This Year May Be a Year of Strengthened Agricultural Policy: Tianxiang Investment Attached List

Guosen Securities

Bullish on “seed industry and animal husbandry”

We expect agricultural subsidies to grow steadily, and the seed and agricultural machinery industries related to agricultural production will directly benefit from the policies of strengthening agriculture and benefiting farmers. In 2009, agricultural machinery subsidies were 13 billion yuan, compared with 4 billion yuan in the same period of 2008; in 2009, improved seed subsidies were 16 billion yuan, compared with 13 billion yuan in the same period of 2008. In the past two years, the profitability of the seed industry has gradually improved under the intervention of the improved seed subsidy policy. Leading enterprises within the regions are all direct beneficiaries of these policies, and their corporate efficiency has improved noticeably. This trend is expected to continue in 2010.

In addition, we expect the pace of urbanization reform in second- and third-tier cities and towns to accelerate, and we recommend grasping the opportunities brought by the wave of internal integration and mergers and acquisitions in the animal husbandry industry in second-tier cities. We judge that the stage of rapid growth in animal husbandry consumption in second- and third-tier cities will continue over the long term alongside the pace of China's urbanization, and regional leading enterprises in animal husbandry will be the biggest beneficiaries.

Therefore, we recommend paying attention to the seed industry and animal husbandry sectors in that order.

● We are bullish on the profit prospects of regional seed companies achieving substantial performance improvement in the next two years. The relevant companies, in order, are Fengle Seed, Denghai Seed, and Dunhuang Seed.

● We are long-term bullish on second- and third-tier animal husbandry enterprises with capacity expansion plans and execution capability. The relevant companies, in order, are New Hope, Zhengbang Technology, Shengnong Development, and Haid Group.
Tianxiang Investment believes that for the agricultural sector, two main investment lines should be followed: first, new policies under the background of food security; second, rising agricultural product prices under inflation expectations.

At the beginning of the new year, we reviewed the performance of the agricultural sector in 2009 and the major events in the agricultural industry, in order to analyze the driving forces behind the performance of agricultural stocks and the direction of agricultural policy. Looking ahead to 2010, we believe two main investment lines should be followed——new policies under the background of food security, and rising agricultural product prices under inflation expectations.

Agricultural stocks performed mediocrely in 2009

Looking back at 2009, the agricultural sector ranked 32nd in Tianxiang's industry rankings by price change, rising 85.79% for the full year, while the Shanghai Composite Index rose 79.78% over the same period. With the agricultural sector achieving only slightly more than 6 percentage points of relative return against the Shanghai Composite Index, agricultural stocks performed mediocrely for the full year of 2009.

In this regard, we mainly reviewed the three factors of agricultural policy, prices, and valuation in 2009:

First, in terms of policy, due to the impact of the financial crisis, the focus of policy in 2009 was on “maintaining growth,” including the introduction of revitalization plans for multiple industrial sectors, so the status of agricultural policy was not prominent. However, we can still see that the introduction of several relatively major agricultural policies still had a certain leading effect on the trend of the agricultural sector, such as the state raising the minimum purchase price of rice, the release of the No. 1 Central Document, two genetically modified varieties passing safety certification, and the convening of the Central Rural Work Conference.

Second, in terms of prices, the price increase of bulk agricultural products in 2009 was weaker than that of industrial products. This can be seen from the comparison between foreign copper futures prices and corn futures prices. For the full year, the wholesale price of corn rose about 27%, soybeans about 5%, rice about 2%, and wheat about 11%. Agricultural product prices did not support an overall rise in the agricultural sector, but cotton and sugar, due to expectations of reduced production, both rose by more than 50%, supporting the rise of cotton and sugar stocks.

Third, in terms of valuation, we see that the performance recovery of the agricultural sector was relatively slow, causing the agricultural sector's premium to the broader market to remain at a relatively high level.

It is worth noting that in 2009, four companies belonging to the agricultural sector went public: Haid Group, Shengnong Development, Huaying Agriculture, and Dongfang Landscape. These four companies are of excellent quality and expanded the market value of the industry sector. We believe that more high-quality agricultural companies will go public in the future, which will expand the market value of the agricultural sector and accelerate the industry's performance recovery.

2010 Agricultural Policy Outlook

We believe that after 2009, a year of economic crisis, 2010 may be a year of strengthened agricultural policy. This year's No. 1 Central Document is expected to once again focus on the “three rural issues,” and its content will be the discussion draft of the pre-holiday Central Rural Work Conference, the “Several Opinions of the Central Committee of the Communist Party of China and the State Council on Increasing Efforts to Coordinate Urban and Rural Development and Further Consolidating the Foundation for Agricultural and Rural Development (Discussion Draft).” The discussion draft emphasizes that future rural work should “promote urban-rural coordination and strengthen the agricultural foundation,” advancing urbanization and new rural construction through a “two-wheel drive.”
 

We believe that this year's policies to strengthen agriculture and benefit farmers may mainly focus on the following aspects: first, promoting the employment and settlement of the agricultural migrant population in cities and towns; second, increasing rural medical care, infrastructure, and other livelihood construction; third, ensuring agricultural supply and transforming agricultural operation models. In ensuring agricultural supply, specifically, the state will increase support for breeding, increase the four subsidies, raise the minimum purchase price, and improve land transfer policies and the grain circulation system.

In addition, we compared the quarterly returns of the agricultural sector over the past three years and found that the agricultural sector has an extremely high possibility of obtaining relative returns in the first and fourth quarters of each year. There are two main reasons: first, agricultural policies are mostly introduced in the first and fourth quarters of each year; second, the production and sales of various agricultural sub-sectors are mostly seasonal, with the fourth quarter of the current year and the first quarter of the following year mostly being peak sales seasons. The discovery of this pattern helps investors better grasp the investment timing of agricultural stocks.

Investment Strategy

Tianxiang Investment

Keep a close eye on “food security + inflation”

For 2010, we recommend investors pay attention to two main lines of agricultural investment:

First, the instability of domestic grain production, the tightening of global grain supply, and the rise in foreign grain prices bring food security issues. This will prompt the government to increase its attention to the “three rural issues,” increase the introduction of agricultural policies, and raise the status of agriculture in policy. The seed industry and the planting industry with land resources will be the industries that benefit most from policy. Focus on the overall sector investment opportunities under the elevation of the strategic status of the seed industry.

Second, inflation brings rising prices of agricultural products, and non-grain agricultural products, especially pork, fruits and vegetables (tomato paste, sugar), and high-end seafood industries, benefit noticeably.

We recommend investors look for individual stocks on these two main lines with relatively fast performance improvement, and also recommend investors pay attention to stocks with relatively low valuations. The main stocks to watch are as follows:

● Seed industry: Denghai Seed

● Planting industry: Beidahuang, Lv Dadi

● Pig farming: Shunxin Agriculture, Zhengbang Technology, Shengnong Development

● High-end seafood: Haodangjia, Zhangzidao

● Tomato paste and sugar manufacturing: COFCO Tunhe, Nanning Sugar

● Low valuation: Tongwei