Potential 101% Gains in Canola Farming

In the course of my never-ending quest for investment ideas and insights, I come across all kinds of quirky opportunities. In particular, I’ve long searched for different ways to get involved in farming. I’d like to tell you about one such opportunity — in Saskatchewan canola production.

But first, a brief trip down memory lane…

You may recall how the economy fell out of bed in 2008. This was not some disaster one read about only in the papers or watched from a safe distance on TV. It affected nearly everything.

I remember making a trip to an investment conference in Manhattan that I go to every year. The big difference this time was that I could stay at the swanky hotel that hosted it. Normally, a $450-a-night hotel — before taxes — one could, in 2008, book a room for half that price — off the rack. And then were plenty of rooms available. A more enterprising soul, with the help of Priceline.com, could stay at a 4-star hotel for $99 a night.

I’ll also never forget eating at an Italian restaurant in Manhattan where they were giving the wine away for free. I guess they wanted to bring warm bodies in there any way they could and hoped somebody would order a dessert so the kitchen could at least earn some kind of profit margin.

Such deals in hotels and restaurants, where such deals were once unthinkable, reflected the hurt of an imploding stock market, of layoffs and of a general popping of a bubble brought to an ugly close.

Farming also felt the effects of the bust. Crop prices still promised a good return for farmers, but financing was harder to come by. Farming is a capital-intensive business. You need to spend a lot of money before you see a dime. So farmers often put off expansion simply because money is so tight.

Say you were a farmer in Saskatchewan and you wanted to add acres to your farm to take advantage of market prices. You’d have to purchase or rent more land. You’d probably need new tractors and combines to handle the extra workload. You’d need more on-farm storage. You’d need fertilizer and seed and chemicals.

How much would all that cost? Recently, I spoke with Brad Farquhar, vice president of Assiniboia Capital Corp., which runs the largest farmland fund in Canada. He said it is normal for farming expansion to cost $150–300 per acre. That means a 2,000-acre expansion needs an investment of $300,000–600,000.

Some farmers have the financial capacity to do that on their own, but most typically turn to a local bank or credit union. In the meltdown days, it was tough for anybody to get a loan. Even now, credit is not as easy as it was in the palmy days of no-doc loans and no-money-down. Lenders are cautious.

So while a farmer could make an extra $100 an acre in revenues for every $30–50 an acre spent in fertilizer, he doesn’t necessarily do it. In fact, farmers cut back on fertilizer in the meltdown days, from which we are only now rebounding. Then, too, there are timing issues. Nitrogen fertilizer is often cheapest in July, right when farmers have maxed out on their borrowing capacity. That means that they can’t take advantage of the lower prices.

These funding gaps are where Brad’s Assiniboia steps in to fill the void. They provide the funding as an investor, with the profits shared between the farmer and Assiniboia. The firm has a simple truism as its mantra: “The returns are highest where capital is scarce.” Saskatchewan farming (and agriculture generally, at least at the farm level) is one such place.

You’d think something like this would’ve evolved sooner. But it was a new concept when the firm began approaching farmers in 2009. As Brad describes it, after a lot of time at farmers’ kitchen tables and hundreds of cups of coffee later, farmers began to sign up for Assiniboia’s program. In fact, Assiniboia now has 36,000 acres of farmland from this offer in 2009.

His firm is high on canola now. Why canola? Brad points to a list of reasons. One, canola is not controlled by the Canadian Wheat Board, which fixes prices for wheat and barley. Another is that there is a futures market in canola in Winnipeg, which gives them tradeable market prices. (Crop insurance is done through the provincial fund.)

Finally, the heart of canola country is right in Assiniboia’s backyard, in Saskatchewan. It’s like the Silicon Valley of canola. Brad also points out that “recent genetic developments are pushing yields to whole new levels.” These breakthroughs are happening in Saskatchewan and lead to better economics.

Besides, the profit hook is enticing. “Average crops should provide good returns, but any above-average production or commodity price makes the return numbers take off,” Brad says. “And the majority of the downside is covered by crop insurance. So it’s like having a perpetual call option on canola.”

Brad prepared the next chart, which shows a few scenarios of how a share in his limited partnership (LP) might fare depending on crop yield and price. You can see that a low yield and a low price make for a poor result. But the range of outcomes skews to the upside. A bumper crop and a strong price could hand you a 101% gain. (Note: In the table, “bu” stands for bushel.)

We also harp on ownership in these pages, and one other thing I like about this model is that farmers have skin in the game. About half or more of the profits will go to them, so they have every incentive to make it work.

Assiniboia is raising a new fund now with an expected closing date of July 30. This fund would invest in Saskatchewan during the 2011, 2012 and 2013 growing seasons. Overall, it’s a four-year commitment and the fund would wind up in 2014, when you would get your initial investment back.

If you are interested in learning more about the fund, contact Brad Farquhar at brad@assiniboiacapital.com. Note: The minimum investment is $25,000. I think it’s another fine way to participate in agriculture without actually having to do any farming by your own hand.

Thanks for reading.

Chris Mayer
Whiskey & Gunpowder

July 19, 2010

The Daily Reckoning