Week 210 - Fortune 500 Agronomy and Food Production Companies

Situation: We like food and agriculture related investments because companies in that sector respond to global (not just US) demand. Those companies also respond to farm commodity prices, which are influenced as much by the weather as by macroeconomic factors (e.g. interest rates, labor costs, and GDP). Holding stocks in that sector gives you a non-correlated asset, i.e., one that is out-of-sync with the US economy. This is a good thing because it helps to balance your portfolio in tough times. In addition, since food is an essential good, companies in this sector retain pricing power during recessions. This strategy for insulating your portfolio against the ups and downs of the S&P 500 Index differs from other hedging strategies because long-term rates of return typically outperform the S&P 500 Index instead of underperforming it (as would occur for example by using Treasury bonds as a hedge). That outperformance comes with added volatility because the food and agriculture sector is even more complex than the energy sector. That said, you’ll need a way to categorize and evaluate the key players. 

Mission: Categorize and evaluate companies in the food and agriculture sector, starting with the chemical companies that address the agronomy needs of farmers, and food production companies.

Execution: First we’ll break down the “roles and missions” of companies in each sub-sector by using the analogy of a 4-legged stool. We start with the Fortune 500 List, which ranks companies by revenue and comes with features that help us to categorize and evaluate companies in all sub-sectors of the US economy. This year’s updated list was recently published and includes data on 1000 companies (ranked by revenue). There are a variety of tools for the investor to use, such as the year-over-year (YOY) change in each company’s revenue and earnings. There are also alphabetical lists of companies in every sub-sector. Food and agriculture related sub-sectors include: apparel, chemical, beverages, construction and farm machinery, energy, food consumer products, food production, food services, food and drug stores, forest and paper products, industrial machinery, motor vehicles and parts, packaging & containers, tobacco, food wholesalers, and grocery wholesalers.

The 4-legged stool has 2 legs that are on the buy side and 2 on the sell side. The buy side includes the companies in sub-sectors that help a farmer grow crops and raise animals then find someone who will buy those farm commodities. One buy side leg is for “hardware” (e.g. tractors) and the other is for “software” (e.g. fertilizer). The 2 legs on the sell side are companies in sub-sectors that either make intermediate products for sale to wholesalers, or further process farm commodities for marketing directly to consumers (e.g. a leather goods company). For this week’s blog, we’ll look at one sub-sector on the buy side (chemical companies that serve the agronomy needs of farmers) and one on the sell side (the “food production” sub-sector, as opposed to “food consumer products” that is the other leg of the sell side). 

In constructing this week’s Table, we have compared the Fortune 500 List to the Barron’s 500 List, which assigns a grade-point average to each company based on 3 key operational metrics that are related to growth in earnings and revenue over the past 3 yrs (see Week 205). We’ve screened out companies that have S&P bond ratings lower than BBB+ and S&P stock ratings lower than B+/M.

There are 12 stocks that meet our criteria, 6 from the Chemical industry and 6 from the Food Production industry (see Column T in the Table). Four companies have 30-yr stock price records that have been analyzed statistically by the BMW Method (see Lines U-W of the Table): Archer Daniels Midland (ADM), Seaboard (SEB), Dow Chemical (DOW), and duPont (DD). Column U of the Table shows that all 4 beat the price-only S&P 500 Index (^GSPC at Line 22) over that 30-yr interval, returning an average of 9.9%/yr vs. 7.0%/yr for ^GSPC. Each of the 4 carries a statistical risk of loss in a future Bear Market that is equal to or greater than that for the S&P 500 Index (see column W in the Table). The average predicted loss for those 4 stocks is 48% vs. 42% for ^GSPC. During the 18-month Lehman Panic (see Column D in the Table), those 4 had an average total return of -48.5% vs. -46.5% for the lowest-cost S&P 500 Index Fund (VFINX at Line 21 of the Table). 

Heightened risk is a common feature of commodity-related companies, partly because managers have to plan on selling products worldwide. For example, the US-based companies listed in the Table have to compete with similar companies based in Europe, including Bayer AG (BAYZF), BASF SE (BASFY) and Syngenta AG (SYT). All 3 of those companies actively market their products to farmers and farm cooperatives here in south-central Nebraska where I live. And Syngenta has a large seed production and research facility here. “The world is getting smaller” and companies that need to compete globally are finding that they have to consider merging. Several in the food and agriculture sector have already entered into co-marketing agreements. Monsanto, the world’s largest seed producer, is currently offering to buy Syngenta, the world’s largest pesticide producer.

Bottom Line: There are only two ways to beat the S&P 500 Index. One method is to trade on insider information (try that and you’ll go to jail). The second is to trade in stocks that carry more risk than the S&P 500 Index. The most productive risk plays address global rather than regional opportunities. Riskier stocks that beat the S&P 500 index long-term are typically issued by companies having business plans that are relatively immune to the macroeconomic forces (like US interest rates and GDP cycles) that drive the S&P 500 Index. Such a company’s prospects are instead driven by global, non-macroeconomic events (e.g. weather cycles). Most of those business plans are linked to a commodity “supercycle”. Your best bet is to study companies that use an essential commodity for their main feedstock. That way the market for their products will be driven by global growth in middle-class consumers as well as non-macroeconomic events. This logic takes you to considering companies that supply farmers with seeds and pesticides, as well as companies that produce protein-rich food. 

NOTE: The risk-adjusted returns you’ll enjoy from this method of investing are no greater than from an S&P 500 Index fund. The main reason to add commodity-related stocks to your portfolio is the benefit that comes from owning non-correlated assets over several market cycles (e.g. 30 yrs), which is to reduce your portfolio’s S&P 500 Index-related volatility without sacrificing returns.  

Risk Rating: 7.

Full Disclosure: I own stock in CF, MON and DD.

Note: Metrics in the Table that are highlighted in red denote underperformance relative to our key benchmark, the Vanguard Balanced Index Fund. Metrics are current as of the Sunday of publication.

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