Week 312 - Farm Equipment

Situation: Food production is experiencing a “glitch.” Too many people know how to do it too well. Food commodities are being supplied in excess of demand, tapping out storage facilities. Farmers are doing well to “break even” after expenses, i.e., Cost of Goods Sold (CGS) is barely covered by prices paid at the grain elevator. There may not be enough money left to make “precision farming” upgrades to farm equipment. Relations between farmers and their bankers have become strained, since bankers typically refuse to make long-term loans for anything other than farmland. That leaves farm equipment dealers having to make the long-term loan or forego the sale.

Mission: Outline the equipment requirements for farming and create a spreadsheet of public companies that supply such equipment.

Execution: see Table.

Administration: Farming is now in the digital age, where GPS satellites collect information on vegetation and soil that the farmer can buy to better regulate irrigation and the application of fertilizer. His agronomist will use the data to make more cost-effective decisions on the use of pesticides, herbicides, and fungicides. “Precision farming” can sometimes double crop yields compared to the pre-satellite era. But the result of using these devices on his tractor, wi-fi downloads to his agronomist, and upgrades to the accompanying software has not only been expensive but the added efficiencies have to cut crop prices in half. The “family farm” is rapidly disappearing from the planet.

Bottom Line: Commodities will always be risky investments, even the most essential (food and fuel). When there is something people can’t “live” without, the business world will allocate capital toward its production. That effort continues until overproduction converts multi-year profits to multi-year losses. Subsistence farming is giving way to corporate farming because of the abundance of capital being allocated to crop production. Shortages of skilled labor limit the buildout of “precision farming”, giving rise to further technological breakthroughs. These are expensive, and contributed to the 10.5% decline in US farm incomes last year, extending a trend that started in 2014. 

The increases in farm productivity are likely to keep crop prices low until the less-efficient farms (both family and corporate) go out of business. We’re in a period when farmers are less able to afford new equipment and need to make greater use of services to upgrade existing equipment, where Deere (DE) is the dominant company. An increased emphasis will also be placed on non-food uses for corn (268 processing plants in US and Canada) and oilseeds (64 processing plants in US and Canada), where Archer Daniels Midland (ADM) is the dominant company with 265 food & non-food processing plants worldwide. Ethanol, biodiesel, and soy oil plants dot the landscape of farming regions and are a convenient point of sale for farmers, which also link to rail and barge networks that transport crops to food processing plants worldwide. Investors also need to consider owning stock in one of the smaller companies: e.g. Raven Industries (RAVN is the leading supplier and servicer for precision agriculture products) and Valmont Industries (VMI is the leading supplier and servicer for center-pivot irrigation systems).   

Risk Rating: 7-8 (where 10-Yr US Treasuries = 1, S&P 500 Index = 5, and gold = 10). 

Full Disclosure: I dollar-average into XOM and also own stock in CMI, preferring to wait and see whether a new commodity supercycle will be starting soon.

Note: We use discounted cash flow from dividends and sale of the stock (after a 10-Yr holding period) to estimate Net Present Value; see Columns V-Z in the Table. The exponential growth rate in stock price over the next 10 years is estimated to be an extrapolation of the growth in stock price over the past 16 years. The Discount Rate is set at 9%, meaning that a stock with a positive NPV would return more over 10 years than a 10-Yr US Treasury Note paying 9%/Yr. Dividend Growth over the next 10 years is extrapolated from Dividend Growth over the past 4 years. Be aware that our NPV calculation is for comparative purposes only. Any rise in the rate of interest paid by 10-Yr Treasury Notes would diminish stock NPVs, provided that those Notes continue to carry a AAA credit rating from S&P.

Red highlights in the Table denote underperformance relative to our benchmark: Vanguard Balanced Index Fund (VBINX) at Line 22. Purple highlights denote metrics of concern.

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