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Feb 03, 2009

Fields of Gold

By Andrew Mickey, Q1 Publishing

Corn, wheat, soybean prices are at or near multi-decade highs. Fertilizer stocks have soared more than 500% across the board in the past two years. Even shares of tractor maker Deere (DE:NYSE) are sitting just under 30-year highs.

The global agriculture boom is in full swing.

A five pound bag of rice costs a half a day’s wages in India. Skyrocketing wheat prices have caused bread prices to double in countries where three-fourths of a family’s income is spent on food.

Jeffrey Sachs of Columbia University says, “This is the world’s big story.” Sachs further adds, “There are riots all over the world in the poor countries... and of course, our own poor are feeling it in the United States.”

The good news is, despite the problems caused by high agriculture prices, the boom is still just getting started. And there will be plenty of profit opportunities for those companies that can solve the problems. Here’s why…

The agriculture situation is a simple one. There are five factors that will propel the bull market in agriculture for a long time to come:

    - Record global population growth and lack of new farmland
    - Steady decline of production from current farms    
    - Biofuel Boom: Crops for fuel instead of food
    - Soaring demand from growing global middle class
    - Government intervention to “solve” the problem

Food prices have already started to rise. Rampant speculation in the agriculture markets has already pushed wheat, rice, soybeans…almost anything you can grow…to new highs.

But the fast money speculators have pulled out over the past couple of months. The pull-out caused a big correction in agriculture markets. Now, the fundamentals are starting to show through and it’s time to ride the agriculture bull to new highs.

I have to warn you though, all the easy money has been made in agriculture.

Fertilizer stocks like Potash Corp (POT:NYSE), Mosaic (MOS:NYSE), and Agrium (AGU:NYSE) are all up more than 500% in the past two years. And when I hear the talking heads discuss potash on CNBC, you know word is out.

There’s lots of money to be made here, but we’ve got to pay attention to the risks. After a lot of these big names have had such big runs, there’s some upside potential, but there’s a lot of downside risk too.

To find stocks worth buying in this stage of the agriculture cycle, we’re going to have to look a bit harder…but it's not impossible.

All we have to do is cut through the noise and get to the meat (no pun intended) of the story. That’s how we’re going to score big on the remainder of the run in agriculture.

We’re in the third inning of the global agriculture boom. The next big profit opportunities in agriculture are just heating up.

The five stocks you’ll learn about in the next few minutes will be some of the biggest profiteers of the ongoing agriculture boom. There is a crisis brewing in agriculture and there are a few companies that will not just help prevent a global famine…but profit handsomely.

Agriculture Stocks: Farmland: They’re Not Making Any More of It

The root cause of the agriculture boom is a pretty simple one. Demand is rising and supply isn’t keeping up. The chart below says it all.

The amount of arable (suitable for farming) land is in steep decline compared to the world’s population…and it’s only getting worse.

In 1961 there were only 3 billion people in the world. There was plenty of food to go around. There were about 40 arable acres for every man, woman, and child in the world. That was more than enough to feed everyone.

In the five decades since, the situation has completely changed. Today, the world has about 6.6 billion people. That doubling of population has pushed the amount of arable land down to less than 25 acres of farmland per person. That’s a 37% decline in arable farmland per person…and falling.

The world’s population is growing and the amount of available farmland is not. Supply is static and demand is growing, farmland has continued to go up in value. That’s how I like to invest.

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Farms in Iowa have been changing hands for a record $11,000 an acre. Hedge fund dealmakers are scouring Saskatchewan to buy up as much farmland as possible. The Bill and Melinda Gates Foundation is betting big on farmland in Africa. The race to buy up available farmland has begun and it’s only going to continue to drive up prices.

Agriculture Stocks: Fertility Issues

It’s not just that there’s not much more farmland available creating a stir, it’s the decline of production from current farms. On a per acre basis, the growth in production from farmland is starting to decline.

In the 1960’s a population boom in India sent the country into a harsh famine. The rapid development of genetically modified organic seeds (GMO) and chemical fertilizers averted catastrophe. It was the Green Revolution that allowed farmers to get more crops from each acre.

Four decades later, we are starting to realize the Green Revolution was just a Band-Aid and continued population growth is, once again, putting a lot of stress on farms.

Take a look at the chart below. It looks pretty good, right?

Well…not exactly. On a per acre basis, wheat production continues to grow. But if we break it down, the situation is much more alarming.

Between 1970 and 1988 the amount of wheat grown per acre increased from 1.5 tons per hectare to 2.25 tons per hectare. That’s a growth rate of 50% for the whole period or 2.7% growth per year.

Over the next 18 years wheat production only increased to 2.75 tons per acre. That’s total growth of only 22% for the entire 18-year span. On a per year basis, the growth rate is about 1.22%.

This is the sign of a huge problem. Growth rates have plummeted 55% in the past 20 years.

Don’t let the chart lie to you (statistics are often too easily skewed). At first glance, the growth looks fine. When viewed on a year-to-year basis, the growth rate is declining. Combine that with an accelerating population growth and it creates a strong foundation for the agriculture bull to run a lot further.

Any company that can help farmers squeeze more production from each acre is going to do very well over the coming years. In a moment, we'll look at a few companies that do help farmers make more with less. But first there are a few more drivers of the agri-boom we can't ignore.

Agriculture Stocks: Biofuel Backfires

There’s another driver for the agriculture boom: biofuels. Ethanol is the proverbial straw that is breaking the camel’s back. Government-mandated ethanol production is adding another layer of demand to an already tight corn market. And when farmers plant more corn, they plant less of other crops. Ethanol has a domino effect across the entire agriculture industry.

I know what you’re thinking, “Andrew, ethanol doesn’t work. It makes no sense economically when corn was $2 a bushel and makes even less sense at $5 a bushel. It’s just not worth it.”

You’re dead right. Ethanol doesn’t work. Back in 2006 when I first crunched the numbers and told investors to run away from the ethanol bubble, I wasn’t a popular guy. Ethanol was supposed to be the “green solution” we’ve been waiting for.

That has all changed now, but the ethanol industry is not going away. It’s all because of subsidies. In the United States, the ethanol industry is only making money because taxpayers are footing the bill.

The agriculture lobby is one of the strongest in the United States (why do you think Iowa always goes first in the Presidential primaries?) and they’re going to ensure ethanol is here to stay.

Senator Obama is behind ethanol. Senator McCain is on board with ethanol. The Renewable Fuels Association, the lobbying body of the ethanol industry, is currently in talks to sign on Tom Daschle, former Senate Majority Leader, as an advisor.

Ethanol’s Washington ties run deep. Let’s face it ethanol is here to stay…regardless of how absurd it may be.

Agriculture Stocks: Riots in the Streets

Ethanol is just a part of it. The biggest factor of all is most likely the new found wealth of emerging markets.

Think about it. China’s economy is growing at a near double-digit rate. India too. A new millionaire is made every few minutes in these hyper-growth economies and the wealth is trickling down. India and China are quickly developing a middle class, and they’re not splurging on BMW’s and extravagant vacations…the first thing they want is food.

Grain imports in China are rising rapidly. The country’s agriculture system can’t keep up with demand. Meat consumption per capita has increased more than 150% since 1980. And it takes a lot more grain to feed all that additional livestock.

In the past few months, food riots have been popping up all over the place. Food riots have hit Egypt, Yemen, India, Haiti, Singapore…the list goes on and on, I think you get the point. It’s all due to skyrocketing grain prices.

According to the U.S. Department of Agriculture, India exported 5.6 million tons of wheat in 2003. After five years of prosperity, India imported 6.5 million tons of wheat last year. It’s all switched around and demand is only getting higher from here.

What’s the government solution? Should they let the markets sort it out? Would it be wise to allow a few entrepreneurs to buy up underutilized farmland and ramp up production to turn a profit on higher grain prices?

Governments around the world are stepping in to “help” in the only way governments can, by taking a bad situation and making it worse.

Those solutions would make sense, but that’s not going to happen. Governments don’t work like that. Voters want a solution now, regardless of the long-term consequences and the governments are going to keep them happy. Politicians around the world have already started halting exports, raising taxes on exports, or doing other things to interfere with efficient markets.

Governments can’t legislate themselves out of this one. The agriculture boom is a global situation and it’s going to take some entrepreneurial companies operating in a free market to solve it.

Agriculture Stocks: 5 Agriculture Power Plays

As you can see, the agriculture boom is not going away. But all the easy money has been made and we’re not going to see shares of multi-billion dollar companies soar another 1,000%. But that doesn’t mean there’s no opportunity. There’s a lot. And these five agriculture power plays will play a big role in preventing a worldwide famine and turn a nice profit doing it.

Agriculture Power Play #1 – AGCO (NYSE:AG) is the pure play on surging demand for farm equipment. It makes combines, plows, seed planters, balers…everything farmers need.

Its two leading competitors are Deere and CNH Global (NYSE:CNH). The downside to those is that Deere also makes a lot of construction equipment (housing and construction downturn is not doing a bit to help) and CNH’s growth is built on acquiring new dealerships artificially skewing its growth figures higher.

AGCO doesn’t have those issues. As a pure play on farm equipment, it’s going to do very well from the ongoing agriculture boom. After all, farmers are running their equipment hard and growing as much as they can. Also, after years of low prices and running equipment for longer than normal, they need new equipment. Now, they’ve got plenty of money to spend on it.

As always, the proof is in the numbers. Since the ag booom really started to take off, AGCO’s profits have averaged 181% growth since 2005 (that’s not a typo). Meanwhile, Deere’s profits have grown at a mere 12% per year.

AGCO is a pure play that is reaping the benefits of the agriculture boom. CNBC “expert” commentators might be cheering for Deere, but the big winner will be AGCO.

Agriculture Power Play #2 – Cresud (NASDAQ:CRESY) is a publicly traded farm in Argentina. It’s a farm, plain and simple. Cresud produces wheat, soy, and a lot of other crops.

The key thing about Cresud is that it’s cheap. On a per acre basis, the best way to compare the value of farming companies, you’re not going to find anything cheaper.

Hidden Value in Farming Stocks
Company Ticker Symbol:Exchange Market Value Per Hectare**
First Farms FFARMS:Stockholm OMX $9,453
Landkom LKI:LSE $3,998
Black Earth Farming SEK SDB:Stockholm OMX $3,665
Cresud CRESY:NASDAQ $1,447
* Source: Public company filings and reports
** 2.47 acres = 1 hectare

As you can see in the chart, Cresud trades for more than 50% less than its closest competitor, Black Earth Farming, and it’s 84% cheaper than First Farms. Of course, we have to take into account soil qualities, political risk, and a lot of other factors. But it’s plain to see, on a relative basis, Cresud is very cheap.

Cresud is a pretty simple bet. It’s some of the cheapest farmland in the world. And as farmland goes up we can expect the value of Cresud to go along with it.

Agriculture Power Play #3 - Potash One (TSX:KCL or Pinksheets:KCLOF) - is one of the leading potash “junior” companies. Potash One and a handful of others are still chasing after the big potash prize, but Potash One has first mover advantage. It has been developing a potash project in the heart of Saskatchewan's potash belt for more than three years (the process takes a long time - a minimum of 5 years).

It is well funded and is actively laying the groundwork for a big joint-venture (i.e. with a foreign country that would put up a big loan in exchange for a supply agreement) or takeover. If you look at some of their management teams, it would not be overly surprising to see one of them become a producing mine in the next few years.

The way I look at Potash One is simple. It is a highly "leveraged" way to play the potash boom. If you like Potash Corp (NYSE:POT), you've got to love Potash One. It will double or triple the returns of Potash Corp over the next few years (i.e. if Potash Corp climbs 100%, Potash One will clime 200%).

The larger reward, however, does not come without increased risk. Given the situation we're looking at in potash though, the risks are much lower for Potash One than a lot of other junior mining companies. This is the real deal and should be a very big winner over the next few years.

Agriculture Power Play #4 - Sadia (NYSE:SDA) is one of the most efficient food suppliers in the world. Sadia produces 1.3 million tons of meat and poultry products each year. It sells them to customers in more than 100 countries.

Its main operations are in the fertile regions of Brazil known as Soylandia. Labor is cheap and shipping costs are low because it’s right in the middle of South America’s most fertile farming region.

To top it all off, Sadia recently opened up another major processing facility in Russia and inked a long-term supply deal with McDonald’s. 

Sadia has a lot going for it and its paying off in the numbers. Its sales are growing at 25% per year. It has kept costs under control and kept a healthy operating margin of 27% despite its strong growth. And it’s got P/E ratio of 3.  That’s not a typo.  It’s Price to Earnings ratio is 3 – ten times lower than Google's!

Sadia is far and away the cheapest meat processor in the world and lately it has been getting a lot cheaper. Sadia recently lost all of its profits for 2008 thanks to being on the wrong side of a currency bet. The CFO has been fired and the company should make it through. Sadia shares will be attractive at $4 per share and extremely attractive at $2. This will be a winner over the long-term, but the story will take a long time to play out.

Agriculture Power Play #5Viterra (TSX:VT or Pinksheets:VTRAF) is one of the safest agriculture stocks around. Viterra is the new name of the Saskatchewan Wheat Pool.

Viterra was created more than a century ago to provide a market for farmers in western Canada’s agriculture belt. Not much has changed. It’s is still a middle man. As a result, it’s a unique position to generate strong profits without having to take on the risk.

I look as Viterra as the pipeline of the agriculture industry. The company owns the silos, sells the seeds, and makes sure farmers have what they need to farm. It’s the Wal-Mart of the agriculture industry.

Viterra makes good money when the agriculture market is out of favor and makes a lot of money during the good times. The good times are going to last for quite a while and Viterra is one of the safest ways to take advantage of it.

As I write, they are currently dealing with a workers strike. That’s made the stock cheaper.  Once the strike is resolved, Viterra will likely be back on the rise.

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Agriculture Stocks: Bull Speed Ahead

The agriculture bull market is poised to set new highs in the months and years ahead. There will be plenty of winners and some losers along the way. But now, as we move into the next stage of the bull market, safety is of paramount concern.

The days when any Ag-related stock is going to go up 10% each month is over. It’s time to be a bit more cautious, analyze the situation, and look at the fundamentals. Our five agriculture power plays are a safe place to start.

It’s not too late to get in on the next leg of the agriculture bull run. This could have another five years or more left in it. Getting in now and waiting for dips to buy will go a long way to making you a more prosperous investor and start you on your way to true financial freedom.

Good investing,


Andrew Mickey
Chief Investment Strategist, Q1 Publishing

Originally published August 19, 2008

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