Is Ruralco Holdings Ltd the next big share market winner?

Credit: Andrew Stawarz

Ruralco Holdings Ltd (ASX: RHL) is probably unknown to most investors, given its niche business model and measly market capitalisation of approximately $265 million. However, its position as one of Australia’s leading agribusinesses places it at the centre of current investor appetite for agricultural assets, and in the company of current market darlings A2 Milk Company Ltd (ASX: A2M), Bellamy’s Australia Ltd (ASX: BAL) and Bega Cheese Ltd (ASX: BGA).

With favourable dynamics supporting its industry, I believe Ruralco is one stock to watch this year for the following reasons.

The industry

Agribusiness is no stranger to the ASX, with Australia sporting a host of agriculture focused businesses including Australian Agriculture Company Ltd (ASX: AAC), Elders Ltd (ASX: ELD) and Nufarm Limited (ASX: NUF). Despite only accounting for a fraction of the ASX’s total market capitalisation, agribusiness companies have been punching well above their weight in recent times, thanks to increased global demand for fresh food and produce.

In fact, a report from Deloitte Australia earlier this year revealed that agribusiness stocks returned an average 66.9% last year, undeniably outperforming the S&P/ASX 300 Index’s (ASX: XKO) -0.3% return in 2015.

Of course, the dramatic outperformance was in part due to market darling Bellamy’s Australia, which surged over 1,000% during 2015. Nonetheless, the report indicated that companies in the sector demonstrate a “high level of capital efficiency”, reinforcing the view that “the long term prospects of the sector are strong.”

With growing demand for Australian agriculture coming from China and other emerging markets, it follows that now might be the time to purchase companies exposed to these industries. This brings me to Ruralco.

The business

Unlike most other agribusinesses, Ruralco is a diversified holdings company, associated with nearly every segment of agriculture possible. The company started in 2001 following a merger with Grow Force Australia Limited and is today represented at over 500 points across the country.

Ruralco owns over 40 different businesses, each providing expertise across all agricultural sectors such as merchandise, livestock, fertiliser and water management (to name a few). This makes it highly leveraged to agricultural exports, standing to benefit from further demand for Australian food and produce from global consumption giants China and India.

The financials

In its 2015 full year results, Ruralco reported an 18% increase to sales revenue. Net profit after tax (NPAT) jumped a massive 33% to $14.1 million, with its return on capital employed increasing 1.8% to 17% for the year (consistent with Deloitte Australia’s view).

The increased appetite for Australia’s agriculture worked wonders for Ruralco, with an uptick in demand for its livestock bolstering earnings by $23 million, largely due to volume (a.k.a. demand) increases.

A negative coming out of its full-year results was that net debt increased 56% to $59 million on the back of acquisitions and an increase to working capital (i.e. the funds used to support the business). Management indicated that this was a product of pursuing expansion without cutting its dividend payout. Whilst such a move bodes well for short-term returns, in my opinion, it would have been pleasing to see management reduce debt rather than pay its dividend.

Nevertheless, Ruralco’s current gearing (as at 30 September 2015) sits at 21% of total equity, and its final dividend was reduced by 13% to partially offset the increase in debt, indicating prudent management going forward.

Foolish takeaway

Ruralco operates in a cyclical business which requires high levels of capital expenditure to reap rewards. Accordingly, one must remain cognisant of its risks given no industry is immune to a downturn. However, I suspect Ruralco is insulated against a severe downturn given the breadth of its businesses and position in the market. With current demand for Australian agriculture providing favourable macroeconomic tailwinds to its business, I believe this makes Ruralco one stock to be watching this year.

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Motley Fool contributor Rachit Dudhwala has no position in any stocks mentioned. Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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