Another Investment in Agriculture - Input Capital Corp.

This week I established a position with Input Capital Corp. (INP)
http://inputcapital.com/

Here is what INP does:

Input Capital is a brand new company based on the prairies that helps farmers with their working capital needs. We buy canola from farmers using multi-year contracts where we pay the majority of the cash upfront.

It claims to be the world's first agricultural streaming company.

Background

I have started to invest in Canada's agricultural sector for a variety of reasons:

1. Increased Global Demand

I expect that the demand for agricultural foodstuffs will increase as a result of population growth and a remarkable increase in global standards of living.  I will not address this at greater length as there are many studies readily available on the subject.

2. Most Countries Rely on Imports

In today's context, most countries are not self sufficient i.e. they do not produce enough food to meet national needs and must rely on imports to meet demand.

There are many research papers which address this matter.  It is complex.  For example, if concerted efforts (and sacrifices) are made, countries can increase food production dramatically viz. the tremendous increase in production and productivity achieved by Great Britain during WW II.  However, many countries are unable to do this for a variety of reasons: unsuitable land for expansion, lack of infrastructure, lack of knowledge, cultural institutions/practices which are resistant to change and so on.  It is also possible that the nature of demand can change over time e.g. changes in sources of protein in national diets.  Also, technological innovation has the potential to change production and distribution patterns e.g. the rise of "engineered food" in non-farm settings.

The following research paper is well worth reading as it attempts to integrate a variety of perspectives.

Spatial decoupling of agricultural production and consumption: quantifying dependences of countries on food imports due to domestic land and water constraints
http://iopscience.iop.org/article/10.1088/1748-9326/8/1/014046/pdf

Abstract

In our globalizing world, the geographical locations of food production and consumption are becoming

increasingly disconnected, which increases reliance on external resources and their trade. We quantified to

what extent water and land constraints limit countries’ capacities, at present and by 2050, to produce on
their own territory the crop products that they currently import from other countries. Scenarios of increased
crop productivity and water use, cropland expansion (excluding areas prioritized for other uses) and
population change are accounted for.

We found that currently 16% of the world population use the opportunities of international trade to
cover their demand for agricultural products. Population change may strongly increase the number of people
depending on ex situ land and water resources up to about 5.2 billion (51% of world population) in the
SRES A2r scenario. International trade will thus have to intensify if population growth is not accompanied
by dietary change towards less resource-intensive products, by cropland expansion, or by productivity
improvements, mainly in Africa and the Middle East. Up to 1.3 billion people may be at risk of food
insecurity in 2050 in present low-income economies (mainly in Africa), if their economic development does
not allow them to afford productivity increases, cropland expansion and/or imports from other countries.

3.  The Asymmetric Impact of Climate Change

The impact of climate change will not be expressed evenly across the world.  There will be "winners" and "losers".  An understanding of impacts must take into account a variety of considerations:

• "Developed" societies have a greater capacity to deal with climate change (e.g. major events such as drought, floods, heat waves, the emergence of new pests and diseases) than less developed societies.  It is easier to adapt to change when the following elements are in place: societies which are flexible and have the social, political and economic institutions to innovate and adapt.  
• Geopolitical turmoil can cause countries not to reach their potential even when traditional agricultural practices are present.  
• Some regions are already "stretched" to the point where any additional stress will cause major disruptions to agricultural production.  Desertification is spreading and the availability of water for agriculture is a major constraint in many of the most densely populated parts of the world.  In other words, agriculture is being conducted within very "thin ecological margins".  

Overall, the global outlook is not promising.  

https://en.wikipedia.org/wiki/Climate_change_and_agriculture#Food_security

A Few Conclusions about the Strategic Implications for Canadian Agriculture

1. Canada is self-sufficient and has the capacity to export some crops, especially canola and grains, to global markets.
2. Canada has some advantages: the likelihood that the amount arable land will generally increase over time as a result of climate change; the capacity to adapt to challenges caused by warmer weather, drought and new pests and diseases; institutions which can provide financing to farmers for innovation; a well-developed infrastructure (e.g. transportation, marketing, education, etc.) to support agriculture, etc. 
3. Canada has a long tradition of exporting western agricultural products to foreign markets.  The value of this is sometimes underestimated.  It is also important to note that exports can take on a variety of forms: commercial trade, and food aid (which I figure will grow in importance in order to foster stability in geopolitically unstable areas of the world).  
4. My estimate is that the demand for Canadian agricultural products will increase over time.  
5. Canada must compete with other countries such as the U.S., Brazil and others.  There will be bumps along the export road.  https://www.blogger.com/blogger.g?blogID=4060705938490392352#editor/target=post;postID=1214078820676151995
6. The "agricultural cycle" is at a low point.  

Where to From Here?

I have discussed two Canadian agricultural companies in previous editions of The Financial Passage Maker:

Rocky Mountain Equipment (RME)

Clean Seed Capital Group (CSX)

CSX has made significant progress in bringing a new technology to marketplace.  Since my initial investment in 2015/01/12 and subsequent follow-on purchases, the value of my holdings is up about 30 percent. The strategic play is the need for technology which is labour-efficient and which allows farmers to get the maximum returns per area unit (square meter scale) through adapting to variations in field conditions.  Likely as not, I will continue to increase my stake as the company makes further progress.  It may be a take-over target.  

RME has had a rockier path.  The sale of farm equipment is influenced greatly by crop prices and growing conditions.  I am down by about 30 percent.  However, company management has experienced "down times" before and has the institutional memory to survive tough markets for its goods and services.  Visit the company's website to see how it has adapted.

The dividend yield has alleviated some of the pain.  I have faith that the company will prosper when the agricultural cycle turns ... and it surely will.  Read this but note that forecasts are just as apt to be wrong as correct: https://www.fcc-fac.ca/en/about-fcc/media-newsroom/news-releases/2014/canadian-agriculture-in-strong-position-going-into-two-thousand-and-fifteen.html

I had a reservation about RME when I checked glassdoor.  

https://www.glassdoor.ca/Reviews/index.htm?&countryRedirect=true

The company appears to have a high employee turnover rate. Many former employees have bitched about the company: insensitive and incompetent management, the failure to act in accordance with espoused company values and so on.  On the other hand, they generally liked their fellow workmates.  I checked the reputation of other related companies and found similar complaints.  Is it a phenomenon associated with the sector or is it a product of the sociology of this type of industry?  Having worked as an employee at a drug store distribution centre for two summers while putting myself through university, I can understand the gulf between management and the shop floor.  We had many of the same complaints and reacted strongly when laid off with little notice, only to be rehired back within a few weeks.  Imagine how that affected our collective attitude toward the company!  

I contacted the company about this (gently) but have yet to receive a response some two weeks later.  This is in contrast to a response I had from the President and CEO of Clean Seed.  He responded fully to my request within hours!  I'll try again.  

Observations about Investing in Innovative Companies

I have a soft spot for innovative companies.  Many of the companies featured previously in The Financial Passage Maker are founded on new technologies and business models. Input Capital is yet another example.

A caution regarding investments in innovative (small) companies:

• Management generally does "not get it right" the first time around and results are often inconsistent in the early going.
• Many new companies have a very high "burn rate" (expenditures) as they develop their technologies, marketing channels and so on.  The demand for cash is infrequently met by internal earnings so management has to secure outside financing.  Very often, this leads to share dilution (extreme example is Polaris Materials) to the detriment of early-in share owners.   
• Small companies lacking a "moat" can be out competed by other rivals with deeper pockets and more developed distribution channels.  
• Smaller enterprises are generally more susceptible to a variety of risks: increases in financing costs, disruption of their businesses from internal factors such as staffing difficulties, problems with developing technologies, regulatory issues, and so on. 
• The "market" is notoriously fickle: falls in love quickly and is just as quick to spurn a company at the slightest hick-up.  
•  The "value" of small companies can often take a long time to be recognized by the market, especially when they are under the radar of analysts.  (This can be an advantage for the small investor who is prepared to be patient e.g. Questor Technology Inc. was in the doldrums before the market awoke to its potential.)
• The companies are not attractive to large institutional investment entities which can "set the tone" for copy cat retails investors.  They are not attractive to income seekers as they most often do not pay dividends. 

The Plus Side of the Equation

• Investing can be very profitable, especially in comparison with larger, more well-established companies.  My first ten-bagger was with Silver Wheaton, an early entrant into the precious metals streaming business.  (I still keep this beauty around as an "old pet" and think that it yet has life in its bones.  The major profits were taken several years ago near the height of the market - lucky timing for which I take no credit.) 
• It is often easier to "follow" smaller entities as they are less complicated than their larger brethren.  Further, senior management is generally more accessible and forthcoming than in larger companies where they are sheltered by the wall of investor relations departments. I am often pleased by the extent to which senior management is willing to "tell the story" and provide supporting material.  
• It is amazing what one can learn about these companies from investor discussion boards.  If you are lucky/astute, you can tap the experience of "old hands", some of whom are intimately involved in the sector.   
• I get a feeling of satisfaction in providing support by investing in innovative companies - the wealth creators and agents of increasing productivity and/or solving problems.  

Input Capital Corp. (INP) http://inputcapital.com/

Check out the company's investor presentation for an initial orientation.
http://s1.q4cdn.com/784243260/files/doc_presentations/2015/151116-InvestorDeck-F16-Q2-Ops-Update-v1.pdf

Here is how the model works.
http://s1.q4cdn.com/784243260/files/doc_downloads/global/agricultural-streaming-infographic.pdf

Reasons for Investing in INP

• The business model is attractive in that it is scalable, generates cash early on in the investment cycle, and produces reasonably predictable returns.  It holds the possibility of being extended to other crops.  Also, it is relatively "insulated" from the downside of commodity pricing events. 
• Management is seasoned, well embedded in the agricultural community (it understands its customers and the world of farm finance) and has a track record of past success.  I also like the company's "muddy boots" approach in establishing relationships with its customers.  
• I was impressed by the resumes of the regional account managers.  They are well educated, have varied life experience and are no strangers to the farm field.  While looking at their pictures, the thought arose that they would be welcomed at the kitchen table ... an intangible that would never be included in standard analytical reports.  Take a look and make your own judgement: Account Managers
• No debt. 
• The company has been able to raise additional capital on a consistent basis in order to expand its business.  Further, its internal earnings are very significant.  
• It has an enviable profile in the investment community: well regarded by a significant number of analysts and rated generally as a "buy".

Cautions

• It is a competitive world.  Will other entities modify their businesses to offer similar services?  Reputation counts for a lot in farm communities and it appears that INP has a nice head start in the field.  
• Untoward weather events such as hail, flooding and drought may affect the ability of farmers to meet their contractual obligations, thereby interrupting anticipated revenues on the part of INP.  To some extent, this can be mitigated over time by revising contractual agreements.  (It is not in the interest of farmers or INP to experience failure.) 
• The company has experienced tremendous growth in the number of its streaming contracts.  However, it recently reported the loss of three contracts.  The market reacted strongly and negatively to this news.  Here is the company's take on the loss. I am not bothered by it.  Instead I used the decline in share price as an entry point to purchasing shares. http://s1.q4cdn.com/784243260/files/doc_news/Input-Capital-Corp-provides-update-on-streaming-contracts.pdf
• The initial rate of company growth has been impressive.  I wonder about its sustainability and the extent to which the market has priced expectations of high growth into the share price. The share price is vulnerable to changes in sentiment as investors are quite risk averse these days, especially as it will take time for innovative business models of this nature to stand the test of time in the agricultural community.  

If this positive take on the company makes me look like Alfred E. Newman, then fine.  

or how about this?

I have few worries about including INP in the Financial Log Book.