Market Overview: Bulgaria's Cinderella Asset Class

Bulgarian agricultural land is often described as the most undervalued asset class in the country.  How valid is this ascertion?

Farmland in Bulgaria is currently 11-12 times cheaper than the EU-15 average and 2 to 5 times cheaper than its CEE4 peers. 

With 38 million Dekars (3.8 million hectars) of arrable land at current land prices of EUR 110 per Dekar, gives a price tag for all the arrable land of EUR 4.18 billion.  At agricultural land prices, the theoretical market capitalisation of the entire country is EUR 12.2 billion or roughly half of the theoretical market capitalisation of Luxembourg, which has 2% of the territory of Bulgaria.

Despite its significant undervaluation in relative terms, this is not sufficient to prompt land price convergence.  The expected fast appreciation of agricultural land in Bulgaria and its gradual convergence to EU average levels will be propelled by several factors connected with the county's entry into the EU and developements on the international markets for agricultural commodities in general, driven by fast economic growth in China and India, high energy prices and economic impact of global warming.  These factors will greatly impact the agricultural sector by improving its efficency and profitability.

The EU will benefit Bulgarian agricultural sector in several direct ways:

• Access to a highly protected from external competition market for agricultural products (Fortress Europe);
• Signifficant agricultural subsidies in the form of EU direct payments plus top-up national direct payments- 2007 total: EUR 450 million or a total of EUR 10 per Dekar or roughly 10% on current land prices;
• Additional agricultural support through minimum intervention prices in key crops, effectively setting a floor on agricultural prices;
• Improved competitiveness on international markets through additional export subsidies;
• Tax-breaks and tax-incetives for production of biofuel crops and wind farm construction;
• Preferential terms for financing, leasing and mortgaging of assets;
• Inflow of foreign capital and know-how.

The global factors aiding agricultural business in general can be summed up under the following points:

• Beginning of a sharp, long and secular rise in prices of soft commodities, driven by
  • Strong demand from China & India,where rising living standards lead to higher meat and hence cereal consumption;
  • Dwindling global grain reserves
  • Risng demand for production of bio-fuels (ethanol, bio-diesel etc)
• Reduced land availability, as global population growth and continued urbanisation have dramatically cut the agricultural land available per head;
• Glowbal warming reduces crop yields, but also has kick-starteda variety of alternative energy industries (wind farms, bio-fuels, solar pannels) which use and bid up agricultural land;

  Given the very low level of wage cost in Bulgaria, the signifficant subsidies will dramatically improve profitability of agricultural sector.  At their full level, the EU direct payments would be sufficient to cover all the run costs for crops such as corn & wheat. are signifficantly

Bulgarian crop yields from hectar are signifficantly below EU levels, reflecting years of absence of any investment in the sector, inferior know-how, technology and machinery, lack of access to the lucrative European market and low prices of agricultural commodities on the international market.  Many of these factors are changing now in favour of the agricultural sector. 

Despite the considerably lower yields per Hectar, due land prices which stand at 5-8% level from Western European levels, the returns from agricultural business per unit of land is higher by a magnitude of 50%.  Calculations also assume, equal level of run costs set at Bulgarian level, which tends to understate the return gap / differential.  The calculations exclude the EU subsidies which would boost higher returns (in the case of Bulgaria by 10%).

Soft Commodities:  Way too cheap!

The flattering returns above have been givve a signifficant boost by the recent sharp rise of corn prices on the international markets over the past 4 months, driven by  poor crops and depleting stocks.  Soft commodity prices will continue to influence the financial returns of the agricultural business and hence that of farmland not only in Bulgaria but also globally.  So, is there room for further price appreciation in soft commodities?  Lets take corn for example.

In nominal terms, corn prices have not only not appreciated but have lost signifficant amount of their value.  In US$ corn has lost 35% of its value, while its depreciation in DEM has been even more staggering, some 65% from its peak in 1983.  The nominal slump in corn prices over the past 30+ years is even more shocking given the 10-fold increase in oil prices during the same period.

Inflation adjusted performance of corn prices is even more disappointing,  It is often difficult to come up with an asset class (except fixed income bonds), which underperformed cash during the inflatinary 1970s.  Corn lost 50% of its real purchasing value during the decade and went on underperforming inflation to hit a rock-bottom level.  By 2006 corn had lost 80% of its value.

Global Grain Stocks: What reserves?

Despite the relativeley low grain prices, global stocks have not only not increased, they have fallen to critical levels.  All the more staggering is their drop in the face of growing global consumption.  The coverage ratio, global gran stocks over consumtion, has thus fallen to its lowest level in the last 45 plus years, a mere 58 days of consumption.  Last time the global grain stocks were at such low coverage ratios was in the early 1970s and led to a manyfold increse in the price of soft commodities in the international bourses.

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