Sunday, December 23

Week 77 - Low-risk Stocks in Food-related Companies

Situation: Currently, the stock market is overpriced according to the indicator with the greatest predictive value: The 10-yr cyclically adjusted price-earnings ratio (CAPE). It presently stands at 21.86, whereas CAPE has averaged 16 over the past 130 yrs. Partly this elevation is due to the Federal Reserve feeding $2 Trillion into the economy over the past 4 yrs. The Federal Reserve has just announced it will keep doing so at the rate of $85 Billion per month, i.e., purchasing $40 Billion in mortgage-backed securities and $45 Billion in US Treasury Notes (see Week 76 for a discussion of Financial Repression). That money gives banks and other corporations the ability to obtain cash at ~zero cost relative to the rate of inflation. However, that cash cannot be converted into loans/jobs/factories until the economy recovers enough to justify such investment. The result? Stock prices go up but earnings barely increase at all.

The other reason stock prices are going up faster than earnings is that sentiment has improved. Traders think the economy will gradually regain its full strength. Remember that stocks are priced to reflect expected corporate earnings 6 to 9 months from now. Under the current circumstances, what should you do? When all asset classes are overpriced because of Financial Repression, the best plan is to invest more in companies that will benefit from shortages in supplies when demand finally increases. The most critical looming shortages look to be food-related, given that per-capita food production hasn’t kept up with demand for more than 10 yrs. Grain yields have reached a plateau worldwide but a larger percentage of grain is going for animal feed and automobile fuel every day. Meanwhile, world population grows by 220,000 every day (Brown, Lester R.: Full Planet, Empty Plates, Norton, New York, 2012, 144 pp).

Our mission is to find food-related stocks that won’t follow the roller-coaster of grain prices but will reflect the coming ~5%/yr growth in grocery store prices. Here at ITR, we have come to define such “low-risk” stocks (see Week 76) as those having:
   a) dividend yield at least as great as the 15-yr moving average for the dividend yield of the S&P 500 Index (1.8%);
   b) annual dividend growth over the past 5 yrs of at least 6%/yr;
   c) price loss during the 18-month Lehman Panic (10/07 to 4/09) of no more than 30% (vs. 46% for the S&P 500 Index);
   d) 5-yr Beta of less than 0.65, meaning the stock price goes down less than 65% as far as the S&P 500 Index in a bear market;
   e) less than 50% of total capitalization is from long-term loans;
   f) dividends have been raised for at least 10 consecutive yrs.

We have come up with 10 stocks by using those metrics (Table). Only 6 are food & beverage production per se (HRL, LANC, MKC, SJM, PEP, KO) but the other 4 play important supporting roles: McDonald’s (MCD), Wal*Mart (WMT), CH Robinson (CHRW, the leading worldwide distributor of fresh vegetables labeled The Fresh 1), and Aqua America (WTR, the largest regulated North American water utility).

Bottom Line: Look at looming shortages. Oil was the #1 looming shortage until drillers in the US started using advanced technologies from Schlumberger (SLB) to drill horizontally and break up oil-containing rock formations by injecting a sand slurry under high pressure (hydrofracking). Now food is the #1 looming shortage, due to a water shortage that compounds a host of other shortages (tillable land, fertilizer, modern agricultural infrastructure, crop protection chemicals, drought-resistant seeds, affordable energy). To make matters worse, there are 3 billion more people having the wherewithal to buy meat, milk and eggs for their families than there were 20 yrs ago. However, animal protein requires 4 times as much grain to produce than does the simple consumption of that same grain for human nourishment (instead of using it for animal feed). Finally, over 10% of corn and sugar cane production worldwide is now being diverted from food supplies for use as automobile fuel. You can see that problems abound with food production. There are solutions for each problem but those will require time to phase in, and full support of a new generation of politicians who see fit to appropriate the necessary resources.

Risk Rating: 3.

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