’s what you think you do know but just isn’t so.
As it happens, I think Genus was and remains a decent business. I’m in no rush to invest as I think that the valuation is still a little expensive but it is one to watch and if FY2025 turns out as promised, we may start seeing Genus on an upward trajectory once again.
Agronomics, interim results
History
Agronomics was founded by Jim Mellon in 2011 on the Isle of Mann, where he is the largest landowner. Mr Mellon has a bit of a Midas touch after selling his first business at 28 and becoming a millionaire, and since then he has had a string of successes leading to three more zeroes being added to his wealth. I first became aware of Agronomics because Mr Mellon is a fairly regular guest on some of the investment-related podcasts, such as Merryn Somerset-Webb’s Merryn Talks Money. The business exists to provide funding to businesses involved in developing new technologies in agriculture that address areas including sustainability, water pollution and antibiotic resistance. The portfolio is currently valued at c. £167m, including £22m in cash, and is made up of 23 companies. For more information, I urge readers to look at the Agronomics website to get a rounder understanding.
Interim results
The net asset value per share during the period was flat at just under 17p. Nevertheless, the share price continued its three-year relentless decline to 9.5p and thus the share price now represents a discount of >40% to the net asset value. As is usual, the outlook statement was optimistic from Mr Mellon with approvals from the US Food and Drug Administration expected in 2024 that will allow some of the portfolio businesses to achieve commercialisation during the years ahead.
Opinion
There is another lesson in exuberance and not overpaying displayed in Agronomics. A couple of years ago, when interest rates were rock bottom, investors were willing to value ‘pre-profit’ enterprises much higher than today. For a while, therefore, Agronomics traded on a decent premium to its net asset value – peaking at just under 2x. Since then, the shares have fallen almost 75% and the valuation has gone from a near 100% premium to a >40% discount.
I’m personally fascinated by agriculture and land management and Agronomics is trying to address current and coming challenges through investment. This sort of enterprise is always going to require a leap of faith because you are taking the value of the portfolio from the company. In reality, these sorts of assets are only worth what they are worth because the investment trust says so. Nevertheless, having been at a slightly silly valuation for a number of years, the shares are now demonstrating some semblance of a margin of safety. Furthermore, it only takes a couple of these businesses to do really well for the trust’s value to explode higher. I don’t own the shares yet but, as a diversifier with the potential to yield tremendous returns should things go well, Agronomics is becoming very tempting.
~
Jamie Ward
Note: owing to its small size and tightly held shares, the spread is typically around 5%. This is slightly offset by the fact it is Isle of Mann domiciled and therefore attracts no stamp duty.
Jamie owns shares in Renishaw
Got some thoughts on this week’s commentary from Jamie? Share these in the SharePad “Weekly Market Commentary” chat. Login to SharePad – click on the chat icon in the top right – select or search for “Weekly Market Commentary” chat.