Sunday, June 24

Week 364 - Ethanol Producers

Situation: “Market research analysts at Technavio have predicted that the global bio-fuels market will grow steadily at a CAGR of almost 6% by 2020”. But arguments against blending ethanol with gasoline are building. In 2016, 15.2 billion gallons were produced at 214 plants, with Archer Daniels Midland (ADM), Valero Energy (VLO) and Green Plains Renewable Energy (GPRE) being the main publicly-traded producers. For example, those 3 companies operate 4 ethanol plants in Nebraska that together produced 2.2 billion gallons, representing 31% of the state’s crop. Not only is fuel a big business for the agriculture sector, but the by-product (“distillers grains”) is a rich source of animal feed. For every ton of ethanol produced, there are 0.24 tons of distillers grains

You need to think of ethanol plants as a permanent feature of the Corn Belt, i.e., the 11 states of the Upper Midwest. Government subsidies for ethanol plants in Europe and the United States aren’t going away, for two important reasons. Ethanol is a renewable fuel, and adding it to gasoline makes tailpipe emissions less damaging to the atmosphere. Furthermore, ethanol plants represent the only stable market for the dominant farm product of those 11 states (North Dakota, South Dakota, Nebraska, Kansas, Minnesota, Iowa, Missouri, Wisconsin, Illinois, Indiana, and Ohio). But, before you buy shares in one of the 6 companies we highlight here, you need to understand a number of factors that impact the feedstocks and ultimate markets served by those plants. Start by reading this summary prepared for Green Plains (GPRE) investors.

Mission: Analyze the 6 publicly-traded US companies in the ethanol business, using our Standard Spreadsheet.

Execution: see Table.

Administration: Ethanol plants have changed the lives of farmers in the Corn Belt from being a speculator to being a professional businessman. Iowa, the state that produces the most corn, almost exclusively grows #2 field corn  destined for ethanol plants. 20% of that corn becomes “distillers grains”, and dry distillers grains are shelf-stable and greatly valued as animal feed all over the world. So, that’s a stable and global market. And, ethanol is increasingly being shipped out of the US, either separately or blended with gasoline. For example, China recently adopted the same 10% ethanol content requirement for gasoline that the US has been using. That is seen as an export opportunity for US ethanol plants.

Bottom Line: Corn Belt = ethanol plants. That’s the equation you need to remember. It’s all based on #2 field corn. The #1 sweet corn that we like to eat is rarely grown in the Corn Belt. A state outside the Corn Belt (Washington) is the leading producer. But it’s only been 11 years since the Bush Administration pushed Congress to blend 10% ethanol with gasoline. Yes, hundreds of ethanol plants were built as a result but the economics of running those plants is only now being sorted out. If you invest in any those, you’re a speculator by definition. 

Addendum: Here’s the definition of a red line for “speculation” given in the May 28, 2018 Bloomberg Businessweek on page 8: “...a conservative threshold for volatility, typically lower than that of the broader market for relevant assets…” Column M in all of our tables lists the 16-year volatility of each company (with the required trading record) and highlights in red those that have a greater volatility than the Dow Jones Industrial Average (DIA). Of the 6 companies in this week’s Table, even Archer Daniels Midland (ADM), the longest-established (and highest rated by S&P) company, has a volatility well above that of DIA.

Risk Rating: 8 (where US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10) 

Full Disclosure: I dollar-average into Archer Daniels Midland (ADM), which is a member of “The 2 and 8 Club” (Extended Version; see Week 362).

"The 2 and 8 Club" (CR) 2018 Invest Tune All rights reserved.

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Sunday, June 17

Week 363 - Big Pharma

Situation: There are 11 pharmaceutical companies in the S&P 100 Index, with an average market capitalization of ~$130 Billion. Stocks issued by healthcare companies (including  hospital chains, pharmacy benefit managers, medical insurance vendors, and drugstores) are thought to be defensive “risk-off” bets, like stocks issued by utility, communication services, or consumer staples companies. But they’re not. Healthcare consumes almost 20% of GDP but it is a highly fragmented industry, rife with government interference seeking full control. Medical innovation for the entire planet has to take place in the United States because the healthcare industry is socialized elsewhere and large amounts of private capital are needed to conduct clinical trials. That innovation makes US healthcare into an ongoing research enterprise. For biotechnology companies, there is an ever-present risk of being eclipsed by another company’s research team. Stockpickers who have some appreciation for biochemistry can perhaps identify biotechnology groups that are onto a good thing. But Big Pharma companies survive by looking to buy those same startups. Can you really scope-out a “good thing” better than their scientists?

Mission: Run our Standard Spreadsheet for the 11 pharmaceutical companies in the S&P 100 Index.

Execution: see Table.

Bottom Line: This is not a game for the retail investor. All she can do is buy stock in one or two of the 11 “Big Pharma” companies, and hope that its CEO can find small biotechnology groups conducting breakthrough science, then buy at least one a year to throw money at. That’s an iffy business. Why? Because large-scale clinical studies (costing hundreds of million dollars) have to be conducted before the bet pays off. Usually it doesn’t. If you’re a stock-picker new to this industry, start by researching the old standbys that reliably pay good dividends: Johnson & Johnson (JNJ), Merck (MRK), Pfizer (PFE) and Eli Lilly (LLY). 

Risk Rating: 7 (where US Treasury Notes = 1, S&P 500 Index = 5, gold bullion = 10)

Full Disclosure: I dollar-average into JNJ and also own shares of ABT.

"The 2 and 8 Club" (CR) 2018 Invest Tune All rights reserved.

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