Bought in todayNew to this sector but like the diversification and its potential. Bought SOIL for the same reasons
Financial Post article
Ag bulls unshaken
Peter KovenJul 22, 2011 – 2:28 PM ET| Last Updated: Jul 25, 2011 8:41 AM ET
Agriculture bulls often like to say that their favourite sector is impervious to economic jitters. Everyone has to eat, the theory goes, so who really cares if some debt ceiling or other is breached?
Of course, that theory has been proven wrong before — witness the laughably bad performance of fertilizer stocks amid the 2009 recession. But there is an underlying truth right now that the global population is rising fast and food inventories are historically low. That should bode well for these companies, regardless of the economic worries that are making the broader markets skittish.
But that hasn’t been the case lately. Despite a vicious heat wave in North America that threatens crops, reports of famine in East Africa, and skyrocketing earnings across the agriculture sector, the stocks have done very little over the last few months.
Like most other resource equities, they went on spectacular runs in late 2010 and now appear to be waiting for some sort of catalyst to get going again. But there has been no sign of that yet, and experts say that it may take a while before investors get comfortable with the valuations again.
“It’s going to be a gradual recovery,” says Edlain Rodriguez, an analyst at Gleacher & Co. in New York.
It is not like there is any shortage of potential catalysts. The steaming weather outside is an obvious one. Corn prices are nudging up against a whopping US$7.00 a bushel, up from about US$2.50 four years ago, despite reports of healthy spring planting in the United States. And last month, China accepted a big potash price hike of US$70 a tonne from the fertilizer companies that will carry through the rest of the year.
Fertilizer firms are also in the midst of their earnings season, and Mosaic Co. reported very strong results this week that bode well for its competitors (including Potash Corp. of Saskatchewan Inc., which reports on Thursday). Mosaic had a gross margin of nearly US$1-billion in the quarter, up 500% in the last five years. Potash Corp.’s should be even higher than that.
But holding everything back right now is a concern that crop prices, which have been extremely volatile, are not sustainable. There is speculation that prices could drop because farmers are increasing planting to take advantage of high prices, or because the United States could halt the ethanol subsidy program that tightened up the corn market. About 40% of U.S. corn production is currently re-routed to ethanol production, according to the New York Times, which is a staggering amount given food shortages in other parts of the world.
In the fertilizer sector in particular, there is a huge disconnect between fertilizer equities and corn prices, with the latter dramatically outperforming the former (an unusual event). One lingering issue is that India is playing hardball with the potash producers and holding out for lower prices. But after China signed the contract with the big price increase, investors are less focused on that issue.
So what are crop prices actually going to do? Plenty of analysts have tried to break it down on a micro level. BCA Research, for example, expects grain prices to move up in the second half of 2011 (for many of the reasons above, plus low wheat acreage in the United States and Thai government policy that should increase rice prices). On the other hand, it sees lower prices in 2012 because of increasing production and the potential phase-out of the U.S. ethanol policy.
A short-term indicator on prices will arrive in mid-August, when the U.S. Department of Agriculture releases a crop production report that should indicate what effect the heat wave had on crops. It is one potential market mover for the equities.
But the agriculture bulls, like Bill Doyle of Potash Corp., rarely dig into those micro numbers. They point to the bigger picture, which is that the global population is expected to rise to 9.2 billion people by 2050, and food production will have to grow 70% in order to feed them. It all means food production and food security are going to be increasingly important in the long run, so who really cares if investors move in and out of the sector in the short term?
“The reality is that [grain] demand has grown faster than we have been able to keep up with it. And we don’t see that changing anytime soon,” says Soren Schroder, head of North American operations at U.S. agribusiness giant Bunge Corp.
With such low food inventories around the world, he says that there will have to be virtually no blips in food production over the coming months to keep prices in check (unlike the last 12 months, when there were huge weather-related problems in Australia and Russia).
And while a bit of a buffer is likely to be created over the next couple of years from rising production, he thinks the agriculture boom remains sustainable, and that farmers have all the motivation they need to continue to grow their acreage and invest in technology.
“It’s fair to say that the overall price table of agricultural commodities have come into a new plateau, and we won’t be going back to the prices we saw four or five years ago. Those days are gone,” he says.
The general performance of the equities suggests that investors agree with him. While they have some mild concerns about the direction of grain pricing that may be keeping the equities in a holding pattern, the stocks have also been quite impervious to downside pressure. Investors appear content to sit back for now and let these companies make more money and get more attractive from a valuation standpoint.
If that lasts a while longer, experts say that it isn’t such a bad thing. If anything, it might bring more credence to the theory that this sector really will prove to be recession-proof this time if global economic concerns get a lot worse.
“What I like about this sector is that we’re not dealing with fads or fashions,” says
Don Coxe, chairman of Coxe Advisors LLC and an outspoken agriculture bull.
“When you’re dealing with tech stocks, you have to figure out which handheld device people are going to want in nine months. I don’t want to be involved in that kind of thing. I simply say that people want to have more protein in their diet, and we know exactly how it needs to be done.”