Sunday, November 17

Week 124 - Farm Equipment, Fertilizer and Seed Companies

Situation: You’ll soon tire of reading agricultural blogs that begin by projecting that the world’s population will grow to 9 Billion by 2050. What’s the catch? It’s that improved standards of living imply that there will be a doubling of food production by then. Most of the increase will be in the form of animal protein: meat, poultry, fish, shrimp, milk, and eggs. And we’ll also keep reminding you that it takes 4 pounds of grain to produce a pound of meat but only one pound of grain to produce a pound of shrimp. So, you’ll be seeing more about aquaculture too.

How do we double food production in 35 years? Well, let’s look back to the 60s and 70s when the “green revolution” doubled food production primarily through improvements in farm equipment, fertilizer, herbicides, pesticides, fungicides, and seeds. Improvements in logistics and water use were also important. To double food production yet again, we’ll have to double down on innovation in all of those areas. What’s the kicker? It’s that the price increases, which will arise from the inevitable shortages in raw food commodities, can be counted on to drive such innovation.

As an investor, you’ll want to look at companies that produce and/or market farm equipment, fertilizer, fungicides, herbicides, pesticides, and seeds. You already know that almost any commodity exhibits sharp price fluctuations over time. That is because the price has to rise high enough to justify the large, up-front, fixed costs that are needed to increase the supply of any commodity. This always looks like a worthwhile investment by the time it is made. But competition soon becomes fierce, which leads to a supply glut that drives prices down to the point where almost every producer loses money for awhile (or goes bankrupt). That’s very painful, so the financial backers all swear off making further investments to grow production. That’s why prices will have to rise to high levels before investment starts to increase again. Governments that depend on revenues from commodity producers go through the same whipsaw experience as investors.

This week’s blog focuses on companies that make it possible for farmers and ranchers to increase the production of food commodities. If you understood the preceding paragraph, you’ll know that these companies go through wrenching changes in their stock prices. Farm and ranch land values also depend on raw commodity prices, and fluctuate accordingly. Now you won’t be surprised when you check out this week’s Table. While every entry is a high quality Barron’s 500 stock, as noted in columns G & H of the Table, every entry also has a high 5-yr Beta (Column K in the Table). 

That degree of volatility is unsuitable for retirement portfolios. Monsanto (MON) is the only stock on the list that has both long-term Finance Value (Column E) and short-term Finance Value (Columns G and H), meaning that MON beat the market (VBINX) over the long-term (Column C), incurred lower losses during the Lehman Panic (Column D), and showed increasing sales and cash flows over the most recent 3 yrs (Columns G & H). But its volatility (Column K) and valuation (Column L) are both excessive--and have tended to remain so over the years.

Bottom Line: The “Green Revolution” in agriculture remains dependent on companies that make farm equipment, fertilizer, seeds, herbicides, fungicides, and insecticides. The imprudent use of any of these products will have important negative effects on the environment, which will require further innovation to manage effectively. The stock prices for these companies reflect, in part, how much money farmers made (or lost) at the end of the last growing season by using (or under-using) their products.

Risk Rating: 8

Full Disclosure: I have stock in DD, CAT, MON, and POT.

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