Description

I wrote up AGM in 2009 and today I’m writing it up again for a different reason (and looking back, there was no reason to sell). Back then it was a bargain-basement price at a cycle bottom with fixable non-core short-term issues. Since then it has grown at an above-average rate and I believe we could be on the cusp of a significant rise in the stock price for macro reasons.

Just as a quick reminder/intro, AGM is a provider of agricultural loan products and services with a mandate to increase the availability and affordability of credit in rural areas. The company was started in 1988 because there was an agricultural boom in the 70’s that went bust in the 80’s. A lot of over-indebted farmers left their land, banks went under and the Farm Credit System reported a loss for a few years. AGM provides a secondary market so that bankers can lend in the Ag space and thus compete with bigger banks, the Farm Credit System, insurance companies, specialized lenders, cooperatives and private sources of capital. Now a new cycle of rising commodity prices is starting but this time Farmer Mac exists as an established component of the system. They will benefit. Here are the main products the company offers today:

• Purchasing at par loans and loan participations secured by first lien mortgages on eligible agricultural land and affixed buildings

• Purchasing guaranteed portions of USDA Farm Service Agency and Rural Development loans from the lenders that originate them

• Wholesale Financing (“AgVantage”): low-cost wholesale funding for institutions’ eligible agricultural assets

• Farm & Ranch Credit Protection: consists of two credit enhancement products for protect assets that sit on banks’ balance sheets

AGM has the potential to get into more products: because farmers have many types of loans, the company can - and probably will - look into offering all types so that it can do financing package deals and establish all-encompassing relationships.

Another interesting thing about AGM is they’re getting deeper into servicing; they want to service the loans as much as possible not just because it’s good business but because it also helps them get to know the end user. Furthermore, they’ve been increasingly using technology for modeling and are much more sophisticated than they were in 2009.

Bull Thesis

The Russia vs. West conflict is having a significant ongoing consequences in terms of global geopolitics and economics. A realignment is under way – one that has negatively impacted the U.S.’s relationship with India, Iran, Saudi Arabia, possibly Turkey, Mexico, China, obviously Russia and more. It’s also leading to intra-Europe tensions, namely decreasing patience in a couple of Eastern European countries and perhaps problems with PIGS too. The main problem is economic: the world is realizing that financialization and control of financial institutions doesn’t matter as much as a secure supply of food & fuel. It seems increasingly likely that over the foreseeable future, many countries will feel pressure in the following areas:

- Higher energy prices due to oil-producing countries realizing they’re better positioned than previously believed (this affects input costs for various people including farmers)

- Higher food prices, given that food grown in Russia/Kazakhstan (and perhaps other countries) will be sold to the West at a lower priority level

- Higher fertilizer prices

One of the main effects that we’ve seen is very high diesel prices, which affects farming profits quite a bit, to an extent that U.S. farmers are wondering if they’ll be able to plant and/or harvest economically. Farmers are also taking a pay cut on what they still are producing, due to lower profit margins.

Furthermore, from an internal-politics point of view, governments want to prevent people from rebelling and to maintain social cohesion; one way to do that is establishing a margin of safety in terms of food and fuel. The Western world will learn that power in this new paradigm comes from low debt, high reserves of hard money and hard assets, and the ability to have a self-sustaining economy as far as the basics go: food, fuel, housing, health. It’s crazy that so many medical supplies in the U.S. come from China, for instance.

Add to that the potential for any of the following: stagnating economy, possibly stagflation, lack of credit because of lender uncertainty, interest rate uncertainty, a cycle of rising rates which many have never seen in their careers, political change/turmoil and a reversal of the trend toward globalization. Farmers are not fully ready for theses types of outcomes. You can take a look at certain graphs at the link below (for example: Plans for Farm Machinery Purchases - Figure 5) and see that as of the date of this study, sentiment has not shifted to reflect these realities:

https://ag.purdue.edu/commercialag/ageconomybarometer/farmer-sentiment-plummets-as-production-costs-skyrocket/

It seems like we’re headed towards a situation where the government will want to make sure farmers keep producing, which will eventually mean introducing government programs that modify the financial landscape such that certain normally uneconomic projects become economic for farmers. Good old America!

AGM’s mission is to maintain an efficient secondary market for farm credit (and other rural credit), notably taking conforming loans off of banks’ balance sheet. As we know from the housing bubble, removing risk exposure from a large number of participants and transferring it to one participant provides a lot of juice. In the case of farming, should the government want to help/encourage/grow/sustain the industry, they will go to AGM. The company is the only federally chartered corporation that does what it does. Five of its 15 directors are appointed by the President with the advice and consent of the Senate. Standards for loan guarantees have been modified before and can be again at the stroke of a pen. New programs can be created. If the government wants to stimulate, the infrastructure is in place. And the sector is small enough (now) that taxpayers won’t mind. They want to eat and this isn’t as big of an expenditure as defense or health care.

I think the commodities trend, in typical American fashion, will overshoot. It’s even possible that in 10-20 years we have a U.S.A. where tons of people have a small farm and produce their own food, a great success of transitioning to more self-sufficiency, more awareness, more organic food and perhaps much decentralization, all courtesy of small government-sponsored loans. But it can also be large loans to large players. Either way, this would be a bonanza for sellers of various equipment/supply, for the financial sector and for sure the one piece of the picture where we have a monopoly: the securitization/guarantee business.

AGM has a billion dollar market cap. People aren’t paying that much attention to a stock like this. Once there’s a real bull market in farming, this stock becomes widely followed even though it’s not a mega-cap. And if we see a flow back from big cities into rural areas, AGM benefits in other ways because they also participate in the financing of animal farming as well as rural utilities.

And this is not a company that will go crazy from one day to the next. It took time for FNM/FRE to become the degenerates they became, so there will be plenty of time to exit of one fears things are going too far. It’s been for many years a nicely growing stock with a good dividend and a somewhat boring story. Farming will now become just a bit more sexy.

More on AGM’s Business

In recent years AGM has focused on technology to enhance customer experience. The main example is AgXpress, launched in October 2019. This platform is used for borrowers who have a 720 FICO and up to 55% LTV. The turnaround time is 24 hours max (much of the time, approval comes in minutes) and there’s minimal documentation: the underwriting is based mostly on people’s existing profile. Also, there are no restrictions on the use of funds. This product is now AGM’s most popular underwriting option. In October 2020 they doubled the max loan amount to $1.5 million. In 2021 they made the process 100% online and added (and are adding more) features to the online portal, such as rate comparison and locking in a rate.

In terms of the value proposition, there are many benefits to banks offered by Farmer Mac:

- They enable banks to do complex transactions involving multiple entities and multiple individuals, with a higher loan amount
- They enable the financing of 95-100% of someone’s first land purchase because it’s split up into 2 mortgages: the first with the bank and the second with the USDA through the Farm Service Agency (the latter tranche is purchased by AGM)
- They enable the borrower to get a fixed rate for 15-30 years
- They allow banks to keep growing because as volumes grow, a bank can’t take loans on its own balance sheet anymore
- They enable banks to offer loans that exceed their normal lending limit


Conclusion

So how much can a stock like this rise? Usually when there’s a bubble (created by government intervention or otherwise), the sector’s size rises to multiples of the baseline (at the very least double) and in the case of AGM, if we get into a situation where purely private companies shy away from lending, the government-sponsored player gets a disproportional share of the growth and it’s even more bullish. I’d expect at minimum 2x over the next five years if there’s simply more government help for farmers, which is 15% compounded (plus you get dividends). If we go all the way into a farming-resource-nationalism bubble, it could easily be 5-10x. I’d divide the probabilities as follows:

- 10% chance of a boring outcome, no government help and everything stays the same its been over the past decade. No change in farming’s role in the American economy

- 45% chance of government intervention but without it turning into a bubble

- 45% chance the pendulum goes all the way to the other side and we have a raging farming bull decade

Currently the stock trades at around 10x earnings and 1.1x book

Risks

The main risk I see here is that they deal in fixed-income, so any sort of hyperinflation that takes away people’s appetite for fixed-income securities is going to impact AGM negatively. Also, there’s simply execution risk when it comes to managing their hedges. Interest rate curves are getting interesting. But perhaps the use of adjustable-rate instruments fixes much of this and keeps investors confident.

Catalyst

- Russia continues to pivot away from the West; Ruble keeps its strength

- Other countries follow Russia’s lead and the world becomes more multi-polar

- Deteriorating relationships with other countries

- Any sort of inflation or variance in the rate of inflation

- Any kind of food crisis, supply shocks, great variance in Ag prices

- Recession/stagnation

- Rates that vary a lot