Week 165 - Production Agriculture Companies in the Barron’s 500 List

Situation: Regular readers of this blog have already been introduced to 2 key strategic facts about making investments in food-related companies: 1) food prices tend to rise 1-2% faster than general inflation because demand for protein increases faster than supply; 2) food-related commodities are what we call “countercyclical” because pricing is dictated by the weather, not global economic patterns. If you don’t want all your retirement savings tied to the economic cycle, a good alternative is to consider investing in businesses that supply farmers and help get their products to market. We’ve recently blogged (see Week 161) about companies that process farm products and distribute those items to grocery stores, hospitals, homes, hotels, restaurants, etc. Because food is essential, those companies can raise prices in response to a commodity shortage. But farmers lose money when they can’t deliver commodities because the weather won’t co-operate. In other words, production agriculture is at the mercy of the weather but the processing and distribution of food products is not.

Many companies support production by the farmer, not just the ubiquitous seed and fertilizer stores. There are suppliers of diesel engines that run center-pivot irrigation systems, tractors to plant seed and spread insecticides, fungicides and herbicides, combines to harvest grain, factories to package meat, others that produce ethanol and animal feed from corn, and companies that ship grain and meat overseas. The screen for this week’s Table includes all 15 Production Agriculture companies in the Barron’s 500 List. That list ranks the 500 largest companies (by revenue) on the New York and Toronto stock exchanges. The Barron’s rankings for 2014 and 2013 are in Columns G & H of the Table. Rankings reflect the letter grades for 3 metrics: growth in revenue over the past year, median 3-yr growth in cash-flow based return on invested capital (ROIC), and the past year’s growth in ROIC divided by median 3-yr ROIC. 

Most of the stocks in the Table are volatile in terms of both the 5-yr Beta (Column K) and losses during the 18-month Lehman Panic (Column D) when compared to our benchmark, which is the Vanguard Balanced Index Fund (VBINX). Monsanto (MON) and Archer Daniels Midland (ADM) appear to be the only companies where rewards outweigh risks enough for the stock to fit into a retirement portfolio. But long-term rewards for each of the 15 stocks (Column C) are far greater than for the lowest-cost S&P 500 Index fund (VFINX). Red highlights denote underperformance relative to our benchmark (VBINX).   

Bottom Line: The companies that serve the needs of farmers are at the mercy of the weather. If farmers don’t have money to spend on a) technologically-advanced farm implements, b) seeds engineered to resist drought and disease, and c) fertilizers to correct losses of essential elements from the soil (potassium, phosphorus, and nitrogen), those farmers aren’t going to be efficient producers this season. That means they’ll have less money to spend on such “productivity upgrades” next season, and the companies that supply those upgrades to farmers will make less money. When the weather makes a turn for the better, farmers will have excess cash and those vendors will do well going into the next season. And, when farm operations are productive that increase in supply will dampen price increases for items on grocery store shelves. In other words, the economic cycle tends to be moderated by the weather cycle: the two are out of sync. As investors, we need to have retirement money working for us in both cycles to smooth out our returns on investment.

Risk Rating: 7

Full disclosure: I have no plans to purchases shares in companies that are listed in the Table, but do own stock in MON, POT, CMI, DE, DD, and CAT.

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