Agriculture gets policy red packet, seed, feed and vaccine sectors viewed favorably

This year agricultural stocks have generally outperformed the broader market, and several recent high-level meetings, such as the Central Rural Work Conference and the modern seed industry symposium, are closely related to agricultural development. Compared with previous years, what new opportunities does the agricultural sector have in the future? Which sub-sectors deserve close attention? To this end, a Securities Times reporter interviewed Xie Zhigang, fund manager of the HFT Pension Income Mixed Fund, as well as Xie Gang and Zhang Junyu, researchers at Qilu Securities, who ranked first in the 2013 New Fortune agriculture, forestry, animal husbandry and fishery industry category.

Earnings release plus policy catalysts

Agricultural stocks rise in the second half

Securities Times reporter: In the second half of the year, agricultural stocks significantly outperformed the broader market. What are the main reasons?

Xie Zhigang: After mid-2012, the revenue and profit growth of the agricultural sector declined, and the industry remained sluggish in the first half of 2013. Starting in the third quarter, industry net profit and its growth rate already rebounded substantially quarter on quarter, and listed companies began to release earnings. On the policy side, strong support for agriculture was also mentioned many times, including encouraging capital to invest in agriculture, market-based pricing of agricultural products, advancing land system reform, and safeguarding food security. The combination of earnings release and policy catalysts established the foundation for the rise in agricultural stocks. In addition, the agricultural sector is almost a concentration of small-cap stocks, and small-cap stocks have generally performed better than large-cap stocks this year. These three factors enabled agricultural stocks to outperform the broader market this year.

Xie Gang and Zhang Junyu: Agricultural stocks performed slightly weaker than or roughly in line with the broader market in the first half, and clearly outperformed it from July to October, mainly for two reasons. First, since the second quarter, the overall industry climate improved, bringing quarter-on-quarter earnings improvement; second, since September and October, the market had strong expectations for agricultural industry policy, and agricultural stock valuations were clearly boosted.

Large-scale development becomes a trend

Securities Times reporter: On December 24, the Central Rural Work Conference closed. That evening, Vice Premier Wang Yang of the State Council chaired a symposium on poverty alleviation and development and modern seed industry work. What policy tone does this reveal? Does the seed industry have relatively large opportunities?

Xie Zhigang: From this Central Rural Work Conference, it can be seen that this government attaches very high importance to agriculture. The seed industry is a foundational and strategic core industry in our country, and this industry positioning was further strengthened in 2011. Policy support for the seed industry will certainly benefit the industry's development in the long run. On the one hand, the state supports land transfer, and downstream ability to distinguish the quality of seeds and services has greatly improved, which helps superior varieties and leading enterprises expand market share. On the other hand, the Ministry of Agriculture supports mergers and reorganization of seed enterprises, allowing market concentration to rise.

Xie Gang and Zhang Junyu: The Central Rural Work Conference has a far-reaching impact on the agricultural sector. The meeting set the main tone of placing food security at the core. Ensuring food security has two meanings: first, ensuring an absolute increase in output, guaranteeing national supply, maintaining a relatively high self-sufficiency rate, and reducing dependence on foreign sources; second, ensuring food safety.

The main tone of agricultural development is large-scale, specialized and modernized development, and the trend of large-scale development in crop farming and livestock breeding is viewed favorably for the future. For example, for upstream supporting industries, government support for enterprises in feed, seeds, pesticides, chemical fertilizers, veterinary drugs and so on will continue to increase, and this will bring about higher industry concentration.

This high-level meeting on seeds can be regarded as a major epoch-making reform. The meeting clearly proposed that before 2015, scientific research institutions should completely withdraw from the commercialization field. In the next two years, the entire industry will undergo relatively large consolidation. Core technical personnel separated from scientific research institutions will join seed enterprises, and the research and development strength of seed companies will be greatly enhanced. In addition, strengthening intellectual property protection and cracking down on counterfeit and inferior varieties will give legitimate seeds room to double in the future.

Favorable on seeds, feed and vaccines

Securities Times reporter: Based on strategies such as the food security strategy, land transfer and modern agriculture, what new opportunities may appear in the agricultural sector?

Xie Zhigang: Policy-driven acceleration in the upgrading of agricultural development models is expected to benefit the agricultural sector broadly over the medium and long term. Efficiency-enhancing sub-sectors such as seeds, feed and vaccines are expected to benefit from agricultural reform policies. Whether it is developing sustainable agriculture, land system reform, or reform of the seed industry research mechanism, the primary goal is to improve agricultural production efficiency. Therefore, over the medium and long term, this is favorable for enterprises selling production materials such as seeds, feed and vaccines, as well as large-scale breeding companies.

Xie Gang and Zhang Junyu: The most important opportunity is first reflected in land transfer. In the future, relevant enterprises will have new business models. Judging from the current situation, planting efficiency and large-scale operation in crop farming are not yet mature. Some enterprises are making innovative attempts in business models, and integrated high-end planting, processing and sales may become a major direction. In addition, combining ecological agricultural planting with rural real estate may also become a major model. Moreover, under the trend of modern large-scale planting and breeding development, upstream supporting enterprises such as pesticides, seeds, chemical fertilizers, veterinary drugs and feed will shift from selling products to selling services. Enterprises that can provide high-quality services will be better able to enjoy the benefits brought by the large-scale development of modern agriculture. For example, leading enterprises in feed, veterinary drugs and so on may achieve 30%-40% growth each year over the next three to five years.

Securities Times reporter: Avian influenza has struck again. When will poultry farming see a turnaround? Is the poultry and livestock vaccine industry worth watching at present?

Xie Zhigang: Avian influenza will certainly affect the poultry farming industry, but from the current perspective, the impact of avian influenza on the sector is limited. How it will evolve in the future still depends to some extent on the scope of the virus's impact, so it is relatively difficult to predict.

Over the medium and long term, vaccine opportunities also stem from the increase in large-scale farming households. In recent years, the increase in large-scale farming households has led to greater demand for poultry and livestock vaccines and an expansion of market size; at the same time, the demand structure of large-scale farming households for vaccines has also shown an upgrading trend. Therefore, the impact on the vaccine market is a positive effect in both scale and structure.

⟧ Xie Gang and Zhang Junyu: This year the poultry farming climate was worse than that for hogs. The main reason is that in April this year, affected by avian influenza, market demand for poultry meat declined. In the second and third quarters of this year, poultry inventories fell significantly, and the supply side contracted. Whether the industry can rebound next year still depends on how large the impact of avian influenza is. If the impact of avian influenza ends next year, demand for poultry meat may rise substantially, and the rebound in the industry climate may be significantly greater than that for hogs.

At present, the livestock vaccine industry is viewed relatively favorably. The main reason is that against the backdrop of rising large-scale farming, large-scale farming households are placing greater importance on vaccines and increasing cost input, raising demand for veterinary drugs and veterinary vaccines as a whole. Over the past five years, the veterinary drug industry has grown by about 15% each year. We are favorable on the market-oriented promotion prospects of veterinary vaccines. Within sub-sectors, we are especially favorable on the market-oriented promotion of vaccines for porcine reproductive and respiratory syndrome and foot-and-mouth disease. Since these two types of vaccines are in the early stages, their compound growth rate may reach 50% each year in the coming years.

Short-term adjustment demand exists

Securities Times reporter: How do you view the current valuations related to the agricultural sector?

Xie Zhigang: Recently, valuations in the agricultural sector have already fairly fully reflected expectations, and there is some adjustment demand.

Xie Gang and Zhang Junyu: Based on 2014 dynamic price-earnings ratios, the price-earnings ratio corresponding to the feed sub-sector is around 20 times, seeds around 30 times, and vaccines around 25 times. The valuations are relatively reasonable, with room for further upward movement in the future.

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