Agriculture: The Good and Bad in a Sector that Looks Cheap*

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The case for investing in global agriculture supply companies is fairly obvious and well known. The world’s population cruised past the 7 Billion mark this year, and while all of these people are unique individuals with different buying power and preferences, one thing is for sure; they all eat food. Agricultural supply has built in growth over the long term, but this year, as stocks in general have risen significantly, the agriculture supply industry as a whole is down around 9%. Common sense tells you there must be some value to be had, but where is it?

The Bad

Let’s start with where it isn’t. Potash producers such as Mosaic (MOS) have borne the brunt of the losses in price as evidenced by a chart of an ETF that tracks them, Global X’s Fertilizer ETF SOIL.


 

This has led many to conclude that there is value to be had there, but the news that caused the big drop at the end of last month is still relevant. The Belarusian Potash Company, a joint venture between Belaruskali and Russia’s Uralkali was unwound. This giant producer had enormous pricing power, and the ending of the cartel has produced a sharp drop in prices around the globe.

The problem I see is that artificially high prices have, over the years, resulted in increased supply. This level of supply is still there and, at market pricing, it will be years before the supply and demand equation comes back into balance. In a few months, the recent bounce back may start to look like a pause in a medium term decline in the industry. Long term, it will undoubtedly present some opportunities, but the industry may well have further to fall before that happens.

Agricultural supply companies not dependant on potash have also underperformed in general this year and the best value may be found there, but again, not all are equal.

Monsanto (MON) is a controversial company because of their focus on genetic modification. That may continue to weigh on the stock, but my reasons for staying away have more to do with valuation and the technical look of the chart.

 

The series of lower lows and lower highs evident here is hardly encouraging. Couple that with a P/E over 18 and the company looks, at best, fairly valued.

The Good

Valmont Industries (VMI) is not a pure play on agriculture. Their fabricated metal and coatings products have other applications, but the company was founded on irrigation systems and they are still their best known product. With a global concern about water usage and conservation, their expertise in that area should be invaluable in the future. They are a solid, profitable company and a P/E around 12 looks remarkably cheap.

 

In this case, a bottom seems to have been found just above 130, which, if nothing else, gives a decent stop-loss level.

Deere & Company (DE) is probably the best known agricultural supply company outside the industry, due to their consumer products division. They too have underperformed massively this year, losing a couple of bucks overall. Assuming continued gradual recovery in the consumer area and growing demand from agriculture, DE also looks good value at a P/E under 10.

A more global play can be had by an investment in the IQ Global Agribusiness Small Cap ETF (CROP). This fund is actually up around 10% YTD, but has still underperformed the market. The fund’s focus on small cap agricultural businesses around the world makes it more risky than DE or VMI, but it is a pure bet on the growth of agriculture around the world. As demand increases, so technological advancement becomes key, and an investment spread amongst small companies makes it more likely that you will have a piece of “the next big thing” when it comes along.

As the stock market continues to move basically sideways, the importance of identifying sectors with potential for growth is exaggerated. In the case of agriculture, the opportunity is there, but it is not universal. Internal dynamics could keep the fertilizer suppliers depressed for some time, but in other areas a simple return to the mean will provide a decent profit.

We all eat (some more than others: see my picture above) and the world’s population continues to grow, so demand for the end product of agriculture is assured. It is possible to profit from this, but selectivity is the key.

 

*I cannot tell you how strongly I had to resist the temptation to write a headline about “planting a seed” or “reaping a profit”!



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Investing Ideas , Commodities , ETFs

Referenced Stocks: CROP , DE , MON , MOS , SOIL , VMI

Martin Tillier


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