Input Capital Corp: The Ag Streaming Cash Cow
The Company - Input Capital Corp (TSX.V:INP) (INPCF)
Source: Input Capital Corp
History
Input Capital Corp's beginnings go back to 2005 when Doug Emsley and Brad Farquhar started Canada's first farmland fund, Assiniboia Farmland LP. They raised $3 million to start buying farmland and continued to do so over the next decade. They sold the farmland fund to the Canada Pension Plan in 2014 for $128 million. The fund returned 19.8% on an annualized basis over 8 years, net of fees.
As time progressed, because of their close relationship with many farm tenants they were able to get a glimpse of the farming world, how farmers operated, how they made decisions and how they responded to various external forces.
In 2008 oil hit the peak of $148 a barrel and commodity prices spiked upwards. Wheat hit a record price and Canola, which many farmers grew, hit a record price as well. They thought the farmers would be excited, but this was not the case. The farmers were gloomy. They were gloomy because it wasn't just the price of canola that was up, but also the price of fertilizer, fuel and many other inputs that were reaching record highs. So there hadn't been a significant improvement in farming margins.
Many of the farmers were cutting back on fertilizer in order to control their costs. This attempt to reduce costs was coming at the expense of the yields of the crop. It got Brad and Doug wondering if there was a way that they, as guys who knew how to raise capital in the markets, could help fund the additional fertilizer requirements and receive a share of the improved yield in return. This was the initial spark of an idea that would grow into Input Capital Corp.
They had been to various agricultural conferences around the world and seen for themselves how companies were attempting to get involved in agriculture by buying up land, tractors, etc and farming, but they never liked the corporate farming model, so they took a smattering of ideas and put together a fund called Input Capital LP.
Farmland investors were approaching the fund looking to get more exposure to agriculture by stepping past the safe-haven of agricultural land, a little bit more risk for a little bit more reward. So, Input Capital went to the investors and pitched the opportunity to joint venture or find an arrangement that would work for farmers where Input Capital would fund the inputs like fertilizer and in return, they would get a portion of the crop which they can then sell.
Over a couple of years Input raised around $7 million to do pilot testing on their idea. The company liaised with farmers and asked for feedback so they could see what worked and what didn't. They continued this pilot for 3 years, testing out different contracting methods and types of relationships with farmers and this provided Input's management with the pro's and con's of their ideas.
So it's now around 2012 and Brad had purchased shares in Silver Wheaton (SLW:NYSE) as he was a fan of precious metals and he liked their non operating business model. It occurred to him several months later that what they were trying to do at Input Capital was very similar to what they were doing at Silver Wheaton.
Silver Wheaton was funding producers who needed capital and in exchange, they were getting a portion of production that came out of the mine and making a smaller payment on delivery. Basically, buying the right to buy a deeply discounted commodity as it is produced off into the future. This was so close to what Input Capital LP was trying to do, Brad wondered if the model could be adapted for agriculture.
What he saw in the streaming companies were companies with no operating exposure and lots of commodity upside, high cash-flow margins and they traded at good multiples to their cash-flow in the public market. Brad talked with the other members of management and proposed the idea of becoming a streaming company. Turn what they are trying to do with farmers into a streaming contract. They spent a few months modelling it out and the more they thought it out, the more they thought it could work.
In the fall of 2012, they launched Input Capital Corp. They raised $25 million in a private placement, primarily from existing farmland investors. Their business plan was pretty simple.
They conveyed to investors that they had been pilot testing the various models for 3 years so they understood the agricultural issues and the streaming model had been proven to work for years in the mining sector. They were confident they could make it work within agriculture.
The plan was to deploy investor funds into deals with farmers over 12 to 18 months and then take the company public so they could raise more capital to keep growing the business and work toward attracting the market multiples available to streaming and royalty companies.
The deployment of capital was completed a lot sooner than expected and they had achieved their goal within 4 months instead of 18 months. Management then decided that it was the right time for them to get on a path to going public. Input Capital Corp went public 9 months after the first round of financing in July 2013.
The People
The single most important factor to consider before purchasing ownership in a company is the quality of the management that are running the show. As I detailed in the beginning of Input Capital's history, Brad and Doug were the founders of Assiniboia Farmland, a Canadian farmland fund that was grown from $3 million and sold for $128 million giving investors an annualized return of nearly 20%. This is an amazing achievement in any sector, let alone agriculture.
I haven't yet had the pleasure of speaking with Doug, but I know Brad is a fellow contrarian and entrepreneur. He's the sort of person that I like to put my money behind.
Doug Emsley, Co Founder, Chairman, President and CEO
- Co-Founder and President of Assiniboia Capital and Palliser Farmland Management Corp.
- President of Emsley & Associates (2002) Inc., Chairman of Security Resource Group Inc. and Sabre West Oil & Gas Ltd.
- Former Board Member – Bank of Canada, Royal Utilities Income Fund.
Brad Farquhar, Co Founder, Director, Executive VP and CFO
- Co-Founder, Vice-President & CFO of Assiniboia Capital and Palliser Farmland Management and President of Nomad Capital Corp.
- Advisory Board, AgFunder.com
- Director of Mongolia Growth Group Ltd. (TSXV: YAK), Greenfield Carbon Offsetters Inc., and SIM Canada
- Member of the Saskatchewan Chamber of Commerce Investment & Growth Committee.
Gord Nystuen, Co Founder, VP Market Development
- Former Deputy Minister of Agriculture and Chairman of Saskatchewan Crop Insurance Corporation.
- Former Chief of Staff to the Premier of Saskatchewan.
- Previously served as VP of Corporate Affairs at SaskPower.
- Partner, Golden Acres Seed Farm.
David H Laidley, FCPA, FCA, Independent Director
- Counsel, Davies Ward Phillips & Vineberg LLP
- Chairman Emeritus, Deloitte LLP (Canada).
- Former Lead Director, Bank of Canada.
- Chairman, CT REIT.
- Director, Aimia Inc., EMCOR Group Inc., Aviva Canada Inc.
Dr Lorne Hepworth, Independent Director
- Board of Advisors, Assiniboia Farmland Holdings LP.
- Member, Canadian International Food Security Research Fund Scientific Advisory Committee.
- Member of the Canadian Agriculture Hall of Fame.
- Past President of CropLife Canada and Former Saskatchewan Minister of Agriculture, Finance, Education, and Energy & Mines.
David A Brown, QC, Independent Director
- Former Chairman & CEO, Ontario Securities Commission (OSC).
- Former Chair, Board of Directors, Canadian Employment Insurance Financing Board.
- Director & Member, Funds Advisory Board, Invesco Trimark Group of mutual funds.
- Director, Canada Health Infoway.
John Budreski, Special Advisor
- CEO, Morien Resources.
- Executive Chairman, EnWave Corp.
- Director, Alaris Royalty Corp., Sandstorm Gold Ltd.
- Former Vice-Chairman, Cormark Securities, President & CEO of Orion Securities Inc., and Head of Investment Banking, Scotia Capital Inc.
Agricultural Streaming
Source: Input Capital Corp
The ag-streaming graphic needs no explanation, it's a very simple process. The farmers get the upfront cash that they need to purchase inputs like fertilizer in the off season when the biggest discounts are to be found (up to 40% off). Being able to purchase in cash means they also avoid the interest costs on any debt that would normally have been taken on for purchases. Under the terms of the streaming contract, they also pledge to hire an agronomist or agrologist to help them improve the efficiency of the farm, generating a higher yield.
Sometimes getting farmers to change their "tried and true" methods can be a challenge, particularly if it might cost more. Part of Input's pitch is that Input's money can fund the additional costs, and that if the plan is implemented properly, the farmers will get higher yields and make more money than if they hadn't entered into the streaming contract with the company in the first place.
The Commodity - Canola
Source: Input Capital Corp
Canadian Canola contributes $19.3 billion to the Canadian economy each year, including 250,000 jobs and $12.5 billion in salaries. It is Canada's most valuable crop generating 1/4 of all farm cash receipts. More and more acreage is being devoted to Canola because of the profitability and resilience of the crop.
Canada is for Canola what Saudi Arabia is for oil. 70% of the global export supply comes from Canada. When the country has a bad crop, the Canola price goes up substantially and when there is a bumper crop, the price comes down. When the price does come down, Input is able to make up for the reduced price with increased volume.
Canola is mostly grown in the western provinces of Alberta, Saskatchewan and Manitoba. British Columbia, Ontario and Quebec also grow smaller amounts of the crop. New varieties of Canola are pushing the boundaries of where it can be grown.
Canada exports 90% of its canola as seed, oil or meal to 55 markets around the world. The biggest buyer of Canola oil and meal is the United States, accounting for about 65% of oil exports and 96% of meal exports in 2014. For raw seed, the most important destinations are China, Japan, Mexico and the United States.
Source: Canola Council of Canada
The growing middle class and improving diets in Asia are driving an increase in Canola consumption within the region. Within the USA there is also a trend of improving diets and recently the FDA has announced a ban on trans-fats. This means canola is well positioned to replace soybean oil, peanut oil and other oils that are used heavily in processed foods within the USA. Canola is not widely grown in the USA because the climate is not suited to it, giving Canadian growers an excellent advantage.
Click on picture to enlarge
Source: Input Capital Corp
Agronomically, Canola is a 1 in 3 year rotation crop and Canada has reached the point where over 1/3rd of all the acres that could be seeded with Canola are seeded to Canola every year. So, there's not much room to expand the area that is under cultivation. Increases in yield will need to be achieved through better, but more expensive, agronomic practices. This is where Input Capital makes its mark.
Benefits and uses of Canola
Global demand for Canola continues to increase at a steady rate as people discover the benefits and uses of Canola in its various forms. They include:
The health benefits of Canola
Canola is rich in two fatty acids that are essential to the diet because the body cannot synthesize them:
- Alpha-linolenic Acid (ALA) Essential omega 3 fatty acid. Protects against heart attacks and strokes by lowering cholesterol.
- Linoleic Acid (LE) Essential omega 6 fatty acid. Important for brain development and the growth of infants.
Compared to all other vegetable oils on the market, Canola oil has the lowest levels of fat that are bad for human health. Saturated fats raise the bad cholesterol (LDL) in your body and have been linked to coronary heart disease. Canola oil has the lowest saturated fat level of all vegetable oils.
A high protein source feedstock
Canola meal has a unique protein profile that helps cows produce more milk. In 24 research trials that included Canola meal in cow's diets, milk production increased by a whopping 2.2 pounds per day. This is because Canola meal has more Rumen un-degradable protein (otherwise known as bypass protein). Bypass protein makes it through the Rumen so the cow is able to utilize it at the right time.
Whilst Canola meal might not always beat other crude protein sources for overall crude protein content, more of Canola meal's protein gets turned into milk. When looked at from this perspective, Canola meal protein is used 16% more effectively than Soybean protein.
Using a more efficient feed-source helps dairy farmers produce more milk with less money.
Bio-Diesel
As of July 2012, all diesel fuel sold in Canada must contain 2% bio-diesel. Bio-diesel can be made from a variety of feed-stock, including vegetable oil, animal fats or recycled restaurant grease.
In Canada, it makes sense to make bio-diesel from canola because of the advantages the crop provides over other sources:
- Proven technology and demand
- High oil content
- Superior flow in cold weather
- Oxidative stability
- Quality standards
- Carbon sequestration
Canola bio-diesel is already widely used in Europe, which is expected to produce more than 7.3 billion liters of bio-diesel from vegetable oil in 2012. In the EU, rapeseed and canola are the foundation feed-stock for bio-diesel. Canola produces more oil per unit of seed than other oil-seeds. That means bio-diesel producers realize greater efficiencies from canola than seeds with lower oil contents, notably soybeans. Canola oil has the lowest level of saturated fat. That helps canola bio-diesel perform better in cold weather. Canola bio-diesel has a very low Cloud Point (the temperature at which small crystals form in the fuel).
2015 Crop
The planting season started out dry with an early spring. Some of the early seeded crop got frosted in May and had to be re-seeded. Some areas of Eastern Alberta and Western Saskatchewan had trouble with germination because it was so dry.
Input Capital doesn't have many streams in those areas and so the company was not seriously affected by the dry spring. The forecasted decrease in yield from the affected regions has caused the Canola price to rise. Input will benefit from those higher prices.
The market seems to have been discounting the company because of an assumption of overall bad weather, but this has not been the case.
The company's contracts are predominately weighted to Eastern Saskatchewan and Western Manitoba where conditions have been very good this year. Some farmers have described this year as the best crop they have had in recent times.
Click on picture to enlarge
Source: Input Capital Corp
Inputs contracts are based on a fixed amount of tonnage so for the most part, they don't participate in yield upside or yield downside. A typical canola yield would be 30-35 bushels an acre and the company likes to contract at approximately 10 bushels an acre, giving the company a large margin of safety. The reason for this is even a bad canola crop will produce 15-20 bushels an acre giving the company the assurance that there will be enough physical canola on each of the farms to satisfy the contract the farmer has signed with the company.
Management is pretty confident about the Canola volume. There is a higher price available and the company has been locking in some of that higher price within their contract for the fall Canola sales. That will translate in to some healthy revenue for the company this fall.
Sales Team
In the beginning, Gord Nystuen was the company's face to the farmers. He sold all of the first 20 deals working his contacts and networks. Input now has a substantial sales force spread out regionally around Western Canada and these networks are now being leveraged.
Management also conducts local advertising that helps bring in leads to pass on to the sales team. The company is conducting heavy marketing at the farm trade show circuit. Most Canola farmers have now at least heard of Input Capital, even if they don't understand what the company does or how a streaming contract would work for them.
This is a big change from a year ago and makes marketing a lot easier when there is a warmer relationship as opposed to a cold call with no familiarity of the company.
Management added 3 more sales people in June 2015, bringing the total to 8, and are in the process of interviewing a few more. They are working to establish a good footprint of sales people all across the Canola growing region. As these sales people begin to get traction, they will bring forward a lot of deals earlier than the company has previously experienced.
Strategy
Input Capital's goal is to underwrite contracts in the high teens to 20% IRR range. If the price of canola goes up, they do even better than that. Input has 78 clients right now and there 50,000 canola farmers operating in western Canada alone. So there is a huge opportunity to grow over the next few years.
The company is looking for farmers who can make good use of Input's capital. Roughly half of the farmers in the region would fit into the company's addressable market. So that's around 25,000 farmers who, if given the right pitch, could potentially sign up and make use of the capital available, adding value to their farm.
Click on picture to enlarge
Source: Input Capital Corp
Crop Diversification
Farmers in Manitoba have asked management to look at soybean streaming because they're growing more Soybeans than Canola. As new varieties of the crop come out, they're working their way north and west and up past the Mississippi valley into southern Manitoba and then gradually into Saskatchewan and Alberta. Based on that feedback, the company is examining the opportunity.
Were the company to expand into Soybeans, it would provide them with the advantage of crop diversification along with additional geographic diversification. On the other hand, it could be a distraction from the core commodity which the company knows best.
Part of what the company is pitching to farmers is that there is so much more yield in the canola crop that most farmers are not realizing because they are under-fertilizing and under-feeding their crops. Canola is amazingly responsive to incremental amounts of fertilizer.
If Input can help farmers optimize their working capital, thus optimizing their agronomics, the yield upside potential in Canola exceeds any other crop that is grown in western Canada. This is what gets farmers excited. Not only can they lower their costs for inputs, but they can increase their yield and win both ways. Canola has this feature that management just doesn't see in other crops at this point.
Financing
The first round of financing was at $1.00 per share. Input Capital went public at $1.60 and have since completed two financings at $1.60 and $2.30 per share. So in total, management has raised around $111 million. They've deployed around $90 million into streaming contracts (78 of them) and they're all producing revenue in their very first year.
The company is in the explosive growth stage of the business and because of that, every year is a record year over the previous year, and this year is looking no different. Input has 75,000 tonnes of canola to be sold at an average of $500 a tonne, that's $30-40 million in revenue coming their way in the next 6 months.
That capital will be turned around and deployed into new deals this winter by the sales force. This is where the compound growth effect takes off. Input can grow the business at 25% per year with internally generated cash-flow, without having to tap the market and issue any more shares.
This will be the first year where the company funds investment into new streams almost exclusively with internally generated cash flow. Input Capital is in a favorable position where the only thing that would cause them to return to the market would be greater demand for capital from farmers than the company can provide, a nice problem to have for any business.
The company has around $30 million in cash with another $30 million expected from the crop that is coming off soon, so there will be close to 60 million in deployable capital for this coming winter.
Low Hanging Fruit
Given the seasonality of agriculture and the company's reporting cycle, Input is in a light news period until the first week of January when they will put out a quarterly update on activity in the quarter that runs from October 1st to the end of December.
Due to the early spring, the harvest may be a little early as well. This may enable the company to move more crop by the end of September and they may report that in early October. If there is a way for the company to get an earlier crop harvested and sold, that would generate earlier revenue than the market would expect giving investors a nice surprise.
Inside Ownership
Between management and directors, insiders own 20% fully diluted, 14% basic. A British insurance company, XL Catlin owns 17% of company. With both Insiders and XL Catlin owning nearly 40% of the company, management has a large vested interest in the performance of Input. The remainder of the shareholders are dominated by high net-worth retail investors who purchased many of their shares at $1.00 per share in 2012. As the company has grown, it is attracting significant institutional attention. Management believes institutional ownership to now be about 37%.
Share Structure
A nice, tight share structure. With the cash the company is generating, a dividend or repurchase plan could possibly be expected some time in the future. Obviously for the moment the company is focused on growth through the reinvestment of capital into additional streams.
Click on picture to enlarge
Source: Input Capital Corp
Risk Mitigation
If there was an overall frost and it took the entire canola production down by a few million tonnes, that would result in a stronger Canola price, which the company would benefit from. So in many ways, a mediocre crop is the best outcome for Input because they get the volume and the better price.
The streams are with family operators. There is counter party risk in the sense that if something goes bad on the farm, how will the company get its Canola? Management mitigates a lot of these risks with registered mortgage security on farmland and the company doesn't do streams with farmers who don't have any equity in their land for the company to secure against.
Input has life insurance on many of the farmers. This ensures that if a farmer was to die, life insurance would pay out and the company would be able to end their streaming relationship with that family without having to foreclose on any of their land, so the family can continue their life and the company gets their capital so they can redeploy it elsewhere.
The company requires farmers to take out one of several kinds of crop insurance. The vast majority use Canadian government backed crop insurance, which guarantees 70% of the farmers' historical total crop production. is significantly in excess of the tonnage that is owed to Input so the company's revenues are effectively guaranteed by the government insurance.
- Geographic diversification.
- Streaming contracts call for fixed tonnage and are not yield dependent.
- Crop insurance.
- Life insurance on farmers.
- Agronomist on all farms to improve yield.
- Ability to accept other commodities of equal value in lieu of contract crop.
- Contractual protection on the use of proceeds.
- Strong security covenants embedded into every contract.
Margin of Safety
The company is down significantly from its 52 week high and provides investors with an attractive entry point. I'm buying at this level and will continue to average down if given the opportunity.
Click on picture to enlarge
Summary
Input Capital Corp is blazing a trail as the first agricultural company to implement the profitable streaming business model. The company is led by people who have a track record of success within the agricultural sector and who have most importantly, made investors a lot of money.
This is the third year in a row that Input has expanded upon its capital deployment, from an average of $22M in each of its first two years to $47M in the third year. Despite the Canola price volatility, the company has managed to keep the IRR at its 20% goal.
Input Capital Corp is still in the explosive growth phase, continually adding additional streams and generating increasing revenue as each year goes by. The expansion of the sales force will see that the company is on the lips of every Canola farmer in the region, many of whom will recognize the benefit they will gain by partnering with Input through a streaming contract.
I asked Jason Stevens, Investment Executive with Sprott Global for his thoughts on Input Capital Corp:
"Input Capital demonstrates two of the most important qualities I look for in any investment; (i) A history and pattern of disciplined deployment in high return investments and (ii) extensive opportunities to reinvest free cash flow. In the last year, Input has increased their number of streaming contracts from 20 to 78 and more than doubled the volume of their expected canola deliveries for the coming year. At the same time, they’ve been able to generate close to a 25% return on invested capital. In a market of 50,000 canola farmers, Input’s high-return growth is far from over." - Jason Stevens
For investors who are looking to get exposure to the agricultural sector, Input Capital presents a low risk, cash flow generating, geographically stable investment. The current discounted stock price provides investors with an entry level that is far below the 52 week high, a significant margin of safety.
"Great investment opportunities come around when excellent companies are surrounded by unusual circumstances that cause the stock to be misappraised." - Warren Buffett
Disclosure: I must give credit where credit is due so I would like to thank my good friend and fellow speculator, Adem Tumerkan from Diutinus LLC, for the ...
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