Week 246 - Corn Belt Prosperity: Is It Gone?

Situation: The farming counties of the Corn Belt are in a recession due to the collapse in corn price per bushel, but the US economy is still growing. “In the past 50 years, every recession has seen the number of jobs in the economy decline by at least 1%. And jobs have never declined by that much outside of a recession. Today, the number of jobs in the U.S. has been growing briskly—up 292,000 in December and up 2.7 million over the past year. This is why many economists remain confident the U.S. can avoid recession.” That quotation from the Wall Street Journal summarizes the way we measure growth vs. contraction in the economy but jobs are a “lagging” indicator. The country is already on the brink of recession because of the “knock-on” effects of slow growth and high indebtedness in emerging market countries, mainly China. Their plight is made worse by our Federal Reserve’s policy of raising interest rates. The “capital flight” that has been happening in emerging market countries simply gets accelerated as the dollar gets stronger and as interest rates move higher. In other words, investors are pulling money out of emerging markets but those are the very markets where real growth is happening. A third of the revenue for S&P 500 Index companies comes from those countries. Earnings for the S&P 500 Index will fall as those countries head into recessions, triggered in part by our strong dollar. News Flash: almost all of the 45 major stock markets around the world are currently in a Bear Market.

Mission: Drill down on the Corn Belt centered in Illinois, Iowa, southern Minnesota and the eastern half of Nebraska, where 57% of US production occurs. That’s also where almost half of US ethanol plants are located. Cropland in those states has been falling steadily in price/acre for 3 years, and 2015 showed no hint of relief. The average price per acre in those 4 states in 2015 was $6418, which is 2.9% lower than in 2014. For Iowa, where 2015 values were $8200 per acre, prices were down 6.3%. But farm incomes have fallen 55% in the past two years, so it is only a matter of time before cropland values start to reflect that loss in productivity. 

Execution: Let’s see how large AgriBusiness companies based in North America are doing, specifically those that meet our quality standards: Monsanto (MON), Potash (POT), DuPont (DD), Dow Chemical (DOW) and Deere (DE). Looking at this week’s Table, we see that they mirror what’s happening to commodity producers everywhere, namely, too much supply is being generated just when demand is collapsing for a variety of reasons. 

Administration: What you can do, as an investor, is to remember that this is a very rewarding group of 5 stocks to own over 2-3 market cycles (see Column C in the Table). Mostly, you need to avoid taking action. Don’t go out and buy cropland, don’t sell any of these stocks that you already hold, and keep dollar-averaging into those that you do own long-term. The thing about commodity markets is that during bear markets producers either fail or barely survive. Production eventually falls enough that remaining companies have to struggle to catch up with demand (demand that is no longer being satisfied). It will not be difficult to ramp up operations at that point because stocks (and bonds) issued by commodity producers will be snapped up by investors. However, these capital expenditures won’t take effect for a while because so much investment has to be directed at replacing fixed assets and skilled labor lost during the downturn. But production eventually catches up to (and then exceeds) demand. That is why these are called long-cycle investments. Boom-bust-boom turnarounds typically span two or three stock market cycles.

Bottom Line: This commodity supercycle is finished. Most estimates show that global commodity-related production is approximately 150% of demand. Farm commodities are no different. Those produced in the US have to be marketed at too high a price in foreign countries, because of the “strong” dollar. That means farmers in Brazil, Argentina, the Ukraine, Australia and Canada have a competitive advantage over US farmers. The US-based AgriBusiness companies that have worldwide operations will recover faster than US farmers but a difficult decade lies ahead. In rural counties of the Corn Belt, prosperity is unlikely to recover soon.

Risk Rating: 8 (on a scale where gold-related investments are 10 and inflation-protected US Savings Bonds are 1).

Full Disclosure: I dollar-average into MON, and own stock in DD, ADM, and DE.

NOTE: Metrics in the Table are current for the Sunday of publication; metrics highlighted in red denote underperformance vs. VBINX, our key benchmark. Total Returns in Column C of the Table date to 9/1/2000 because that marks the peak of the S&P 500 Index before the “dot.com” recession. There have been two peaks since, in 2007 and 2015, so we’re entering the third market cycle since 2000.

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Week 129 - Crop irrigation equipment

Situation: The “Green Revolution” of the 1970s grew out of innovations in farm equipment, augmented by improvements in tillage techniques, fertilizers, insecticides, herbicides, and seeds (see Week 124). Possibly the most important innovation came soon afterward, when groundwater irrigation (from wells) began to replace surface water irrigation (from canals). That transition grew from the innovation of “center-pivot” sprinklers in the 1950s and 60s. Those sprinklers can water 136 acres (of the 160 acres in a quarter section of land) in a single rotation around the center pivot. That cuts the water requirement for growing corn by over 40%. Now another innovation is gaining acceptance, and that is buried drip irrigation systems which selectively irrigate the root zone and cut water requirements by another 40%.

At present, there are a billion acres of irrigated land worldwide. Nine million of those acres are in Nebraska, which is arguably the most productive region for agriculture on the planet. Nearly 8.5 million of those 9 million acres are irrigated by groundwater pumped to center pivots. This doubles productivity in a state that gets only 22 inches of rain a year. Dryland farming depends on rainfall and rainfall of less than 20 inches produces only 110 to 140 bushels of corn per acre, whereas, the yield with center-pivot irrigation is roughly doubled. 

Historically, dams have been the most important piece of irrigation equipment. The technology of storing water during the rainy season, for use during the dry season when crops are maturing, has until recently been the only way farmers could “ride out” a multi-year drought. Dams also protect fields and towns from flooding, recharge the aquifer, and provide recreation opportunities that bring in tourist dollars. The unfortunate aspect of the Green Revolution is that farmland has increased 10-fold in value, making it too expensive to buy up and flood with a new dam. (Eminent Domain cannot be used to seize land for the apparent purpose of enriching farmers.) Here in the US, the Army Corps of Engineers worked in the 1970s and 80s to map out all the best locations for placing dams but few have been built. That forces greater use of groundwater wells but also removes the best way to recharge the aquifers that support those wells, which is the reservoir behind a dam--combined with drainage canals that divert excess water (produced by floods) into holding basins. For further information on crop irrigation strategies visit the University of Nebraska at Lincoln website (http://water.unl.edu/web/cropswater/).

As an investor, we think you’ll want to know which listed companies provide irrigation equipment. There are two companies that make center-pivot sprinkler systems, Valmont Industries (VMI), which holds the original patent, and Lindsay Corporation (LNN). You’ll also want to know which listed companies make and install subsurface drip irrigation (SDI) systems. Again, there are two: John Deere (DE) and Toro (TTC). For groundwater irrigation systems, you’ll want to know which companies make the pumps and plumbing that bring well water to the surface and distribute it. Here there are 3 leaders: Xylem (XYL), a company that only recently started issuing stock, Flowserve (FLS), and Marmon Water, a subsidiary of Berkshire Hathaway (BRK-A). Diesel and propane powered generators supply power to groundwater pumps; Cummins (CMI) and Caterpillar (CAT) are the most prominent suppliers. 

The future of irrigation will be driven by data collected on crop moisture levels when tractors make a pass through a field. Trimble Navigation (TRMB) has software that uses satellite weather information to produce virtual data on rainfall at any GPS location specified by the farmer. Modern tractors have global positioning systems (GPS) that link to an onboard computer containing data from previous passes through the field. Software packages take over the chores of seeding the field, deciding how much and what kind of fertilizer to place where, and doing the same for insecticides, herbicides, and fungicides. In a new program called Field360, the data collected on John Deere (DE) tractors will be wirelessly downloaded to a local DuPont Pioneer (DD) field office for analysis. Information on crop moisture levels in different parts of the field will be made available to the farmer to use in programming sprinkler (or drip) irrigation systems. A similar system is being rolled out by Monsanto (MON) and another is available through Raven Industries (RAVN) that links to AGCO tractors. 

For this week’s Table, we have populated our basic spreadsheet with data for the companies cited above; total returns are impressive. There is, however, a problem for investors: the spreadsheet looks like it has the measles because red highlights are everywhere. Those indicate substandard performance vs. our benchmark (the bond-hedged S&P 500 Index - VBINX). This means that while the potential rewards from investing in irrigation equipment are high the risk is even higher. 

Bottom Line: Modern farming is increasingly about automation, and programmed with the help of GPS. This system is gradually reducing the overuse or underuse of inputs like fertilizer, insecticides, herbicides, fungicides, and now water. That automation is based in tractors and combines, standard pieces of farm equipment for generations, that now cost several hundred thousand dollars apiece. For example, at a cost of less than a thousand dollars a year that information can be transferred wirelessly in real time from Deere (DE) tractors to a DuPont Pioneer (DD) field office for analysis. In many parts of the world, water scarcity is the key factor limiting production farming. The new era of micromanagement via GPS promises to optimize water use by responding to known crop moisture levels and rainfall in different parts of a field. Further progress in optimizing water use will depend on large-scale financing for projects that collect and store rain and flood waters by using dams, diversion canals and holding basins. In agricultural areas afflicted with creeping desertification, such projects are the only known way to recharge the depleted aquifers that support groundwater irrigation.

The only stocks mentioned here that currently have good long- and short-term Finance Value, along with high S&P bond ratings, are Berkshire Hathaway (BRK-A) and Monsanto (MON).

Risk Rating: 7

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Full disclosure: I have stock in Deere, Flowserve, DuPont, Cummins, Caterpillar, and Berkshire Hathaway.

Week 121 - Water Utilities Among the Dividend Achievers

Situation: Globally, water use is growing twice as fast as the population. This represents more intensive water use than in the past. For example, a recent study out of Columbia University notes that withdrawals from US municipal water systems increased 130% since 1950 while the population was increasing by 99%. Is exponential growth in water use sustainable? Not as long as water remains so cheap. If you use withdrawals under a regime of improved conservation measures to estimate sustainable water use, how many people can be supported going forward and still allow rainfall and snowpack to halt the depletion of our aquifers? About 5 Billion, which is 2 Billion fewer people than we have now and half the population the planet will have by 2060. Can desalination of ocean water make up the difference? Yes, but it is energy-intensive, expensive, and polluting. The new desalination plant at San Diego County has cost more than a billion dollars to build. The water it produces will have to be priced at twice the current rate, i.e., at $1,000 for a family of four for one year instead of $500. And, the pace of building desalination plants in the Western Hemisphere is much too slow to address the problem. In the Eastern Hemisphere, a wider acknowledgement of the problem has led to appropriate investment in desalination plants but the pace needs to pick up.

Most experts expect the pricing of water to increase rapidly, given the rate of population growth and the fact that 70-80% of water has historically been used for agriculture. The water distribution problem is compounded by global warming, and the fact that a billion people already live in regions undergoing desertification where water must be imported. A global water crisis can be expected in the next 10-15 yrs, unless the construction of desalination plants (and the expansion of water allocation regimes) “scale-up” much faster than is currently envisaged. For example, farmers in California have long prevented the legislature from imposing an allocation regime for groundwater use (wells), and resist metering.

Water utilities often take the form of municipal or regional cooperatives, using a clean water source combined with rate-based financing of the distribution system. However, the use of fertilizer by farmers can introduce excess nitrates into these water systems, necessitating the construction of water treatment plants. That requires financing, which may include issuance of common stock. Water rights can be expensive, which also requires upfront financing. This week’s blog looks at 7 water utilities that have increased their dividends annually for at least the past 10 yrs (see Table). Note: all values in the Table are current as of October 26, 2013. Red highlights denote values that are inferior to benchmark (VBINX) values. The main “takeaway” from the Table is in Column J, where you see that 5 of the 7 companies already have unsustainably high valuations. In other words, investors are well aware that water is undervalued and are betting that the dividends paid by these companies will grow faster.

Bottom Line: There aren’t many solid growth industries but water utilities certainly represent one. Clean water is destined to become more valuable than oil in our lifetimes. All 7 of the water utilities in this week’s blog represent worthwhile investments in terms of long-term Finance Value (Column E of the Table). In terms of dividend growth plus dividend yield, Aqua America (WTR) stands out. It is also a large enough company to have a Standard & Poors stock rating (A/L).

Risk Rating: 3

Full Disclosure: I don’t own any shares issued by these companies.

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Week 64 - Food Production Companies

Situation: All investors are interested in gaining information about the Next Big Thing that will drive movement in the markets. We think that could be food production because 
   a) there’s not going to be enough land under cultivation to feed 9 Billion people by 2050; and
   b) the land that is under cultivation will produce less food given there are more droughts such as those we’ve been experiencing. 

Food production has many moving parts, most of which are in a continual state of flux and difficult to document. Weather, technology (“The Green Revolution”), soil erosion due to flooding and wind, global warming, population growth, availability of fuel for power grids and farm machinery, irrigation requirements for water, estate taxes that break up family farms, diseases that affect plants and animals, internet access to regulated futures exchanges and weather forecasting websites, diversion of food grains to fuel production, transportation of food to markets, and financing needed to purchase farm machinery, farm land, seeds, insecticides, veterinarian services, futures contracts, and well digging equipment. All of these listed items change from season to season and year to year, and impact market prices.

This last item listed above (financing for farmers) is of particular interest to us as investors but is, unfortunately, “flying under the radar.” That is, stocks and bonds aren’t issued by finance firms to successful farms for listing on public exchanges where fair prices can be arrived at through active trading. Family farms are about as amenable to high finance as family homes, and we have witnessed the results of what happened when bonds were created from thousands of mortgages: prices were inflated. So, “high finance” for a farmer = belonging to a farmer’s co-operative. These local/regional organizations pool money from several or many farmers to invest in farm necessities and market farm products. Farmers (i.e., the co-op members) share in the proceeds. If you buy gas at a Cenex station or enjoy Land O’Lakes butter, you’re paying into a farmer’s co-operative. The 100 largest co-operatives in the US earn over $200 Billion a year in revenue. The largest is CHS Inc. (Cenex), based in Minnesota, with sales of over $40 Billion/yr and profits of over $1.5 Billion/yr. They do pretty much all things “Ag” and in most every location, including operating their own oil refineries (Laurel, MT & McPherson, KS). Land O’Lakes is the second biggest co-operative, handling 12 Billion pounds of milk annually and operating the Purina Mills animal feed business.

Current estimates are that 1.3-1.6 Million more acres have to be brought under cultivation using Green Technology before there will be enough food to support a world population of 9 Billion by 2050. That will be even more difficult in the face of global warming. I decided to get a ringside seat to observe this fight against nature: I moved from Cleveland, OH, to Hastings, NE, last spring. I expected to have to wait a few years before a humdinger of a drought got everyone’s attention but soon found my timing was perfect. Our editorial office will remain in Baltimore, MD.

Bottom Line: Investors need to think about how large populations are fed, and then move beyond buying stock in McDonalds. The accompanying Table shows how the 25 food production companies in the S&P 500 Index are doing, i.e., not very well for the most part. People need food but many are out of work and unable to spend much on food.In addition, the costs of food production are soaring. The result is that companies attempt to pass along those increased costs by raising prices only to see people respond by buying less. Some companies have done well: Monsanto, Hormel Foods, General Mills, Potash, Flowserve, and FMC are sound enterprises that are relatively low-risk. However, this is widely known so their stock is somewhat overpriced. Higher risk names that are also sound enterprises include Caterpillar, Deere, Mosaic, and Dupont. Their stock is either fairly priced or underpriced. 

For the seasoned investor, who knows fixed income investments are where the smart money hides out, there’s the Cenex preferred stock issue (CHSCP) paying 6.25% as of 9/12. Cenex is an $84 Billion company that shows strong continual growth due to its worldwide reputation in the food game. It’s a farmer’s co-operative so stock is not issued and it isn’t regulated by the SEC. What is known is that the company’s book value has grown at a rate of 9.65%/yr over the past 5 yrs. Bankruptcy is not even a remote possibility, yet it pays twice the interest of a US Treasury bond. Why? Because investors know nothing about farmer’s co-operatives and aren’t going to know anything until headlines appear in The WSJ such as: “Why isn’t there enough food?” and “Can Farmer’s Cooperatives be Capitalized Better?”

Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com