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Dear Partners & Friends,
We are glad to report that in 2022, our portfolio appreciated to 1.20x Net MoM ($120 per $100 invested). For the portfolio we have owned longer than a year (making a year-over-year comparison possible), we estimate portfolio value of 1.24x, 9% appreciation vs. a year prior.
We benchmark ourselves against other professional ag investors, best quantified by NCREIF’s farmland indices, on returns since our inception. We continued to outperform our closest benchmark, NCREIF’s ~$5B Pacific West Permanent Crop index, 1.24x (Gold Leaf) vs. 1.06x (NCREIF), as well as NCREIF’s All US Farmland index (1.24x vs. 1.18x).
With inflation and interest rates rising, 2022 was a tough year for most asset classes. The S&P 500 was down 19%, and US Treasuries had their worst year since 1788 (not a typo). Few assets held their value, though some traditional safe havens, like gold, ended the year flat or up. Cautious investors may be drawn to safe havens in years like 2022. The problem is, these assets don’t typically perform well long-term. Over the last 10 years, the S&P is up 2.7x. Gold is basically flat.
Farmland offers something of a paradox - relative stability and attractive long-term performance. Our farms illustrate this to some degree, as they held their value despite our own 2022 challenges (particularly, continued low almond price - more on that below). But our valuations above are only estimates, and only cover a short period. So let me turn to the USDA’s numbers.
Since 1950, both US farmland and the S&P 500 have returned 12% annualized. But US farmland has only had one period of negative returns, while the S&P 500 has had 13. Investing in farms is like backing the tortoise over the hare - you will not get quick, high-octane results, but farmland makes up for it with steady long-term performance.
We are designing Gold Leaf to capture and ultimately deliver to all of you farmland’s somewhat paradoxical, yet desirable, combination - low risk and attractive returns. As we continued building our business in 2022, we found ourselves navigating two other paradoxes.
The first is referenced above. We are operating in a challenging almond environment, and have been for the bulk of our company’s short existence. At the same time, we are convinced we’re onto something. The opportunity in agriculture is substantial. In our specialty crop niche, there is very little competition despite decades of high returns for growers. We are hard at work building a company that can seize ag’s abundant opportunity on your behalf.
A second paradox is the idea of both centralizing and decentralizing certain aspects of our business. We are decentralizing our operations, to put decisions in the hands of the people best positioned to make them - our stellar team. At the same time, we have proposed a new structure that would merge our 24 single-farm SPVs into 3 diversified companies. We believe this will ultimately lead to both increased returns and lower risk.
I will try here to explain our thinking on each paradox and the actions we’re taking as a result.
Short-term Challenges - The Last 3 Years
We are operating in what I estimate is the worst market for almond growers since at least the early 2000s. Price has been very low for 3 years, we have just been through 3 years of drought (though recent rainfall will likely mean plenty of water in 2023), costs are up with inflation, and now interest rates have risen too. Most almond growers have made double-digit returns for the last 3 decades, but the last 3 years have been so tough many farmers are hanging up the cleats. Driven by rip-outs and lack of new plantings, almond acreage actually shrunk in 2022, the first decline in 25+ years.
We estimate at least 75% of almond growers lost money on the 2020, 2021 and 2022 crops. Thankfully our farms generally enjoy low cost structures, allowing distributions at most mature farms, and we are well capitalized to operate through this cyclical low. But when will this end? We don’t know. What we do know is that after a humongous 2020 crop (3.2B pounds), the 2021 crop was smaller (2.9B) and 2022 smaller still (2.5-2.6B). We are confident that eventually, increased demand and smaller supply will cause price to rise. As they say, the only cure for low prices is low prices.
(One reminder - our portfolio today is 53% immature and 21% converting to organic. Of the 26% that remains, the lion’s share is conventional almonds exposed to today’s tough market. But as our farms age and convert, cash flow will be less reliant on almonds alone. Thankfully, organic pricing is continuing to enjoy healthy premiums vs. conventional. And pistachios have had a good run the last few years - price has been at or above our underwriting, and pistachio farm valuations have increased. Of course, we know organic, pistachios and all ag markets will have their own highs and lows. We don’t know when, but we do know they’ll occur.)
We don’t attempt to predict commodity price, next month’s weather, or next year’s interest rates. Rather than try to predict the unpredictable, we prepare. We focus our time and energy building our business to weather anything. Over the years, we have tried to seize every opportunity to strengthen Gold Leaf and lower your investment risk - by buying excellent water, using less leverage, and building an in-house farming team. As I’ll discuss, we think our proposed new structure is the next major step in this direction. Going from individual farms to a large, diversified portfolio will certainly lower our risk - reducing challenges like low price or bad weather into more minor speed bumps.
Long-term Opportunity - The 30 Year View
Though the almond market has been terrible for 3 of our company’s 5 years of existence, we are more excited than ever about the opportunity in front of us for two reasons. Farmland, especially farmland growing specialty crops like ours, has produced attractive returns for many decades. And, given ag’s difficulty to access, we face very little competition in our search for great farms.
I like Charlie Munger’s reminder to investors: “the first rule of fishing is fish where the fish are. The second rule of fishing is don’t forget rule number one.”
So how’s the pond we’re fishing in? If all we manage to do right is pick the pond (almonds in this example), but are otherwise average fishermen (farmers), how would it work out?
To answer this question, we looked at what totally average almond growers did over the last 30 years, since 1991. These hypothetical average Joes bought their farms at a county average price, held it for a decade plus, and eventually sold for county average, too. During the decades they farmed “average” orchards, results were just average - industry average yields and price, per the USDA, and industry average costs, per UC Davis.
These “totally average” farmers’ results are surprisingly good - 10-20%+ average cash-on-cash, 10-20%+ IRR, and4-13x multiples over decades. The results hold over any long-term period (10,15, 20, 25 or 30 years) - see below.
Of course, we have been operating in a low almond price environment for the majority of our company’s existence. We did not throw off 20% cash-on-cash in 2022. But this average grower farmed through lows too. By holding for the long haul, even his “average” performance added up to pretty attractive results. If we set out to do the same - invest and farm for the long run - we will balance out the current price lows with great years, too.
I get especially excited about this analysis because of the moment we’re in today. Yes, it has been a hard operating environment for the last 3 years. But, the last time growers had it this tough was in the early 2000s. Returns over 20 years, from 2001 to 2021, are especially good. If we can operate through a few bad years, there are real benefits of buying in at the low and then holding for the long haul.
So - I think we’re fishing in a damn good pond. And looking around, I don’t see much competition. As we often discuss, there is about $3T of farmland in the US and only $30-60B of institutional capital set aside to invest in it. Compare that to my prior life in private equity. On the last deal I closed in PE, we “won” the auction over 100 other firms (yikes). Given the choice of investing in a market where assets to bidders is 100 to 1 or 1 per 100, I’d rather take 100 to 1.
The above “average” results are just that, average. They include no selection of good farms with good water, no organic conversions, no yield improvement, and no cost savings - again, they are totally average. If you ask me, our 80+ person team will run circles around “average.”
We believe concentrating talent is a recipe for success, especially in a noncompetitive industry. We want to build the Yankees, then go play the Modesto Nuts (yes, a real Single A team).
Our business is not labor-intensive, so we can and do invest a lot in our people. This draws in a lot of talent - who we then put through the ringer. Every single Gold Leaf employee completes a “work sample” before they are hired - a difficult 10+ hour test to see if they have the expertise, intelligence, and work ethic to earn a spot on our team. This year, one of our 3rd party headhunters complained because the work sample made it hard to complete the hire. “And by the way” they whined, “no other farmers do them.” Little did they know their “other farmers” argument had the opposite effect. We relish a good opportunity to act differently from our competition. (I doubt the Yankees are OK with “average” scouting.) So we doubled down - the poor next batch of candidates got an even harder test.
All this effort and investment has led to a fantastic team. Our people are hard working, knowledgeable, and humble. Take Armando Galvan, who is borderline famous on the westside of Fresno County after successfully running several operations the size of Gold Leaf. He is skilled enough to positively impact not only his farms but our ops from Sacramento down to Arizona, yet modest enough to work for a newcomer to ag like me and embrace and improve on organic, farmworker pay and our other “unconventional” approaches to farming.
Most of all, our team acts like owners. (They do this naturally, but also because they really are owners - we grant every member of our team a stake in their farms, alongside you.) Some of you know McCarthy family vacations often include farm visits. Two of my three kids have driven to Kingman, AZ as newborns (the 3rd is 15 months - I think we are due for a road trip!). A couple years ago, we drove down I-5 overnight, came across the desert in the early morning, and pulled into our ranch around 6 am Saturday. Within 60 seconds of passing through the gate, a pickup was racing towards me kicking up a dust cloud. Before I had a chance to waive him down, our Senior Foreman Jerry Griffin hockey stopped next to our Subaru “can I help you folks with anything?!?” I have no idea what Jerry was doing monitoring the front gate at 6 am Saturday, but I am sure glad to know he is guard dogging the farm at all hours. After all, that’s what he’d do if it was his personal orchard.
Navigating the Short-term and Preparing for the Long-term
So net/net. We are operating through a challenging moment in almonds, but at the end of the day we think we’re fishing in the right pond. Even an average grower earned healthy returns over the last 30 years, and we don’t see why the next 30 years won’t be equal or better. We face very little competition. And, we have assembled an anything-but-average team.
Decentralizing Everywhere We Can
Sam Walton described his approach to Walmart as “the bigger we get, the more essential it is to think small. One store at a time - no different from our first store in Rogers, AR.” He pointed to two stores in Panama City, FL. One was near the beach, where vacationers shopped, and the other was near the year-round houses. If they had let corporate stock the shelves, the store for locals would have had a bunch of squirt guns and beach towels gathering dust. Instead, the buyers at HQ were instructed to work FOR the in-store merchants and hear what they needed.
Our approach is similar. In our view, a few aspects of our business make sense to centralize, but most things should be DE-centralized. Why? We believe results will be best if we push responsibility to the people who know the farms best - our Asset Managers and Farm Managers. We want to centralize what is helpful. When we tell them they can save money by bulk purchasing fertilizer, they love it. But if we told them to follow an irrigation plan designed in San Francisco, they’d be pissed. It is our job at headquarters to make AMs’ and FMs’ lives easier. Otherwise we should stay the hell out of the way.
But - Centralizing Where It Helps
We have an A+ team, most with the majority of their net worth invested alongside you in their farms - so we feel pretty good about decentralizing authority to the people closest to the action.
For certain things, though, like deciding on investments or managing risk - we should do it centrally. This year, we are proposing a new structure where our 24 farm SPVs would merge into 3 companies. Why is this one of the few aspects of Gold Leaf to centralize? We believe it will unlock our ability to drive returns higher and risk lower. Let me share an example of each.
Higher Returns
Supplying our trees with fertilizer is perhaps ~15% of our total cost structure. Every year, as our company has grown, we go to market with a bigger and bigger purchase order and negotiate tooth and nail to drive the cost down. On this year’s compost order, Brandon, Jackie and Kaitlin saved 21% from initial bids to final price, about $600K in aggregate savings. This flows directly to the bottom line as incremental return to investors.
Interestingly, the biggest item in our budgets, about ~20% of total, is also highly commoditized. You can get it anywhere, it costs nothing to ship, and is nearly identical no matter who sells it. But - rather than use our size to buy it in bulk, we currently opt to purchase it separately, in 24 small orders. This costs us perhaps a million dollars annually and as we scale, the costs will grow. You are probably thinking - what in the hell are these guys doing??
This line item is debt. In our current structure, every loan is held separately against only one farm, of course to wall off the risk to only the investors in that deal. But that is costly. In our new structure, we estimate lenders will charge us 25-50 basis points less in interest, worth $500K - $1M per year at our current size. As we grow and add more debt, our savings will increase.
Lower Risk
Big farmers have many advantages over mom-and-pops. In our case, we can recruit top talent, save money operating at scale, and access capital from investors like you.
One advantage most large farmers have is their diversified operations. Small farmers have one farm in one location growing one crop. Gold Leaf, now a top ~25 farmer in our crops, currently has 24 farms, spread across 10 water districts and at least as many microclimates, in 3 crops (and 15 varieties of those crops). A cold snap in a certain spot, like we had this year at a few farms, can cause devastation for small farmers. Large farmers shake it off, because elsewhere in a diversified operation good luck offsets the bad.
While we are a large farmer in acreage, we are structured as a small farmer. We cannot “shake off” bad weather at one specific location, because we need each of our 24 farms to stand on its own. As I shared in our last quarterly Zoom, two of our very strong long-term farms - GLF3 and GLF13 - had very different years. We were unlucky at GLF3, where we had frost and essentially zero crop, but lucky at GLF13, where we had record high yields. If aggregated, GLF3’s frost and GLF13’s windfall offset. But not in our current structure. Our deal-by-deal setup forfeits our “big farmer” advantage. We are in effect opting for our company, and each of you, to be as exposed to weather and beholden to luck as a mom-and-pop.
As we get bigger, we will continue to operate small, driving performance farm-by-farm. At the same time, we believe the new structure would allow us to seize the big farmer advantages we’re due - lower risk and higher returns. Beyond these core benefits, we think investors will enjoy other perks - simplified reporting, fees assessed on overall performance (not farm-by-farm), less likelihood of manager vs. investor conflicts, etc. The new structure will benefit us as manager, too. It will be easier to oversee 3 balance sheets vs. 24 and to prepare fewer tax returns. Any savings of time, money and mindshare that accrue to us we hope will allow us to do a better job achieving our end goal - low risk and attractive long-term returns.
It is not common knowledge, but Sam Walton once faced a similar centralize vs. decentralize decision. Walmart started out as single-store partnerships. For its first ~10 years, they invested with a group of 78 partners into 32 separate store-by-store deals, and managed the business that way. Eventually, they realized it would work a whole lot better to merge them all together as one company, but keep store-by-store operations. So they did, in 1970. Rob Walton later reflected on their rollup transaction “as far as I know, everybody’s happy today with the way it worked out.” I bet.
As I write this letter, orchards are still dormant. But this time of year, the best farmers are hard at work repairing equipment, testing irrigation, and preparing for whatever the season might bring.
That’s how we run Gold Leaf, too. We are busy preparing for the season ahead and the years to come. We are hiring the best in the business and empowering them to drive results. We are focused on farm-by-farm execution, buying great farms with great water and operating them well. And we are strengthening the business each year - in 2023, by simplifying our investment structure to lower risk and seize other benefits for investors.
Great farmers prepare because they know months later it’ll earn them a profitable crop. We prepare for similar reasons. We don’t know if 3+ years of low almond price will tee up a once per 10-20 year fantastic buy window - but if it does, we will make damn sure we’re ready. By preparing today, we’ll be positioned to capture the opportunity in ag - and to pass farmland’s low risk and attractive returns on to all of you.
The entire team and I are appreciative of your 5+ years of partnership and support. As always, don’t hesitate to reach out if you have any questions, suggestions or just to say hi.
All the best,
Jack McCarthy
Co-Founder & CEO
