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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 assertion?

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 hectares) of arable land at current land prices of EUR 110 per Dekar, gives a price tag for all the arable land of EUR 4.18 billion. At agricultural land prices, the theoretical market capitalization of the entire country is EUR 12.2 billion or roughly half of the theoretical market capitalization 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 developments 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 efficiency 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);
  • Significant 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-incentives for production of bio-fuel 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
    • Rising demand for production of bio-fuels (ethanol, bio-diesel etc)
  • Reduced land availability, as global population growth and continued urbanization have dramatically cut the agricultural land available per head;
  • Glowbal warming reduces crop yields, but also has kick-started a 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 costin Bulgaria, the significant 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 significantly

Bulgarian crop yields from hectare are significantly 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 favor of the agricultural sector.

Despite the considerably lower yields per hectare, 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 give a significant 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 significant 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 inflationary 1970s. Corn lost 50% of its real purchasing value during the decade and went on under performing inflation to hit a rock-bottom level. By 2006 corn had lost 80% of its value.

Global Grain Stocks: What reserves?

Despite the relatively 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 consumption, 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 many fold increase in the price of soft commodities in the international bourses.

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