Riots in Algeria over the cost of sugar and wheat. Mexico’s government buys corn futures to hedge against rising tortilla prices. Indian Prime Minister Manmohan Singh forced to arrange onion imports from traditional enemy Pakistan. Chinese Premier Wen Jiabao promises shoppers in a supermarket in Inner Mongolia that the government will control food price inflation running at better than 11% annually.
Sure sounds like we’re headed back to the bad old days of 2008 when soaring food prices sparked food riots across the globe. According to the food price index kept by the Food and Agriculture Organization of the United Nations, the price of traded food staples such as wheat, corn, and rice climbed 26% from June to November and are near the historic highs set in 2008.
What the world is seeing isn’t an anomaly in my opinion. The peaks of 2008 and 2010 aren’t unusual events caused by an unusual coincidence of unusual bad weather and some terrible (but usual) government decisions to hoard key grains behind export bans. The peaks are indeed extreme but the long-term trend in food prices is upward and it’s the dip from the peaks of 2008 while global consumers were tightening their belts in response to the Great Recession that’s actually the anomaly.
Absent a return to global recession I think the upward trend in food prices is guaranteed to continue. The forces pushing prices upward are just too simple and massive. And the policy responses from governments that might temper the trend are just too limited. If you’re a long-term investor, the upward trend in food prices is one of the safest trends that you can invest in for the long term.
It’s also one of the most frustrating because it is so hard to find good stocks positioned to take advantage of rising food prices. Eliminate those that don’t trade publicly or in the United States and the number gets even smaller. (One of my favorites is Brazilian food processor—beef, pork, chicken, and lamb plus frozen vegetables, ready meals, and pasta—Marfrig Alimentos but while volumes are above a million shares a day in Brazil (symbol MRFG3.BZ), the stock trades hardly at all on the U.S. OTC market.)
But I think you can expand the universe—a bit anyway—if you go back to the root causes of rising food prices.
Demand for staple grains, for example, is forecast to rise by 2% in 2011. Where’s that demand coming from? A larger global population, certainly. But also rising global incomes: as incomes rise, even modestly, people want to eat more meat. Turning grain into pork or chicken or (corn-fed) beef is a very inefficient way to produce protein. And then, at least in the United States, there’s competition for grain from energy production. The International Monetary Fund estimates that 70% of the increase in corn prices in 2008 was due to demand for corn to produce ethanol.
The solution would seem to be simple, right? Grow more food. But increasing food supply isn’t easy. First, the world isn’t producing any more good farmland. In fact, we’re losing farm acres every year to causes that range from desertification to urban development. Second, while increasing the productivity of much of the world’s farm land is certainly possible, we’ve got a mismatch in much of the world between the cost of the inputs that would raise productivity—better seeds, more fertilizer, better irrigation—and the ability of the poor farmers to pay for them. Third, many of the cheapest and easiest methods for raising productivity have hit what are real limits—given the absence of investment capital. For example, cheap forms of irrigation have depleted the water table in farm areas of India and added near-toxic levels of salts from fertilizers to the soil. That situation is certainly fixable but deeper wells, drip irrigation, and soil restoration all require investments beyond the means of many farmers. And fourth, global climate change is making the weather less predictable. For example, it looks like what I think is best thought of as global weirding—and not global climate change or global warming—is in the process of changing the patterns of South Asia’s monsoon rains and the oscillation between La Nina and El Nino patterns in the Pacific.
To think about how this all plays out for investors, break it into two parts. First, rising food prices mean that there will be more farm income (however, inequitably distributed in the world) to invest in growing more food. Second, consumers—and the companies that supply them–will be looking to find ways to cut their cost.
What companies prosper as farmers have more to spend?
The classic play, of course, is farm equipment maker Deere (DE). Deere’s sales closely track farm incomes. So Deere’s shares popped when the U.S. Department of Agriculture announced, on January 12, that U.S. corn, soybean, and wheat inventories fell by 10.5%, 15.2%, and 4.7%, respectively. Lower inventories mean higher prices for U.S. farmers and higher sales for Deere. (Deere is a member of my long-term Jubak Picks 50 portfolio https://jubakpicks.com/jubak-picks-50/
Seed makers are a slightly more long-term investment because the next big payoff is drought resistant seeds that require less water and that research is just starting to put seeds into fields. My two favorites here are E.I. DuPont (DD) and Europe’s Syngenta (SYT).
Can’t grow plants, no matter how drought resistant, without nutrients, and in many countries applying more fertilizer is the best way, in the short-term, to increase yields. My picks here are Potash of Saskatchewan (POT), Agrium (AGU), and Yara International (YARIY).
In that group I’d probably give the lead to Yara International because of its recent moves on bulk liquid fertilizers. The company is in the process of acquiring the part it doesn’t yet own of Yara Nipro, the market leader in bulk liquid fertilizers in Eastern Australia. Liquid fertilizers are particularly well suited to farming in areas where water is scarce and in many of these markets liquid fertilizers are just establishing a foothold. Only 3% of fertilizer in Eastern Australia is supplied in liquid form.
And speaking of water, irrigation is a growth industry as weather gets less certain. Lindsay (LNN), a stock I added to Jubak’s Picks in December https://jubakpicks.com/2010/12/23/buy-lindsay-lnn/ is a leader in big center-pivot irrigation systems. Jain Irrigation Systems, which specializes in extremely efficient drip irrigation systems, is the other irrigation pick I’d make. (Unfortunately for U.S. investors the Indian company only trades on the Indian stock market. Ticker is JI.IN if you can buy it in India)
Now let’s go to the other side of the trend and look at companies that will profit as consumers and consumer-companies look to avoid the worst effects of rising food prices. Brazil’s Marfrig Alimentos is an example. In the last year the company has become a supplier to U.S. fast food restaurants and I think that’s a likely growth opportunity as those companies look for cheaper supplies. I’d also add Bunge (BG), the big soybean supplier. Bunge has the global contacts to source the soy beans it processes at the best global price of the moment—and that will give the company the ability to ride the changing currents of rising food prices. (The stock is also one of my Jubak Picks 50 https://jubakpicks.com/jubak-picks-50/ ) Following this same logic I’d favor the biggest of the global food companies because they can source their ingredients from whatever part of the globe is cheapest at the moment. Here my pick would be Nestle (NSRGY).
That list of 10 stocks (not counting Jain Irrigation) doesn’t exhaust the opportunity. But it should be enough to get you started.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund, may or may not now own positions in any stock mentioned in this post. The fund did own shares of Agrium, Deere, Lindsay, Marfrig, Nestle, Syngenta, and Yara International as of the end of November. For a full list of the stocks in the fund as of the end of November see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/. I’ll have the fund’s portfolio as of the end of December posted in a few days.
creativekev,
For clarity for all readers, here’s what I’d recommend. Determine based upon your goals, risk appetite, etc, what portion of your portfolio you’d like to devote to ag stocks. From there, determine the stocks you want to own to be diversified. If your current portfolio is underweight from your target ag allocation, consider buying a new stock or adding to an existing position.
It sounds like you’ve already done that and determined that you would like to add to your POT position. You have to ask yourself if you’re more of a dollar-cost-averager, who doesn’t try to time the market; a momentum investor; or a pure value investor, who will thumb his nose at a price that is too high. For most investors, dca is the preferred approach. If you use that approach, then on your regular rebalancing date, you should buy more POT at any price. The benefit is that the shares you bought at the lower price will average out with the shares at this price, and your cost basis will still be significantly below today’s price.
My personal approach is a combination of dca and pure value. I bought POT in 2009 at approximately $90, and haven’t added to it since. That said, my allocation is roughly right because it’s gone up with the rest of my portfolio. If you were to ask me if POT is a “fat pitch” value play, obviously trading below fair value, based upon my calculations, I’d have to admit that it no longer is. There are better value plays out there. But I’d agree with your assessment above that the ag trend still has strong winds behind it, and this is a long-term play that has the current momentum. I am not going to sell because I think the trend will go to excess, and it’s not there yet. And the future profits could very well exceed my expectations and the predictions of my model, which is very conservative.
POT’s FCF for the first 6 months of 2010 is already approaching the total FCF for all of 2007. 2010 earnings are projected near $5 and 2011 near $9, which could be low. Interest rates are much lower now than in 2007 and inflation is picking up. And with food prices what they are, farmers will be scrambling next year to squeeze every bit of yield out of their acreage. So right now POT should be trading similarly to how it did in 2008, and I fully expect it to go to all-time highs within 3 years. Note that my general outlook on the market is bullish.
So, like usual from me, you get a long and convoluted answer. It may not be what you were looking for, but I want to always send a clear message. Simple “buy” or “sell” recommendations are useless unless associated with an investing type and risk profile. I’d never tell somebody to buy a stock; only point out an option that is worth considering. That’s the whole reason I am a regular, devoted reader here on Jim’s site. I’m looking to test Jim’s and other people’s ideas in my own model.
So, if I were forced to give a simple answer to you, I’d recommend to dca investors with an underweight exposure to “buy”. For momentum investors, I’d say the trend is on, so “buy”. But for pure value investors, I’d say “hold”. As for me, I’m “holding”.
Note that my propensity for value has caused me to miss out on many gains, by thumbing my nose at “overvalued” stocks. For instance, I didn’t buy Ford last year… my model did not predict a price above $12 and I recommended a “don’t buy” to a friend with my usual caveat. He bought anyway and made a bunch of money. (Somebody on here a while back highlighted AMRN at $1.75. I wish I’d have bought it, but my model told me “no!” Oh well.) My model has a conservative, value bent. That’s ok with me; I’ll live with my model because it works for me. When I defy it, I often suffer! Like most investors will tell you, find something that works for you and stick to it. Don’t ever take my word for anything. Do your own calculations. Maybe I can give you a good idea to put into your own model, and if it works for you, great! That’s what we’re all here for.
Gotta thank Jim for making this all possible.
USDAportfolio,
I hold POT and would like to add to it, but it has had quite a run-up recently taking it from around $138 to currently $172. Should I wait for a pullback from this level? At the same time, I think the current up cycle in farming and fertilizer application has just started recently and should have a ways to go, and so POT could certainly move up more (I remember fertilizer stocks’ nonstop up moves in 2007). What do you think?
USDAportfolio,
Thanks for your comments. I didn’t think about the comfort ride aspect of Deere equipment and how that could encourage upgrading. I see now that DE’s revenue is more continuous and less lumpy than I thought. I’ve now added DE to my watch list.
Everything in the article is acceptable – good logic and good names. The trouble is that it is too late to get into any of these names. I would strongly advice caution – in my opinion they are all priced to perfection. Either wait for a dip or be willing to ride the turbulence ahead.
This trend is perhaps the one I am most comfortable investing in. And right now, the tailwinds are definitely in place for ag stocks. I’m surprised Jim missed it over the last year. I have held POT, DE, DD, and MON since 2009. MON has underperformed, but I think it’s worth the risk in a diversified ag portfolio. For those who want less risk, stick with DD instead of MON. If you’re willing to assume more risk for more potential reward, MON is more of a pure play on ag than DD and I expect them to have the best seed genetics for the long-haul.
For those who don’t want to buy individual stocks, consider MOO.
creativekev — Note that DE makes construction and forestry equipment in addition to ag and lawn care products. In addition to new equipment, they also sell replacement parts. I recommend you visit their website for more information. There you’ll discover that there’s also a “trade up” effect in place. DE is constantly improving the quality and comfort of the ride: full A/C, MP3 and satellite radio system with subwoofers, one-touch NOAA weather channel broadcasts, air-suspended leather seats and steering wheels which dampen vibrations, touch screen LCD displays, and real-time connectivity to cell phones or PCs. Not to mention cleaner, quieter, and more fuel efficient than the competition.
With farm incomes rising, buying new DE equipment is not only about buying the best product to operate and manage your farm operation, but also a personal “comfort ride” and status symbol among farmers. As I said, go to their website and check it out. You will learn something and probably be surprised. This isn’t your father’s Deere.
Does anyone know how often Deere equipment needs to be replaced by farmers? I’ve hesitated to buy DE previously because I was afraid that once farmers buy a particular piece of Deere equipment, they won’t need to buy it again anytime soon. I think of my own lawnmower at home that I have not needed to replace for almost a decade now. Meanwhile, I keep coming across buy recommendations for Deere. I’d feel better about taking a position if I knew how often their equipment is replaced. Also, how many different pieces of Deere equipment does a farmer need – i.e. just a tractor, or other items too?? (Note: I have no background in farming, as you can tell.) Thanks.
re: my last post……. CF Industires (CF) would be a good bet for nitrogen producers. They recently bought Terra so they have quite a strong market position. The stock has already been on a tear so caution is in order but it could be a good bet on any pullbacks.
McDonalds may not seem like a good bet when food input costs are rising, but they are a low cost place to eat and statistics show that when food budgets get tight people move down the cost and nutrition chain. Combine that with new menu options good growth globally, a dividend over 3% (and rising) and a terrific balance sheet and you have a winner.
I mention it now because it has sold off to a decent entry point around $73. I am starting a position and will add to it if the selloff continues.
Potash is at $172 today. Jim, are you recommending a buy here? Didn’t you say to sell it at $90 a couple of months ago? I would look for nitrogen fertilizer producers now while their main production input, natural gas, is so cheap. Their margins should be very very strong.
Any thoughts on ABV’s recent split and plunge?