Week 312 - Farm Equipment

Situation: Food production is experiencing a “glitch.” Too many people know how to do it too well. Food commodities are being supplied in excess of demand, tapping out storage facilities. Farmers are doing well to “break even” after expenses, i.e., Cost of Goods Sold (CGS) is barely covered by prices paid at the grain elevator. There may not be enough money left to make “precision farming” upgrades to farm equipment. Relations between farmers and their bankers have become strained, since bankers typically refuse to make long-term loans for anything other than farmland. That leaves farm equipment dealers having to make the long-term loan or forego the sale.

Mission: Outline the equipment requirements for farming and create a spreadsheet of public companies that supply such equipment.

Execution: see Table.

Administration: Farming is now in the digital age, where GPS satellites collect information on vegetation and soil that the farmer can buy to better regulate irrigation and the application of fertilizer. His agronomist will use the data to make more cost-effective decisions on the use of pesticides, herbicides, and fungicides. “Precision farming” can sometimes double crop yields compared to the pre-satellite era. But the result of using these devices on his tractor, wi-fi downloads to his agronomist, and upgrades to the accompanying software has not only been expensive but the added efficiencies have to cut crop prices in half. The “family farm” is rapidly disappearing from the planet.

Bottom Line: Commodities will always be risky investments, even the most essential (food and fuel). When there is something people can’t “live” without, the business world will allocate capital toward its production. That effort continues until overproduction converts multi-year profits to multi-year losses. Subsistence farming is giving way to corporate farming because of the abundance of capital being allocated to crop production. Shortages of skilled labor limit the buildout of “precision farming”, giving rise to further technological breakthroughs. These are expensive, and contributed to the 10.5% decline in US farm incomes last year, extending a trend that started in 2014. 

The increases in farm productivity are likely to keep crop prices low until the less-efficient farms (both family and corporate) go out of business. We’re in a period when farmers are less able to afford new equipment and need to make greater use of services to upgrade existing equipment, where Deere (DE) is the dominant company. An increased emphasis will also be placed on non-food uses for corn (268 processing plants in US and Canada) and oilseeds (64 processing plants in US and Canada), where Archer Daniels Midland (ADM) is the dominant company with 265 food & non-food processing plants worldwide. Ethanol, biodiesel, and soy oil plants dot the landscape of farming regions and are a convenient point of sale for farmers, which also link to rail and barge networks that transport crops to food processing plants worldwide. Investors also need to consider owning stock in one of the smaller companies: e.g. Raven Industries (RAVN is the leading supplier and servicer for precision agriculture products) and Valmont Industries (VMI is the leading supplier and servicer for center-pivot irrigation systems).   

Risk Rating: 7-8 (where 10-Yr US Treasuries = 1, S&P 500 Index = 5, and gold = 10). 

Full Disclosure: I dollar-average into XOM and also own stock in CMI, preferring to wait and see whether a new commodity supercycle will be starting soon.

Note: We use discounted cash flow from dividends and sale of the stock (after a 10-Yr holding period) to estimate Net Present Value; see Columns V-Z in the Table. The exponential growth rate in stock price over the next 10 years is estimated to be an extrapolation of the growth in stock price over the past 16 years. The Discount Rate is set at 9%, meaning that a stock with a positive NPV would return more over 10 years than a 10-Yr US Treasury Note paying 9%/Yr. Dividend Growth over the next 10 years is extrapolated from Dividend Growth over the past 4 years. Be aware that our NPV calculation is for comparative purposes only. Any rise in the rate of interest paid by 10-Yr Treasury Notes would diminish stock NPVs, provided that those Notes continue to carry a AAA credit rating from S&P.

Red highlights in the Table denote underperformance relative to our benchmark: Vanguard Balanced Index Fund (VBINX) at Line 22. Purple highlights denote metrics of concern.

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Week 311 - A-rated S&P 100 “Defensive” Companies With Tangible Book Value

Situation: We know for certain that this is a period of great anxiety in credit markets. Trillions of dollars in loans have been made by banks in Southern Europe and East Asia that are now worth less than a third of their face value. Many of these loans were made by private banks, but governments are ultimately “on the hook” for the debt. With non-performing debts on their books, banks have less ability to make worthwhile loans to support economic growth, education and upgrades of infrastructure. A credit crunch is going to happen, unless these bad debts are boxed up, tied with a ribbon, and sold to the highest bidder. Remember: the credit crunch of 2008-09 quickly cut worldwide GDP growth per capita in half, from 2%/yr to 1%/yr. And it didn’t start to recover until this year.

What’s the best way for you to drill down on this subject? I suggest that you read Peter Coy’s article, which appeared in Bloomberg Business Week last October. His analysis responds to the International Monetary Fund’s 2016 Global Financial Stability Report that was hot off the press. Here are bullet points from that report: “medium-term risks continue to build”, meaning 1) growing political instability; 2) persistent weakness of financial institutions in China and Southern Europe; 3) excessive corporate debt in emerging markets. In China, combined public and private debt almost doubled over the past 10 years, and is now 210% of GDP (worldwide it’s 225% of GDP).

Mission: What’s the best way to tailor your retirement portfolio in response to these global risks? Become defensive. That doesn’t just mean having a Rainy Day Fund that is well-stocked with interest-earning cash-equivalents (Savings Bonds, Treasury Bills, and 2-Yr Treasury Notes). It means overweighting high quality “defensive stocks” in your equity portfolio. What is the Gold Standard? Companies in the S&P 100 Index that are in the 4 S&P Defensive Industries:
   Consumer Staples;
   Healthcare;
   Utilities; and
   Communication Services.
Large companies have multiple product lines, and membership in the S&P 100 Index requires a healthy options market for the company’s stock, to facilitate price discovery. You have to drill deeper in your analysis, to be sure the company’s S&P credit rating is A- or better, and its stock rating is A-/M or better. Statistical information has to be available from the 16-Yr series of the BMW Method and the 2017 Barron’s 500 List. Check financial statements for signs of high debt: long-term bonds that represent more than a third of total assets, operating cash flow that covers less than 40% of current liabilities, or an inability to meet dividend payments out of free cash flow (FCF). Exclude companies with negative Tangible Book Value.

Execution: By using the above criteria, we uncover 7 companies out of the 32 “defensive” companies in the S&P 100 Index (see Table).

Bottom Line: Defensive companies are less interesting than growth companies or companies involved in the production of raw commodities. But high-quality defensive companies, such as Johnson & Johnson (JNJ) and NextEra Energy (NEE), consistently grow earnings faster than GDP and are quick to correct any earnings shortfall. All an investor need do is learn to read financial statements, and regularly examine websites for data on companies of interest.


Risk Rating: 4 (where 1 = 10-Yr Treasury Notes, 5 = S&P 500 Index, 10 = gold bullion).

Full Disclosure: I dollar-average into Coca-Cola (KO), NextEra Energy (NEE), and Johnson & Johnson (JNJ). I also own shares in Costco Wholesale (COST) and Wal-Mart Stores (WMT).

NOTE: Metrics are current for the Sunday of publication. Red highlights denote under-performance vs. VBINX at Line 15 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256: Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = average stock price over the past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 4-Yr CAGR found at Column H. Price Growth Rate is the 16-Yr CAGR found at Column K. Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% approximates Total Returns/yr from a stock index of similar risk to owning shares in a small number of large-cap stocks, where risk due to “selection bias” is paramount. That stock index is the S&P MidCap 400 Index at Line 20 in the Table. The ETF for that index is MDY at Line 14. For bonds, Discount Rate = Interest Rate.

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