The New World: Karuturi Global and how (not) to invest in Ethiopia

The African nation of Ethiopia is famous for its cuisine, long distance runners and arabica coffee. Few however think of Ethiopia as a rising African power.

  • Since 1990, the rate of return on foreign direct investment in Africa has averaged 29%, nearly tripling FDI in Europe.
  • The Ethiopian economy has grown at a rate of 10% over the last 10 years.
  • Ethiopia has its own space program.

So what made Ethiopia, a sub-saharan state with the same failings and tribal fault lines that plague the rest of Africa, emerge as the region’s engine of growth?

A few magic ingredients:

  • Extremely fertile soil in western Ethiopia (>5% organic matter)
  • Comparative trade advantages such as its proximity to Europe through the Suez Canal and the Middle-East, which is a net importer of food
  • Severe droughts that spurred a central emphasis on agricultural self-sufficiency
  • A stable, growth-oriented and investor friendly developmental state and regime

g066x-ethiopia---shorthand05_hfgonam.png

As seen in the above chart, Ethiopia exports mostly agricultural products and precious metals like gold. Investors have poured into Ethiopia to profit from these trends.

Gold Rush in Agriculture

As New York was once the gateway to the Americas, Ethiopia – through it’s sole port of Djibouti, is the gateway to the Africas.

There are several hundred Chinese, Arab and Indian companies that have bought arable land on long term lease to cultivate cash and staple crops, primarily in the rain fed, fertile regions to the west of Addis Ababa. The rent for a hectare of land is between $5-11 per year. Let that sink in. Yes, it’s cheap. And Ethiopian soil can be especially fertile.

The unit economics of growing crops is tremendously profitable. Here’s the kicker – other farm inputs like labour are also comparatively inexpensive and other expenses like tax rates for commercial farming have also been subsidized by the government.

There is potential both for growing food and cash crops, due to the varied topography and soil conditions. Ethiopian roses are grown in the highlands (above 2500 metres) and are of very high quality. The long-stem roses are exported to satisfy demand as far away as the Netherlands and Japan. Staple crops like maize and rice are grown to satisfy the immense local demand from Ethiopia and the rest of growing Africa. Cash-crops such as sugarcane are grown in the water fed valleys.

High-margin Superfoods like Teff (which is like Quinoa from South America) and the arabica coffee bean are native to Ethiopia and flourish in the soil.

“Everyone is investing in Africa for food just like they are investing in China for manufacturing, and in India for services” – Sai Ramakrishna Karuturi, founder of Karuturi Global, Business Standard.

2017-05-26_1-42-32

Growing roses and food crops for export in Ethiopia clearly didn’t work out very well for Karuturi Global Limited (KGL) – the largest Indian industrial farming company in Ethiopia. So what went wrong?

Risks

Political Risk

Although there is a stable and growth friendly government at the center, it is undemocratic. Dissent is mercilessly suppressed. Human rights are flouted and abused.

The provincial governments have several powers separate from the state and the local leadership can be as corrupt and power hungry as the central leadership is visionary and focussed on Ethiopia’s growth. Karuturi Global was lured away from fertile rain-fed Bako province by an offer of cheaper and plentiful land in the distant province of Gambela by the border with Sudan. In a case of appropriation, the lease of this land was abruptly withdrawn by the provincial communist government inspite of a Bilateral Investment Promotion and Protection Agreement (2007) between India and Ethiopia. Well, TIA – This is Africa.

Flooding and Drought

In a double whammy to KGL, the flooding of the Baro river in Gambela destroyed 50,000 tonnes of maize in 2011 and the stock price of KGL tanked sharply to never recover. The company has since run into much bigger problems such as spiralling debt.

Ethiopia is blessed with rivers such as the Baro and the Blue Nile, but much of the eastern part is sub-saharan arid and desert-like creating a skew in food production. The country has suffered severe droughts as recently as 2016, when foreign aid saved millions from starvation. With a 100 million citizens it suffers from huge demographic pressures on cultivated land.

Social Risk

Ethiopia like India is a country with a history of colonialism and slavery. It suffers severe yearly droughts and famines. The use of the country’s arable and fertile land resources by foreign operators has a historical stigma attached to it.

Although the iron-fisted central government provides the Arab, Chinese and Indian agricultural operators with tax and other incentives – much of this land is used to grow high-margin cash crops such as roses, cotton and sugarcane instead of much needed but lower-margin food crops such as rice and maize.

This has ugly parallels with how the British East India Company forced Indian farmers to cultivate Indigo and Cotton for export to the United Kingdom during times of famine. Similarly, a lot of these commercial, foreign owned farms export the produce only to their local countries. This has the potential to spillover into protest and possible eviction of the foreign operators.

Project Execution Risk

In greenfield projects for industrial farming, a first mover like Karuturi had to learn from its mistakes and develop the nascent commercial farming market. Ethiopia suffers from poor road and public infrastructure. KGL bore the investment expenses of making 30,000 hectares ready for industrial cultivation and buying large farm equipment like John Deere tractors. The risk of expenses spiralling out of control in this business is very real as margins are thin and one bad rainy season can wipe out cash flows. As of today, Karuturi Global has 700 crore of debt on its books against a market cap of 200 crore, and an enterprise value of 900 crores.

KGL acquired too much land, too fast, then the government cancelled it’s land lease in Gambella, leaving it with reduced sources of revenues but huge debt on its books to service.

Once the feature of a London Business School case study, KGL trades today as a penny stock on the bourses. It’s safe to call curtains on the KGL story unless it is subject to some miraculous turnaround.

Future of Industrial Farming in Ethiopia

An investor should learn from the past but always look towards triggers for future growth. Ethiopia inspite of the many risks is on the cusp of becoming the food basket for Africa and a prominent exporter of agri-products to the rest of the world.

Nile River Dam and Improving Irrigation: Although only a small fraction of land is cultivated today over 50% of Ethiopia’s land is arable. One reason for this underutilization is the country’s reliance on seasonal rains for crop growth. Ethiopia however is nearing completion of the Grand Ethiopian Renaissance Dam on the Blue Nile river with its border with Egypt. The dam will help convert large sections of the arable land which are not currently under cultivation into farms for growing much needed food crops.

Trading of Agricultural Products: There is huge potential for matching demand and supply of food and cash crops with India through trading in agricultural products and opportunistic sowing of crops. One example is soyabeans and other oil seeds which are in short supply for India, as the country imports more than half of its cooking oil as I wrote about here. Growing maize and pulses is much cheaper in Ethiopia due to high land rents in India and importing them into India will therefore be hugely profitable. In the other direction – cash crops grown in India can be imported opportunistically into Ethiopia to match increasing demand of the large domestic population.

Conclusion

In summation I feel that the risk-reward ratio of industrial farming in Ethiopia is favorable and there is a strong trend in favor of the country’s emergence as a prominent global food supplier. Investors should look into this trend for its potential to create wealth.

India based companies into farming and trading of agri-products (Chaman Lal Setia etc.) have been re-rated by the stock market in 2016. With last year’s Ethiopian drought fading in memory, and in view of their relative and emerging advantages, it only makes sense that the market re-rates Africa based agriculture companies with healthy balance sheets in 2017.

Edit: As of 6/2/2017, Karuturi Global is de-levering it’s balance sheet via Debt to Equity swaps. The main farms of KGL in Africa remain unoperational.

DISCLAIMER:

I do not own any stocks of the companies mentioned in this blog post. I am not registered with SEBI under SEBI (Research Analysts) Regulations, 2014. As per the clarifications provided by SEBI: “Any person who makes recommendation or offers an opinion concerning securities or public offers only through public media is not required to obtain registration as research analyst under RA Regulations”. No BUY/SELL/HOLD advice is offered on this blog, in any form whatsoever. Views expressed are my own and not of my employer. Stock Markets are very risky and can cause a permanent loss of capital. You should seek professional advice.

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