VEGI: Remains Undervalued In Spite Of Recent Outperformance

Thomas Barwick

iShares MSCI Global Agriculture Producers ETF (NYSEARCA:VEGIA) is an exchange-traded fund that provides investors with direct exposure to publicly traded companies that produce fertilizers and agricultural chemicals, farm machinery, and packaged foods, and meats. The expense ratio is 0.39%, mostly in line with other sector-specific ETFs offered by iShares, and assets under management are $313 million as of November 9, 2022. That follows positive net fund flows of just under $250 million over the past year (see chart below).

VEGI ETF Net Fund Flows

That is a substantial increase in net assets under management. The fact that equities have broadly fallen this year while VEGI has appreciated is a good indication of the level of funds that have flowed into VEGI’s portfolio, whether through VEGI or more directly into the stocks that VEGI holds. VEGI has a global investment mandate, with 158 holdings as of November 9, 2022. Key country exposures include the United States (61% as of November 9, 2022), Canada (7%), India (4%), Norway (4 %), and Japan (4%).

VEGI ETF Key Country Exposures

My last piece covering VEGI was dated June 9, 2022; at the time, I thought that VEGI was undervalued (a “strong buy”). Since then, the fund has appreciated 2.87% on a price-only basis against the S&P 500 US equity index’s change of -1.61%. In spite of strong “post-pandemic” performance, I thought the fund was still undervalued, with an IRR of 12-16% per annum being possible on the data available at the time (including basic consensus earnings projections).

Some time has passed, and VEGI has out-performed. However, so far the out-performance is modest (just under 5% on a price-only basis), so it makes sense that further out-performance is still possible. It probably helps somewhat also that characteristically VEGI’s portfolio has some heavier-than-average weightings toward defensive sectors.

VEGI Key Sector Exposures

This can help reduce the fund’s beta and thus enable a greater chance of out-performance during bear markets. iShares also offer a short breakdown of sector exposures (see below), describing the sectors as Materials (38% of the fund as of November 9, 2022), Consumer Staples (32%), and Industrials (30%).

VEGI Key Sector Exposures

As of Q4 2022, the global business cycle is largely heading into a contractionary period, and so it makes sense for funds with heavier exposures to defensive sectors to out-perform.

Global Business Cycle Positioning axis of Q4 2022

VEGI seeks to track the performance of its benchmark index, the MSCI ACWI Select Agriculture Producers IMI Index, which as of October 31, 2022, reported trailing and forward price/earnings ratios of 12.16x and 10.57x, respectively. The price/book ratio was 2.38x. That implies a forward return on equity of 22.5%, which is very strong, coupled with a forward earnings yield of 9.46%.

On a weighted basis, I have estimated the risk-free rate as of November 10, 2022, for the VEGI portfolio (weighting 10-year bond yields of each country by VEGI’s exposure to those countries, but rebalanced for cash holdings) of 3.80% . If we then add an equity risk premium of 4.2-5.5%, and a small country risk premium of 25 basis points (this is also following a weighting methodology using country risk premiums provided by Professor Damodaran), I arrive at a cost of equity range or 8.0-9.3%.

Using all the information above, including the fund’s benchmark index’s factsheet for financial data, I arrive at an estimated IRR of about 15%. That is based on underlying earnings power.


Author’s Calculations

The implied ERP of over 11% is high. While the portfolio composition and earnings estimates may have changed modestly, ultimately this is a very similar base IRR to my prior estimate, which makes sense given a minor price change since then. I am also assuming, as before, that the return on equity falls back to a more modest 15%, which is possibly conservative. My model implies three- to five-year average earnings growth of about 8.20-10.50%, against the consensus estimate of just over 11.50%.

You could also argue that, given even a 2% nominal growth rate in earnings in the long run, and a cost of equity of 8.0-9.3% (as estimated above) that the long-term earnings multiple could be the inverse of the cost or equity net of growth or 13.70-16.67x. That makes VEGI significantly undervalued, not just based on earnings growth potential but also the long-term valuation multiple. The current multiple is only 10.57x which I have held constant in the model above.

In summary, I would opt to continue to take a very bullish view on VEGI.

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