Today I am speaking with Simon Skerrett, COO and Co-founder of CommStream Capital Limited, Australia's first agricultural streaming company which partners with progressive farmers to provide capital solutions to fund productivity growth and innovation.
With drastic shortages of capital in Australian farming, CommStream leverages its industry expertise and relationships to bring farmers an overdue, innovative financing solution, which drives productivity growth and helps fund generational ownership transfers.
CommStream provides investors with direct exposure to Australian agriculture without the added complexities of traditional farm or agri-infrastructure investments.
Through commodity streaming the Company plans to rapidly accumulate a portfolio of high-quality and diversified agricultural production with low overheads and without the need for capital-intensive infrastructure or land purchases. In turn, CommStream plans to position itself as a key partner for global commodity traders and major Asian consumer enterprises looking to secure food supply.
"Streaming" is a proven, scalable, high-return business model through which upfront cash is paid to a producer of a commodity in order to secure a long-term supply of future commodity production. Demand for alternative finance is growing rapidly in Australian agriculture and in 2016, CommStream successfully deployed its first wheat streaming agreement which you can learn more about here.
Following is the highly stimulating and educational conversation I had with Simon on CommStream and the current state of the agricultural industry in Australia.
Simon, for a farmer what is an alternative if they don't have access to a company such as CommStream offering financing through streaming contracts? Do they secure bank financing or is there really no alternative form of financing they have access to?
The streaming model delivers significant benefits to both CommStream and farmers that are not provided by traditional financing or investment alternatives. Streaming provides a better cash flow proposition to debt as the funding is linked to the farm production, as farmer payments are made in physical tonnes of commodity rather than principal and interest. The CommStream contracting model is flexible enough to adapt to market conditions and individual farmer needs. For example, CommStream is able to share price upside and / or downside with farmers depending on where we are in the cycle. Furthermore, CommStream offers commodity exchange options that allow the farmer to adapt their planting depending on weather and market pricing patterns. We have found that this flexibility really resonates with farmers. It can also provide CommStream with the ability to enhance and further secure its returns in different market conditions and grow its farmer base.
Farming is capital intensive and constrained by a major shortage of rural finance. Australia needs innovative finance, and there is growing farmer demand for viable alternatives to traditional equity and/or debt. Australian farmers need to raise significant capital moving forward to fund growth to meet increasing Asian food demand as well as finance intergenerational transfer of farms. Capital is also required to fund the ongoing trend of farm expansions and industry consolidations to create economies of scale.
CommStream's business model aims to increase the farmer's profitability and productivity to create a win-win situation for farm operators and investors who are looking to gain exposure to the agricultural sector.
That's very insightful. Now you mention there is a major shortage of rural finance. How big is the financing gap? Can you give a respective dollar amount?
Yes Dylan, Australia and New Zealand Banking Group Limited (ANZ) currently have the capital gap at $9 billion, between what farmers need and the funding that's available. This is expected to increase to $160 billion by 2025.
So would it be correct to say that your model is similar to that of Input Capital(OTC:INPCF)?
Yes, Input provides an example of what CommStream is planning to achieve in Australia. CommStream plans to develop a diversified portfolio of crop types, whereas Input Capital focuses solely on Canola. Having a proven international model is important for CommStream, and as a vote of confidence, Input Capital's co-founder, Brad Farquhar, invested into our Company in late 2015. Brad's support and knowledge of agricultural streaming is invaluable.
What commodities do you see having the most immediate potential for CommStream to be involved in and do you see yourself expanding beyond these in the coming years?
Streaming can be applied across a range of agricultural commodities. CommStream is primarily focused on the major Australian export crops with increasing demand profile, initially targeting Australian wheat, which is particularly sought in Asia. CommStream will also look to secure supply streams of cotton, barley, canola, chickpeas, and sorghum, as well as other opportunities such as beef.
What is the average time frame for your streaming contracts? How do you mitigate the risk of default among the farmers you are financing?
The average term of CommStream's streaming contracts are 5-7 years.
CommStream seeks to take security over assets to cover capital invested. For example, CommStream's first agreement is secured by a second mortgage over quality farmland, a Deed of Priority with the bank ranking CommStream's claim as second mortgagee, and an annual interest in the crop registered on the Australian Personal Property Securities Register.
CommStream's claim to the farmer's production is limited to 10-15% of long-term average production, which ensures we have a low exposure to an individual production system, and the farmer is not overcommitted. For example, if the farmer's long-term average production is 10,000 tonnes, the maximum exposure CommStream would seek is 1,000-1,500 tonnes. CommStream's first agreement has a 6% exposure to the farmers long-term average production. This low exposure ensures that if a farmer has a dry year and production is below average, the farmer in most cases will still be in a position to deliver the contracted tonnes. In addition, tonnes committed to CommStream are relatively small when compared to their long-term average allowing the farmer to market the majority of each year's crop through traditional channels.
Now, going back to Input Capital real quick, they had an issue with three defaults about a year ago. They have since learned from this and improved their credit screening of potential clients. What have you learned from this mistake in assessing credit client risk?
There are lessons to learn from the Input experience that CommStream has employed.
Due diligence is our first protection barrier. Initially, we focus on default risk of the farm business and the availability of quality security. If the default risk or security is not favourable, we won't pursue further due diligence. Following the initial test, we ensure that a streaming agreement positively adds to the farm business's net financial position and cash flow. We also take a very close look at Manager performance, financial performance and the quality of natural resources.
We believe our suite of security agreements and policies are sophisticated and more conservative than Input Capital's were originally. Input were in the position of primary lender and the farmers had overcommitted the amount of tonnes contracted to Input leading to eventual default.
So CommStream's strategy is to diversify its exposure to individual farm businesses as well as geographical locations. We will also focus on a range of agricultural commodities. Individual streams will average between A$500,000 to A$1.5 million (10-15% of long-term average production) which is much smaller than Input's original agreements. Diversification and our portfolio approach will ensure that failure of any one stream doesn't jeopardies the performance of the portfolio or the company.
As Input has grown, their strategy has moved toward our strategy, which is verification that we are doing the right thing. Being in regular communication with Input Capital means we are learning from those that have been through the process and CommStream can adapt ahead of time.
I understand CommStream has a high quality management team and group of advisors and investors. Can you discuss this briefly?
CommStream is a culmination of two years of work by a team of highly qualified individuals who share a common belief in the future of Australian Agriculture. The team possesses the experience, skills, industry relationships and knowledge to judiciously manage operations and drive superior returns. The association with Australia's premier farm management and advisory service provider, Agricultural Management Company, further strengthens the Company's capabilities.
Two leading Streaming experts are CommStream shareholders. CommStream Director, Peter Barnes, founded Silver Wheaton (NYSE: SLW), the world's largest precious metals streaming company. Investor, Brad Farquhar, invested in CommStream in 2015 and is co-founder of Canadian canola streaming company Input Capital.
What type of IRR's are you looking to achieve on your streams? Is this attractive enough for farmers to be queuing up to secure financing from you?
We are targeting an unlevered contract portfolio IRR of 12-15%, with 3-5% upside available from Bonus Tonnes.
Additional revenue streams are possible as the portfolio grows through grain marketing services, storage and value-adding for the remaining commodity produced by growers not under contract to CommStream i.e. the other 80-90% of the farmers' production. This presents a large opportunity for CommStream, using the Streaming mechanism to generate a range of other revenue streams, and potential to substantially increase the company's valuation multiple upon exit, or public listing.
Without any marketing, we have developed a pre-qualified deal pipeline of A$8.5mn and a further A$12mn of interest from farmers. To date, we have been developing deals from proprietary networks.
ANZ estimates that ~$160 billion in additional capital may be required between now and 2025 to generate the production and export growth in Australian agriculture needed to capture the anticipated global food demand opportunities. To put this into perspective, total debt in Australian agriculture currently stands at ~$60 billion. ANZ suggests that traditional sources of farm finance (debt and retained earnings) will be insufficient to meet this massive capital requirement and Australian agriculture must find innovative ways of attracting growth-oriented finance.
Failure to attract sufficient capital will reduce productivity gains through lower investment in on-farm infrastructure, new technologies, innovation and a reduced ability to take advantage of economies of scale. Australian farmers are actively seeking growth-orientated finance models such as CommStream to fund this growing requirement for capital.
Having just collected your first stream, do you have capital to deploy into your streaming pipeline?
Dylan, with the 2016 harvest now under our belt we've completed the first cycle of this agreement taking delivery of H2 grade wheat near Moree, New South Wales.
Now that we have proof of concept and farmer demand in Australia we are looking to secure our second streaming agreement and are working toward a capital raising in 2017.
We are planning an IPO in the future although the exact timing will depend on our development through the next 18 months to create liquidity for early investors and access retail capital.
Simon, thank you very much for your time and educating us on the massive potential CommStream has in addressing a sizable funding shortfall in the Australian agricultural industry.
Dylan, the pleasure was mine. Thank you for your time and curiosity in our business.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.