Business and Land Strategy
The strategic objective of Black Earth Farming is to be a leading, diversified, cost efficient agricultural producer on a global basis. The aim is to be profitable at low commodity prices and achieve significant returns in stronger price years, underpinning a valuation substantially above net asset values.
To reach its long-term business objective, Black Earth Farming has developed a strategy based on three key directions, each of which are supported by a number of tactical targets:
- High operational efficiency in the core business
- Land bank optimization
- Diversification into irrigated vegetable crops
High operational efficiency in the core business
As a commodity producer and price taker, competitive advantage comes from a sustainable low cost position. Black Earth Farming’s strategy to improve the profitability of its core business is focused on raising productivity to achieve the highest possible crop yields for the lowest possible costs per ton. To achieve this end, BEF applies a R&D driven scientific approach to farming. The Company employs international expertise and adopts efficient farming methods supported by robust underlying science. A close cooperation with a technical agronomic partner serves to provide the best solutions to soil management, seed variety selection, crop nutrition and crop protection. This includes processing data from internal research or other external sources, as well as the training and education of staff to ensure proper implementation. In terms of organization, the Company has worked towards reducing the number of production units, unify management structures and incentive systems across the business and make sure proper management systems are in place. Over the past four years, BEF has made significant progress towards improving operational control; machinery has been equipped with GPS trackers and fuel sensors, input material application is tracked in real time and equipment maintenance and repairs have been centralized. The Company has moved from nine to five production clusters to achieve the best balance of economies of scale and on-site management and control, while seeking ways to reduce overhead costs. The cluster model optimizes the utilisation of resources as land areas are consolidated around local storage facilities and machinery hubs. The central organization coordinates investments, technical strategy, marketing and procurement.
The farming business has inherent weather induced volatility relating to crop volumes and also faces meaningful price volatility with substantial effects on revenue and profitability. Black Earth Farming aims to manage these risks to the furthest extent possible. Beside the above mentioned efforts to lower costs and diversify the business towards higher value crops, the Company has also introduced a number of initiatives to manage risks. In 2011, the Company launched internally controlled export operations to open an additional sales channel with access to long-term contracts in hard currency and additional sales margin potential. In 2012, the Company took out crop yield index insurance for the first time, to mitigate weather risks to crop yields. In 2013, the Company started a grain hedging program with futures and options trading on MATIF and CBOT. These efforts are directed towards raising and stabilizing the Company’s revenue.
Land bank optimization
Black Earth Farming’s land bank strategy is not directed towards growing the current footprint but rather at improving and consolidating the land portfolio. The continental climate in the central Black Earth Region of Russia, where the Company operates, provides for a crop growing season of approximately 120–170 days from East to West, where yields are generally positively correlated with the number of growing days in a season. The Company’s program to optimize its land bank aims to build consolidated and compact production clusters on land with high productivity by means of divestment of underperforming non-core assets and swaps of land assets. The 2012-2014 land transactions in Voronezh and 2015 swap in Lipetsk-Tambov are part of this strategy, which remains ongoing. Land bank optimization should contribute both to raising average yields and reducing total production costs.
Diversification into irrigated vegetable crops
In 2012, Black Earth Farming signed a 3-year cooperation agreement with PepsiCo to supply potatoes and high oleic sunflowers for PepsiCo’s Frito-Lay Crisps as well as sugar beet for other PepsiCo products. The agreement marked the start of a diversification of Black Earth Farming’s business profile to include higher value irrigated vegetable crops. Irrigated vegetable crops have higher margins per hectare, albeit with significantly higher capex requirements. The Company believes that the vegetable crops offer a valuable complement and a good fit with its core business. While potato is the main crop in the irrigated vegetable crop portfolio, starting in 2015, the Company also added onions and carrots to the crop mix. BEF sees long-term potential in expanding the vegetable segment towards Russian retail, especially in the current Russian strategy of import replacement.
As of 31 December 2015, Black Earth Farming held 227 thousand hectares of land in full ownership, corresponding to 89% of the total controlled land bank of 256 thousand hectares. 25 thousand hectares were held under long-term lease contracts running up to 49 years. The remaining 4 thousand hectares are in the process of ownership registration. Of the 256 thousand hectares, circa 85% is crop land, either in our rotation or rented out to third parties, as well as a small area to be imminently reinstated from fallow following the recent swap deal. The balance is pastures, valleys and fallow that is uneconomic or not in our plans to convert to crop land.
Russian agricultural land is, in the Company’s view, still undervalued, both in comparison with land of similar quality in other countries and in relation to its inherent production potential, especially in the Black Earth Region. As of 31 December 2015, the Company held 232 thousand hectares on its balance sheet at total value of USD 31.6 mn, or 136 USD per hectar. The depreciation of the Russian ruble during 2014 and 2015 has significantly reduced the balance value of the land assets in USD terms, whereas the actual market remained stable to firm in hard currency terms
The Original Land Bank
Black Earth Farming built its land bank from 2006-2009, from having 115k Ha in process of registration at the end of 2006, to controlling 330k Ha at the end of 2009. The original land bank was spread over nine operating units; three in Voronezh, two in Lipetsk, two in Kursk and two in Tambov. In 2012, the Company started to consolidate and improve its land bank through divestment and swaps of non-core and less productive assets. The objective was to increase productivity, profitability, land utilization and ownership quality of the land bank.
Over the last three years the business has undertaken a comprehensive audit of its land assets, assessing the land bank on:
- Productivity; soil quality, altitude, growing days, rainfall
- Land type; proportion of arable land relative to grassland, wasteland, valleys and non-cropped land
- Potential to consolidate land further in the area
- Control; proportion of freehold, leasehold and co-owned land
The Company is now part-way through a multi-year strategy to:
- Increase the proportion of owned land relative to leased land;
- Reduce the proportion of grassland and non-cropped land in the footprint;
- Give up poorer quality land, especially where it is leased;
- Generally shift the production footprint westwards and northwards, where rainfall is higher and growing season is longer;
- Consolidate around a number of large individual operating blocks of larger than 50,000 ha of land, where good operational economies of scale can be achieved;
- Bring uncropped land into production, where it is economically justified to do so.
The divestment and swaps transacted to date have meant that business has consolidated to 5 operating units. Further transactions are envisaged.
Consolidation to Date
Between 2012 and 2014, farmland of 37,254 at Ostrogorsk, Podgornoe and Kalach in the Voronezh oblast was sold. The transaction also included the Ostrogozhsk elevator, with 15,000 tonnes of capacity, as well as 14,000 tonnes of warehouse type storage facilities and yard premises. There were several reasons why the Company considered these farms non-core and a poor fit with the rest of the business. These farms:
- Had a high proportion of leased land;
- Had a rolling topography with lots of valleys, slopes and wasted land;
- Had shorter growing seasons and had repeatedly underperformed on crop yield potential;
- Had lower quality chalky soils.
In 2015, farmland and storage capacity at Stanovoe, in the north of the Lipetsk region, was swapped for land at Morshansk in the Tambov region in proximity to our existing blocks. The swap involved several counterparties and a series of related transactions. As a result of the swap, the Group disposed of a total of 36.6k Ha of controlled land, including 4.5k Ha of grassland, 5.6k Ha of forested fallow, 7.2k Ha of leased land as well as of 20k tons of grain storage. The assets received in the swap amounts to a total of 24.9k Ha of controlled land, including 20.9k Ha of crop land, 4.0k Ha of grassland, 3.3k Ha of leased land, and a 30k tons elevator facility with rail access.
BEF quality of land ownership is siginificantly ahead that of many other businesses who do not necessary register land plots, update cadastral maps, establish GPS boundaries and electronic maps. In the wider industry land is often occupied semi-legally and disputes remain frequent. High quality of land ownership contributes to fair value of BEF land and real estate assets.