Month 91 - Food and Agriculture Companies - Winter 2019 Update

Situation: We all have to eat, so food is an essential good. Even in a commodity bear market, the valuations of food and agriculture companies will likely hold up better than the S&P 500 Index ETF (SPY - see Column D in this month’s Table). Which is amazing, given that grains and livestock account for 29% of the Bloomberg Commodity Index. Another way of saying this is that the volumes of food sold are inelastic, much like gasoline. This gives investments in food and agriculture companies a special, almost unique, competitive advantage. 

The most important development in recent years is that the sugar in corn kernels is being processed into ethanol for gasoline. And, to a lesser extent, soybean oil is being processed into diesel fuel (see Week 364). Two US companies are leaders in biofuels production, i.e., Valero (VLO) with a capacity of 1.4 billion gallons per year, and Archer Daniels Midland (ADM) with a capacity of 1.6 billion gallons per year. Animal feeds are an important by-product of ethanol production, marketed as dry and wet distiller grains, that capture 40% of the energy in a kernel of corn. 

Mission: Use our Standard Spreadsheet to highlight important metrics for listed companies in the Food and Agriculture sector.

Execution: see Table.

Administration: The 21 companies in the Table meet specific standards for quality, which are: S&P Bond Rating of BBB or better; S&P Stock Rating of B+/M or better; and trading records that extend for 16+ years to allow analysis by the BMW Method. 

Bottom Line: In the aggregate, common stocks of these companies look to be a good bet (see Line 23 in the Table). Don’t be fooled. Eight of the 21 stocks track the ups and downs of futures markets in raw commodities (see red highlighted companies at the bottom of Column D in the Table). To build a position in any of those stocks you’ll need to employ dollar-cost averaging. And, only the two companies at the top of the Table have clean Balance Sheets (see Columns N-Q in the Table). 

To invest successfully in this sector, you’ll need to do a lot of research on a continuing basis. For example, note that fertilizer companies and seed companies are missing from the Table. Why? Because of the recent wave of mergers and acquisitions. If you had been an investor in now extinct companies like Monsanto, duPont, Dow Chemical, Potash Corporation of Saskatchewan, and Agrium, you’ll have gained from the pain but also lost money.

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

Full Disclosure: I dollar-average into TSN, KO, CAT, UNP and WMT, and also own shares of HRL and MKC.

"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com All rights reserved.

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Week 388 - Has The 4-Yr Commodities Bear Market Ended?

Situation: In Q2 of 2014, the trade-weighted index of 19 Futures Contracts for raw commodities peaked (DJCI; see Yahoo Finance), as did the SPDR Energy Select Sector ETF (XLE; see Yahoo Finance). Both hit bottom in early Q1 of 2016. That should have been the end of the Bear Market but prices have not risen much since then. On the plus side, both ETFs tested their early 2016 bottom in Q3 of 2017 and failed to reach it, suggesting that prices for both are in a new (albeit weak) uptrend. 

Interestingly, the SPDR Gold Shares ETF (GLD; see Yahoo Finance) has traced a similar track, peaking in Q1 of 2014, bottoming at the beginning of Q1 2016, and failing a test of that low point late in 2016. Other metrics also suggest that the Bear Market has ended. For example, recently posted earnings for Exxon Mobil (XOM) in Q3 of 2018 were robust enough to have reached a level last reached in Q3 of 2014.

Mission: Use our Standard Spreadsheet to track key investment metrics for companies that buy and/or extract raw commodities for processing, transport those by using 18-wheel tractor-trailers or railroads, or manufacture the diesel powered and natural-gas powered heavy equipment tractors that are used to mine and harvest raw commodities. Confine attention to companies that have at least a BBB+ S&P rating on their bonds and at least a B+/M rating on their common stocks,  as well as the 16+ year trading record on the NYSE that is needed for long-term quantitative analysis by the BMW Method.

Execution: see Table.

Bottom Line: Near-month futures prices for commodities have come down off a supercycle that blossomed in 1999, and are now back to approximately where they started. This represents a classic “reversion to the mean”, likely due to supply constraints growing out of the somewhat rapid buildout of China’s economy. We’re not at the end of a 4-Yr Bear Market. Instead, we’re in the long tail of a remarkably strong 2-decade commodities Bull Market. It is important to note that commodity production is changing away from fossil fuels. However, petroleum products still represent more than 30% of trade-weighted commodity production. Going forward, the composition of that production will shift toward environmentally cleaner transportation fuels. Gasoline and diesel will yield dominance to CNG (compressed natural gas) and hydrogen (sourced from natural gas). This will mirror the shift toward clean electrical energy that has replaced coal with natural gas during the build-out of wind and solar sources, along with the necessary enhancements to electricity storage and transmission.  

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

Full Disclosure: I dollar-average into CAT, XOM, R and UNP, and also own shares of NSC, BRK-B and CMI.

"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com All rights reserved.

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Week 369 - High Quality Producers & Transporters of Industrial Commodities in the 2017 Barron’s 500

Situation: Here in the U.S., debt/capita is growing at an alarming rate and is now greater than $60,000. U.S. Government debt is almost $20 Trillion and has been growing at a rate of 5.5%/yr (i.e., twice as fast as inflation) since 1990. By 2020, the Federal budget deficit will start to exceed $1 Trillion/Yr and the dollar’s status as the world’s reserve currency will be threatened. The gold reserves that stand behind the U.S. dollar (currently worth ~$185 Billion) would have to be increased on a regular basis, as would foreign currency reserves (currently worth ~$125 Billion)

The US economy is no longer capable of growing fast enough to balance the budget for even a single year, without introducing draconian measures. Nonetheless, it is worth noting that those can be effective given that Greece appears to have emerged from that process successfully. But the U.S. could not go through that process and still remain the “top dog” militarily. So, the trade-weighted value of the U.S. dollar will fall at some point, and we will no longer be able to afford imported goods and services. Before that happens, U.S. citizens will need to gradually move their retirement savings into commodity-related investments, as well as bonds and stocks issued in reserve currencies other than the U.S. dollar. 

Mission: Use our Standard Spreadsheet to highlight large U.S. and Canadian companies that produce, refine and transport raw commodities, i.e., materials that are extracted from the ground. Select such companies from the 2017 Barron’s 500 list, but exclude any that issue bonds with an S&P rating lower than A- or stocks with an S&P rating lower than B+/M. 

Execution: see Table.

Administration: The S&P Commodity Index has the following components and weightings:
Natural Gas (17.66%)
Unleaded Gas (12.16%)
Heating Oil (12.13%)
Crude Oil (11.41%)
Wheat (5.15%)
Live Cattle (4.87%)
Corn (4.48%)
Coffee (3.88%)
Soybeans (3.84%)
Sugar (3.80%)
Silver (3.67%)
Copper (3.39%)
Cotton (3.22%)
Soybean Oil (2.98%)
Cocoa (2.79%)
Soybean Meal (2.57%)
Lean Hogs (2.04%)

53.36% of the index represents petroleum products, 32.71% represents row crops, 7.06% represents industrial metals, and 6.91% represents live animals. Ground has to be mined, drilled, or planted & harvested with the help of heavy equipment to yield raw commodities. Those have to be transported by barge, rail, truck, or pipeline before being processed for market. 

We find 8 companies that warrant inclusion in this week’s Table. Seven are obviously appropriate, but the presence of Berkshire Hathaway (BRK-B) needs some explanation (unless you already know it owns the Burlington Northern & Santa Fe railroad). Berkshire Hathaway is the largest shareholder of Phillips 66 (PSX), which has 13 oil refineries and supplies diesel for the largest marketing outlet of that fuel: Pilot Flying J Centers LLC. Berkshire Hathaway purchased 38.6% of that company’s stock on October 3, 2017, and plans to increase its stake in 2023 to 80%.

Bottom Line: Commodity futures haven’t been a good investment, given that their aggregate value is back to where it was 25 years ago, given that the most recent 20-year supercycle recently finished and another is just starting. Nonetheless, the companies that produce, process, and transport those commodities did well over those 25 years (see Column AB in Table). The problem is the volatility of their stocks (see Column M in the Table), and the extent to which their stocks get whacked when commodities become oversupplied relative to demand (see Column D in the Table). If you choose to own shares in these companies (aside from CNI, BRK-B and perhaps UNP), you’d be flat-out gambling. 

Risk Rating: 7-9 (where US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)

Full Disclosure: I dollar-average into UNP, ADM, CAT and XOM, and also own shares of CNI and BRK-B.

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

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Week 357 - Dividend Achievers That Support Commodity Production

Situation: Commodities crashed in 2014 but the only S&P industries to be affected were Energy, Industrials (specifically railroads) and Basic Materials. A new Commodity Supercycle began to take hold in early 2017.

Which companies stand to benefit?

Mission: Under the best of circumstances, commodity-related investments are highly speculative. If you gamble at this casino long enough, you’ll lose big and win big. So, let’s confine our attention to “the best of circumstances,” i.e., set up our Standard Spreadsheet to look at companies meeting these requirements: 
   1) S&P credit rating for long-term bonds is BBB+ or better; 
   2) S&P stock rating is B+/M or better; 
   3) Long-term Debt doesn’t exceed 33% of Total Assets; 
   4) Tangible Book Value is a positive number; 
   5) the company is a Dividend Achiever.

Execution: see Table.

Administration: Seven companies meet our requirements. Only the two railroads (UNP, CSX) and Exxon Mobil (XOM) meet the key requirement Warren Buffett has for saying that a company enjoys a “Durable Competitive Advantage” (see Week 54), i.e., steady growth in Tangible Book Value exceeding 7%/yr (see Columns AD and AE in the Table). It is also important to note that all areas of commodity production (aside from aquaculture) employ equipment that digs in the dirt. That makes Caterpillar (CAT) a useful barometer, and its stock has done well since the Commodity Crash of 2014-2016.

Bottom Line: If you’ve held shares in any of these 7 companies (see Table) for more than a few years, I commend your perseverance. Stick it out awhile longer and you may be rewarded. A new Commodity Supercycle appears to be starting, and will likely take hold if China stays the course and becomes a Superpower.

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

Full Disclosure: I dollar-average into Union Pacific (UNP) and Exxon Mobil (XOM).

"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com All rights reserved.

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Week 338 - Alternative Investments (REITs, Pipelines, Copper, Silver and Gold)

Situation: You want to minimize losses from the next stock market crash. News Flash: The safe and effective way to do that is to have 50% of your assets in medium-term investment-grade bonds. Those will go up 10-25% whenever stocks swoon. But a plain vanilla form of protection won’t resonate with your neighbors after the crash hits. You’ll want to tell them about something cool that you did to protect yourself. And, while waiting for the next crash you don’t like the low interest income that you’d receive from a low-cost Vanguard intermediate-term investment-grade bond index fund like VBIIX or BIV. The exotic-seeming alternative is to bet on something related to land and its uses. Those bets carry valuations that track long supercycles, which overlap 3 or 4 economic cycles. But supercycles contain pitfalls for the unwary, and even for professional commodity traders.

Mission: Use our Standard Spreadsheet to examine Alternative Investments, and describe the pros and cons of owning those.

Execution: see Table.

Administration: The main bets are on real estate, oil/gas pipelines, copper, silver and gold. Traders mitigate losses during a recession by hoarding such assets until prices recover. Let’s look at the odds of success. The SEC (Securities and Exchange Commission) is responsible for guiding the average investor away from loss-making bets. For example, the SEC doesn’t allow a stock to be listed on a public exchange unless it has Tangible Book Value (TBV) and appears likely to continue having TBV after being listed. So, S&P identifies 10 Industries that have the structural profitability needed to maintain TBV and dividend payouts for retail investors. 

Real Estate is not such an industry. However, S&P has started evaluating Real Estate Investment Trusts (REITs) with a view toward someday including those. However, the Financial Times of London does not include Real Estate companies in either its FTSE Global High Dividend Yield Index, or the US version of that index, which you can invest in at low cost through an ETF marketed by the Vanguard Group (VYM). Nonetheless, we’ll list what we think are the 7 best REITs in the accompanying Table.

Oil and gas pipelines offer a way to capture tax-advantaged dividend income that transcends the ups and downs of the economy, but typically requires you to buy into a Limited Partnership. To do so, the SEC requires you to be an Accredited Investor. “To be an accredited investor, a person must demonstrate an annual income of $200,000, or $300,000 for joint income, for the last two years with expectation of earning the same or higher income.” You’re also liable for taxes levied by most states through which the pipelines run. As a retail investor, you aren’t going to buy shares of a Limited Partnership. So, none are listed in our Table. But a few “midstream” oil & gas companies issue common stock to help fund a large network of integrated pipelines. Those pay the same high dividends expected of Limited Partnerships, and two companies are listed in the FTSE High Dividend Yield Index for US companies (VYM): ONEOK (OKE) and Williams (WMB). This indicates that each company’s dividend policy is thought to be sustainable. ONEOK has the additional distinction of being an S&P Dividend Achiever because of 10+ years of annual dividend increases.

Gold is the traditional Alternative Investment, which also brings copper and silver into play given that all 3 are found in the same geological formations. Any copper mine that fails to process the small amounts of gold it unearths is a copper mine not worth owning. The same can be said of gold miners who ignore silver deposits. The problem for investors is that mines are costly to develop and have an unknown shelf life. So, owning common stocks issued by miners has fallen out of favor: Dividends are rare and fleeting, and long-term price appreciation is neither substantial nor steady. Nonetheless, we have listed 4 miners in the Table: Freeport McMoRan (FCX) and Southern Copper (SCCO) both focus on mining copper; Newmont Mining (NEM, focused on mining gold), and Pan American Silver (PAAS). 

A better way to invest in precious metals is to buy stock in financial companies based on loaning money to miners on condition of being paid later either in royalties or ownership of a stream of product, should the mine become a successful enterprise. We have listed two such companies: Royal Gold (RGLD), which seeks royalties; Wheaton Precious Metals (WPM), which mainly seeks silver streaming contracts. See our Week 307 blog for a detailed discussion of silver. 

Bottom Line: If you want to venture into Alternative Investments, and would like to take a relatively safe and effective approach, we suggest that you buy shares in the REIT ETF marketed by the Vanguard Group (VNQ at Line 19 in the Table). Better yet, stick to companies in “The 2 and 8 Club” that represent more reasonable bets in the Natural Resources space: ExxonMobil (XOM), Caterpillar (CAT), and Archer Daniels Midland (ADM). One pipeline company is also worth your consideration: ONEOK (OKE, see comments above). 

Risk Rating: 9 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)

Full Disclosure: I dollar-cost average into XOM, and also own shares of OKE, CAT and WPM.

"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com

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Week 337 - Agriculture-related Companies in “The 2 and 8 Club” (Extended Version)

Situation: We’ve narrowed our “universe” to large & established US companies that reliably pay a good & growing dividend, and called it The 2 and 8 Club. Why? Because “good ” means 2% or better and “growing” means 8% or better. We use a wash/rinse/repeat method to find those companies. 

In the “wash” cycle, we collect companies that are listed at each of the 3 online spreadsheets we value: 1) The capitalization-weighted FTSE High Dividend Yield Index for US companies, which is simply the 400 companies in the Vanguard High Dividend Yield ETF. 2) The S&P 100 Index, which has the advantage of price discovery through the requirement that stocks in these large companies have active markets in Put and Call Options. 3) The BMW Method List of statistical data for stocks that have been traded on a public exchange for at least 16 years. 

In the “rinse” cycle, we look up information online about each stock that passed through the wash: 1) We make sure bonds issued by that company have an S&P Rating of A- or better. 2) We make sure stocks issued by that company have an S&P Rating of B+/M or better (go to your broker’s website). 3) We make sure the company’s annual dividend payout has been growing 8% or faster over the past 5 years, i.e., we get a list of payouts from the relevant Yahoo Finance page then put the most recent year’s payout and the payout for 5 years ago into a Compound Annual Growth Rate calculator. 

In the “repeat” cycle, we take the same steps 3 months later, then select stocks to add or delete by using a brokerage that charges you a flat fee of ~1% of Net Asset Value/yr. This allows you to trade without incurring transaction costs (including dividend reinvestment). 

If you’re a glutton for punishment, you can extend your oversight beyond S&P 100 stocks to include those on the Barron’s 500 List, published each year in May, which has the advantage of ranking companies by using 3 cash flow metrics. Then you’ll be running the Extended Version of The 2 and 8 Club, which currently has 32 companies (see Table for Week 329). This week’s blog drills down on the 10 companies in the Extended Version that ultimately depend on feedstocks provided by farmers, to ultimately market foods & beverages, motor engine fuels, animal feed, cigarettes, cotton shirts, and plastics made from corn. 

Mission: Set up a Standard Spreadsheet of those 10 companies.

Execution: see Table.

Administration: Farmers operate a capital-intensive business that requires large-scale production on ~1000 acres to justify the cost of chemicals and fertilizer plus the main cost, which is for the purchase and maintenance of equipment (e.g. combines, tractors, grain carts, center-pivot irrigation systems, sprayers, semi-tractors that haul 30 tons of grain, grain-drying bins, grain storage bins, and satellite navigation links needed for weather forecasting and precision agriculture). Their mobile powered equipment requires diesel fuel, and their grain-drying bins require natural gas or propane. 

Archer-Daniels-Midland is the only pure Ag company on the list. ADM collects crops at railheads for further shipment and initial processing, and distributes products worldwide. Much of that distribution begins by loading grain onto barges in the Mississippi River. 

Weather is the key variable. The software and hardware on weather satellites is IBM gear, and IBM owns The Weather Channel. GPS-based software is an important part of precision agriculture, and similarly depends on satellites running IBM equipment. Cummins (CMI) and Caterpillar (CAT) provide diesel engines, and ExxonMobil (XOM) is one of the largest sources of diesel fuel. CAT also makes skid-loaders and backhoe/end-loaders that some farmers use.

PepsiCo (PEP) and Coca-Cola (KO) process a variety of farm products (including milk, cheese, oranges, oats, coffee and tea) into dozens of branded foods and beverages that are found worldwide. Altria Group (MO) processes tobacco plants into cigarettes and smokeless tobacco for the US market. VF Corporation (VFC) is the largest company that fabricates clothing for a variety of markets, and depends on farmers to produce its main feedstock (cotton). Target (TGT) markets clothing, and Super Target stores offer a large variety of foods and beverages. 

Bottom Line: Farm incomes have fallen 20%/yr over the last 3 years, but appear to have stabilized with this year’s harvest. Cost-cutting and scaling-up are the main survival strategies. Farms that are large enough to sustain a family are multi-million dollar enterprises that cultivate more than a square mile of ground. When farmers are forced to cut costs, suppliers are forced into being acquired by (or merged with) other companies. To further complicate matters, efficient transportation networks now circle the planet. The supply of crop commodities outstrips demand enough that the effects of drought or war in one place are mitigated by bumper crops in another place. 

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

Full Disclosure: I dollar-cost average into KO, XOM, and IBM, and also own shares of CAT and MO.

"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com

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

Week 258 - Barron’s 500 Multimodal Transportation Companies

Situation: If you want to feel the pulse of an economy, look at trends in transportation. Those trends won’t tell you where the economy is headed next but they will show you where it’s been, and where the pressure points are. Right now, one pressure point for the US economy is the inefficiency of off-loading cargo from ships to drayage trucks, and transferring containers to warehouses or railroads. Another pressure point is the “final mile,” or how to get goods into the hands of consumers with a minimum of inconvenience. “Vertical integration” appears to be the answer for both problems, meaning companies like FedEx and UPS (and increasingly Amazon) will try to perform as many integrated services in-house as is possible. Finally, there are environmental considerations, namely, how do we move cargo around without leaving such a large carbon footprint. One solution that is off to a good start is replacing diesel truck engines with compressed natural gas (CNG) engines. The largest US truck fleet (JB Hunt Transport Services; JBHT) is an early adopter. Given the centrality of these above-mentioned companies, it would be a good idea for you to hold shares in one, or shares in an Exchange Traded Fund (ETF) for the transportation sector such as the iShares Transportation Average ETF ( IYT at Line 21 in the Table).

Mission: Provide a capsule summary for investors in Air Freight & Logistics companies, as well as multimodal trucking companies and railroads. Examine only those companies with revenues sufficient to be included in the recently published 2016 Barron’s 500 List. Assess current value by calculating Net Present Value (see Week 256) and providing the Graham Number. That number tells you what the stock price would be if it were to reflect 15 times earnings/share and 1.5 times book value/share. Finally, we’ll take a peek at future valuation by comparing the Weighted Average Cost of Capital (WACC) to the Return on Invested Capital (ROIC).

Execution: see Table.

Bottom Line: Dow Theory is the oldest method to assess current and future value in the stock market. The critical variable is the Dow Jones Transportation Average (DJTA), a running index of stock prices for 20 transportation companies. A “primary uptrend” ( Bull Market) is not declared when the Dow Jones Industrial Average (DJIA) hits new highs, but instead is declared when the DJTA confirms that event by also hitting a new high. We saw a confirmation most recently in November of 2014. The opposite also holds: a “primary downtrend” (Bear Market) must see a new low in the DJIA being confirmed by a new low in the DJTA.

The linchpin that holds transportation together is the Surface Transportation Board (STB), which has “wide discretion...to meet the nation’s changing transportation needs.” The STB is the most powerful Federal regulatory agency that transportation companies (even pipeline carriers) must face. Its power and reach is a boon to investors, since they won’t be permitted to lose much money: There will be volatility but there will be no bankruptcies, or strategic end-runs such as trucking companies underpricing railroads. In this week’s Table, we drill down on the 11 largest companies in the transportation space. Many of you may consider Amazon (AMZN) to be an outlier here, but Amazon is both the largest warehousing operation and the largest logistics company. And there will soon be thousands of Amazon-branded tractor-trailers on the highways. Time is money.

Risk Rating = 7 (where Treasuries = 1 and gold = 10).

Full Disclosure: I dollar-average into UNP and also own shares of CNI.

NOTE: Metrics are current for the Sunday of publication. Metrics highlighted in red indicate underperformance vs. our key benchmark, the Vanguard Balanced Index Fund (VBINX, at Line 17 in the Table). Metrics highlighted in green at Columns P and Q in the Table indicate improving performance trends for fundamental metrics (per analysis by Barron’s 500 editors). Metrics highlighted in purple at Columns Z and AA in the Table indicate a company in current difficulty, ROIC being lower than WACC.

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Week 235 - How Are Our 4 Key AgriBusiness Stocks Doing?

Situation: Ten weeks ago, we took a close look at the 20 largest AgriBusiness companies (see Week 225). We didn’t find much to love. When a commodity “supercycle” ends, it takes down all sectors, including oil & gas, mining, and agriculture. Nonetheless, we concluded that 4 AgriBusiness companies have strong enough balance sheets and wide enough marketing to “muddle through” this downturn. Each of the four firms we selected is a widely known and respected brand: Monsanto (MON), Hormel Foods (HRL), Archer Daniels Midland (ADM) and Deere (DE). Now that the commodity bear market has deepened, let’s look in on these companies to see how they’re holding up. 

Mission: Perform our standard spreadsheet analysis and make comparisons to relevant benchmarks (see Table).

Bottom Line: Hormel Foods (HRL) continues to outperform because of the “great meat rally.” Monsanto (MON) stock fell in price last year after a failed merger attempt with Syngenta (SYT) but is now recovering amid speculation that major agribusinesses will have to merge (given the imbalance between supply and demand for commodities). Indeed, duPont (DD) and Dow Chemical (DOW) have already agreed to do so. Archer Daniels Midland (ADM) and Deere (DE) are both in deepening bear markets due to a sharp fall in revenues. ADM coordinates agribusiness infrastructure worldwide but also gets ~10% of its revenues from ethanol production. That market is under pressure due to several factors, the most important being that a “blend wall” has been reached for blending gasoline that is 10% ethanol. No more ethanol is needed, and gasoline with 15% ethanol can’t be used in cars built before 2002. The blend wall became an issue because cars are increasingly fuel-efficient, and many car owners prefer not to use 10% ethanol. Deere (DE) manufactures heavy equipment for construction and mining in addition to the iconic green tractors and harvesters used in farming. All of those markets have collapsed now that China has largely completed its infrastructure buildout and is going through its own mini-recession. Another important market pressure is that consumers are getting fussier about how foodstuffs are produced and processed. These preferences are undermining the “factory farming” innovations that brought us cheap and abundant food, known as the “green revolution.” In summary, it looks like the AgriBusiness sector will remain under downward pressure for several more years.

Risk Rating: 8

Full Disclosure: I own stock in DE, ADM, MON, and HRL.

Note: Metrics highlighted in red denote underperformance vs. our key benchmark (VBINX). Metrics are current for the Sunday of publication.

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Week 225 - How are the 20 Largest AgriBusiness Companies Doing?

Situation: Commodities have fallen steadily in value since the Lehman Panic. A recent further decline is related to a slowing in the pace of modernization in China, where 40% of commodity production had gone for the past 20 yrs. This has greatly compounded the problem because the rapid pace of modernization there had required remarkable growth in the production of all commodities. Now that China’s infrastructure buildout is largely complete, those upgraded mining and exploration assets in Australia, Brazil, Chile, and South Africa have been idled, and over a dozen billion dollar projects have been aborted. But those aren’t the only commodities out there. What about agricultural products? Demand for soybeans and cereal grains (e.g. barley, corn, oats, rice, rye, wheat, sorghum) is different because close to 20 million people emerge from poverty each year and are able to afford better food, which translates into a protein intake of at least 60 gm/d. The volumes of food involved in meeting that increased demand make it necessary to combine the “green revolution” with “factory farms.” That combination has come to be called “AgriBusiness.” AgriBusiness is focused on efficiently getting water to soil that has been prepared to support the germination of designer seeds through “agronomy.” Agronomy is shorthand for the scientific use of fertilizers, insecticides, and fungicides to optimize plant growth around weather patterns and irrigation systems that meet water needs.  

Mission: Assemble data on stocks representing the 20 largest AgriBusiness companies, and compare their aggregate performance with broad commodity indices--as well as narrower indices that reflect the performance of farming, mining, and energy companies.

Execution: AgriBusiness companies are high risk investments, and each has only a small piece of the pie. In order to compete against one another, each has to maintain a market for its goods and services in dozens of countries. Only 4 of the 20 identified AgriBusinesses are stable enough to warrant inclusion in a retirement portfolio by even the most basic criteria (see Table). These criteria are 1) Dividend Achiever status, 2) an S&P bond rating of at least BBB+, and 3) an S&P stock rating of at least B+/M. The 4 companies that make the cut are: Monsanto (MON), Deere (DE), Hormel Foods (HRL), and Archer Daniels Midland (ADM).

Bottom Line: If you think your portfolio requires exposure to commodities, then you’re in for a rough ride. But “long cycle” investments such as commodities can be quite rewarding if held for two or more market cycles. The safest approach is to own stock in a few of the larger AgriBusiness companies, as opposed to owning stock in mining or energy companies (see Week 221). This week’s blog takes a closer look at those agricultural producers. Be aware, however, that overproduction to meet China’s needs over the past decade has expanded agricultural production capacity along with that for oil, natural gas, coal, iron ore, bauxite, and copper. This is being reversed now that China’s “buildout” has begun to plateau.  

Risk Rating: 8

Full Disclosure: I own stock in CF, HRL, MON, DD, DE, and ADM.

Note: Metrics in the Table that are highlighted in red denote underperformance relative to our key benchmark (VBINX); metrics are current as of the Sunday of publication.

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Week 221 - Status of Commodity-Related Barron’s 500 Companies

Situation: Since 2009, China has contributed twice as much to world economic growth as the US. China has also purchased ~40% of all commodities sold worldwide. One commodity in particular, copper, is used as a measure of the health of commodity demand in emerging markets because it plays an important role in building electrical grids. Copper has recently reached new lows. China is slowing down its investment machine mainly because its total debt load has reached 300% of GDP. To put China’s woes in context for the US economy, the CEOs of several corporations have recently provided specific examples of how China’s economic decline impacts their businesses. 

What does this mean for investors? Basically, for the next one or two years, traders of all asset classes will be in a “risk-off” mode while governments, corporations, and individuals struggle to bring down their debt loads and develop ideas for growth. This cautionary stance will coincide with a bottoming of commodity prices as demand recovers while supplies moderate. The global “oil glut” is a special case, only marginally related to falling demand in China. Instead, it is due to a global “price war” triggered by an oversupply of oil related to improvements in technology, namely horizontal drilling into oil-rich shale deposits combined with hydraulic fracturing. And, oil prices may have further to fall.

Mission: Assess the effect on commodity-related companies of oversupply of commodities. Do this by evaluating all 56 such companies in the 2015 Barron’s 500 List that have at least 16 yrs of trading records.

Execution: This week’s spreadsheet (see Table) shows the carnage. Note the abundance of red highlights denoting underperformance relative to our key benchmark (VBINX at Line 73). Let’s start with a “thought experiment.” You’re looking for GARP (growth at a reasonable price), which will allow you to take advantage of sharply falling stock prices (see Column F in the Table). Let’s start by listing the companies that have moved up in rank compared to the 2014 Barron’s 500 List. Those are the ones with green highlights in Columns P and Q of the Table. Then pick those stocks that aren’t overpriced, i.e., the ones with an EV/EBITDA that is no greater than the EV/EBITDA for the S&P 500 Index (which is an EV/EBITDA of 11).

There are 10 candidates in the “oil & gas” group: HES, DVN, TSO, CAM, CHK, NOV, VLO, HAL, WFT, NBR. Two of those have been labelled “potentially underpriced” per the BMW Method (see Week 193): CHK and NOV (see Column O in the Table). There are 5 more candidates in the “basic materials” group: NUE, SCCO, CMC, X, AA and 6 candidates in the agriculture production group (ADM, POT, MOS, TSN, DOW, PPC). POT is another “potentially underpriced” stock. That totals 21 stocks. However, three of those failed to outperform the S&P 500 Index over the past 16 yrs (per the BMW Method: NBR, AA, PPC (see Column L in the Table). Eliminating those leaves 18 candidates. 

So far, so good. Most of the 18 have fallen hard in recent quarters and now have prices that are 1-2 Standard Deviations below trendline (see Column M in the Table). The BMW Method sorts out “risk” statistically by predicting the extent of loss below trendline that you can expect in a bear market (see Column N in the Table). The abundance of red highlights in that Column denotes stocks predicted to exhibit a greater loss below trendline than the S&P 500 Index faces, which is 32%. Every one of the 18 candidate stocks is highlighted in red, so they’re all unsuitable for a retirement portfolio. But what if you’re a speculator and willing to accept a loss of 40%? That’s a 25% greater loss than you’d suffer by owning an S&P 500 Index fund like VFINX. Even allowing for the added extra risk, only one of the 18 qualifies (ADM at Line 54 in the Table).

Given that commodity-related companies compose at least 10% of a balanced stock (or stock mutual fund) portfolio, we’ll need to dig deeper. For example, 23 of 56 such stocks listed in the Table are already in a bear market (see Column M), i.e., down 2 Standard Deviations (2SD) below their 16-yr trendline. Three of those companies have raised their dividend annually for at least the past 10 yrs (see a list of such Dividend Achievers in Column R of the Table) and have a statistical risk of loss in a bear market that is less than that for the S&P 500 Index (see Column N in the Table): CVX, XOM, PX. The odds that you’d lose money by starting to dollar-average into those stocks now are low.

Another approach is to dollar-average into low-cost mutual funds that reflect commodity investment, including emerging market index funds. There are 3 listed in the Benchmark section of the Table: 1) GSG, the exchange-traded fund for collateralized commodity futures; 2) PRNEX, the T Rowe Price New Era Fund that invests in natural resource stocks, and 3) VEIEX, the Vanguard index fund for emerging markets.

Bottom Line: The global economy faces a difficult period now that China’s fast growth phase has ended. Commodity-related assets are the first to crash, and that means commodity markets and commodity-related companies will be the first to recover. We’ve evaluated 56 commodity-related companies in the 2015 Barron’s 500 List to come up with 4 that are candidates for speculative investment: Archer Daniels Midland (ADM), Exxon Mobil (XOM), Chevron (CVX), and Praxair (PX).

Risk Rating: 8

Full Disclosure: Commodity-related stocks are “long-cycle” investments that I tend to favor, particularly those that are related to agricultural production. I dollar-average into XOM and also own shares of CVX, AA, HRL, ADM, DE, and DD.

Note: metrics highlighted in red denote underperformance relative to our key benchmark (VBINX); metrics are current as of the Sunday of publication.

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

Week 200 - Agronomy Companies on the Barron’s 500 List

Situation: I know, you’re already bored. But we really have to talk about commodity-related stocks occasionally because those are the high-risk, high-reward, high-cost stocks that anchor the world economy. Their prices usually reflect a megacycle that lasts for decades, starting with supply shortages (relative to demand) and ending with overproduction that persistently exceeds demand for a time (e.g. today’s oil & gas markets). The pricing of such stocks correlates with global demand, not with the typical 5-7 yr economic cycle of individual countries or regions. Some commodities are so adept at reflecting the global economic cycle as to earn special respect, like “Doctor Copper”. You’ll want to own two or three of these “non-correlated” stocks that dampen the ups and downs of the economic cycle. In particular, consider production agriculture companies because those have special advantages: 1) Their profits are driven more by the weather cycle than the economic cycle; 2) ten million people per year enter the middle class in Asia and Africa who can finally afford to consume the 60 grams/day of protein that is required for good health and a long life.

Livestock has been the best-performing commodity sector over the past year. Let’s think about what goes into livestock production: grain, hay, and soybeans are the most important inputs. (Four pounds of feed is needed to make one pound of Grade A meat.) Production of those crops requires certain inputs: tractors and combines (see Week 197), irrigation equipment (see Week 129), and this week’s topic about the tools of an agronomist (seeds, fertilizer, insecticides, herbicides, and fungicides). Agronomists work “on call” for individual farmers (or a farmer's cooperative) to address issues of plant genetics & physiology, soil science, and meteorology. Think of them as general practitioners overseeing the crop. Increasingly, this role is played by “seed analysts” from one of the major seed production companies (Monsanto, Syngenta, Bayer or Dupont). Seed analysts also look for farmers who will allow part of their fields to be used for plant research.

This week’s Table has all of the large, publicly-held agronomy companies in the United States and Canada. Stocks in these companies are not suitable for inclusion in a retirement portfolio. But several are suitable for a portfolio of non-correlated assets, i.e., those where prices don’t follow the economic cycle. The pricing of agronomy companies is mainly driven by weather cycles, and the worldwide growth rate for workers who are paid enough to provide their families with an adequate protein intake.

Bottom Line: You need to have a few investments that don’t track the S&P 500 Index, so-called "non-correlated assets." Inflation-protected Savings Bonds epitomize this concept, and you should have a Rainy-Day Fund that is mainly invested in those or Treasury Bills (see Week 162). But there are other, more rewarding non-correlated investments. Most are commodity-related and come with a lot more risk. We like large companies that focus on the needs of farmers and ranchers. This week's Table has 8 of those.

Risk Rating: 7

Full Disclosure: I own stock in MON, CF, and DD.

NOTE: Data are current as of the Sunday of publication; red highlights denote underperformance vs. our key benchmark (VBINX).

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

Week 183 - Buffett Buy Analysis of Oil and Natural Gas Companies

Situation: Oil and natural gas companies account for 8% of US GDP. Their stock prices mainly reflect 3 factors: 1) the pricing of front-month futures contracts, 2) the amount of proven and economically recoverable reserves in the ground, and 3) the expected rate of growth in the world’s appetite for oil. All of those numbers will fall if there is a recession in one of the world’s major economies. Europe is now on the brink of entering its third recession in 10 yrs (triggered by the crisis in Ukraine), which is one reason why the price of oil fell 40% between June and December. But there are two other reasons to consider. 

The US is becoming the dominant oil and gas producing country by rapidly exploiting the twin technologies of hydrofracking and horizontal drilling. This is now causing a price war with the about-to-be-eclipsed countries (Russia and Saudi Arabia). Their strategy is to continue maximal production with traditional technology, which is cheaper than hydrofracking. That means their oil and gas has a lower price point (for making a profit) than US oil and gas. We’ll see who wins, but in the meantime the US consumer gets to have a better Christmas!

The remaining reason why the price of oil is falling is that vehicles are getting better fuel economy. And, $4.00/gal gasoline has changed people’s driving habits, e.g. fuel economy is now the most important consideration when buying a car. More importantly (for the long term), natural gas is starting to replace gasoline and diesel fuel in commercial and municipal vehicles, and even in locomotives and jet fighters. The revolution doesn’t end there, because electric motors will likely power most highway vehicles by 2050, given the current pace of research into battery development. Natural gas will remain an important feedstock for electrical power plants but there will be little need for oil other than as a lubricant and a source of asphalt.

Caveat Emptor: The “story” that supports the prices of energy stocks is always in flux, as well as being complex.

Given that oil and natural gas companies will increasingly emphasize natural gas production over oil production, is this a good time to invest in these suddenly cheap companies? By now, of course, you realize this would be more of a gamble than prudently investing for retirement. Normally, one makes this decision by estimating future earnings (or cash flows), then applying the growth rate for that industry to discount earnings back to the present. That gives an estimate for Present Value for the stock (i.e., what the current price should be). That Discounted Cash Flow (DCF) method has never worked very well for volatile (cyclical) stocks. Those are the ones that track the ups and downs of the economy too closely, such as oil and gas “exploration and production” stocks. 

Instead, let’s use our old standby of the Buffett Buy Analysis (BBA). It simplifies the DCF method by projecting the trend-line for the past decade’s growth in core earnings (as calculated by S&P) to the end of the next decade (see Week 30, Week 94 and Week 135). That number is then multiplied by the worst P/E seen in the past decade. Mr. Buffett adds on the value of its current annual dividend multiplied by 10, since he doesn’t assume the company will be growing its dividend. Voila! He has a price prediction for 10 yrs from now and can calculate the BBA, which is total return/yr over the next 10 yrs (see Column T in the Table).

How has that worked out for him buying oil and natural gas stocks? He bought 18 million shares of ConocoPhillips (COP) early in 2006 for Berkshire Hathaway but soon thereafter decided he’d bet on the wrong horse. Now he’s down to 1.4 million shares of COP and 6.5 million shares of Phillips 66 (the recent spin-off of ConocoPhillips’ refinery operations). With the proceeds from those sales, he bought 41 million shares of ExxonMobil (XOM) and 7.3 million shares of National Oilwell Varco (NOV). In other words, he changed his mind when the Great Recession exposed the underlying value of specific energy companies (see Table).

The Buffett Buy Analysis starts by determining whether the company has a Durable Competitive Advantage (DCA). Mr. Buffett defines a DCA as a decade’s worth of steady growth in Tangible Book Value (TBV) at a rate of at least 9%/yr, with no more than two down years (see Column S in the Table). We’ve used his method to analyze the 40 oil and natural gas stocks in the Barrons 500 List of the largest US and Canadian companies. After excluding companies that don’t have the required DCA, plus an S&P investment-grade bond rating (i.e., BBB- or better) and an S&P stock rating of at least B+/M, we are left with the 9 companies in the Table. 

Bottom Line: Only two of these 9 oil and natural gas companies had a Buffett Buy Analysis that projected returns higher than 7%/yr over the next decade, namely, Cameron International (CAM) and National Oilwell Varco (NOV). Both are too risky to include in a retirement portfolio. However, ExxonMobil (XOM) is worth considering because it has the largest investment in natural gas production and is projected to have a total return close to 5%/yr over the next 10 yrs. Most importantly for you, XOM does satisfy our requirements for inclusion in a retirement portfolio: 
   1) the stock has a Finance Value (Column E in the Table) that beats our key benchmark (Vanguard Balanced Index Fund - VBINX); 
   2) the stock is an S&P Dividend Achiever; 
   3) the company’s bonds have at least a BBB+ rating from S&P; 
   4) the stock has at least a B+/M rating from S&P;
   5) the stock has had dividend growth of at least 5%/yr for the past 14 yrs, and 
   6) the company is large enough to be included in the Barron’s 500 List published each year in May. The Barron’s 500 List is particularly useful because it ranks companies by sales growth and cash flow-based ROIC (Return On Invested Capital) for each of the two most recent years. 

Risk Rating: 6

Full Disclosure: I dollar-average into XOM and also own shares of CVX.

Note: metrics in the Table are current as of the Sunday of publication. Red highlights in the Table denote underperformance vs. VBINX.

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