The value effect has been a very potent source of alpha in the past. I advocate investing in stocks based on value over trying to divine the price movements of commodities. Investors seeking alpha in the agricultural sector are better served by trying to find cheap stocks to buy instead of trying to guess the price movements in futures markets.
This perspective is also based on the observation that commodity markets are tough to predict. A price performance comparison between popular funds, such as the iPath Pure Beta Agriculture ETN (DIRT) and the iPath DJ-UBS Agriculture TR Sub-Idx ETN (JJA), versus corn futures has shown that a long corn position outperformed almost all commodity and commodity-related investment products in 2012. However, so far in 2013, positions in corn have underperformed U.S. equities.
Thus, investors looking into the agricultural sector must carefully seek individual opportunities as opposed to a general investment in an industry or perceived trend. In short, value investing still applies among commodity stocks.
Agriculture Stock Results
Agrium (AGU) reported a higher-than-expected fourth quarter profit, posting $2.34 worth of earnings per share compared to analysts' estimates of $2.00 per share, because of an increased demand from farmers for fertilizer and crop protection products. Even as wholesale sales of Agrium's products dropped 7 percent due to weakened demand for potash in key international markets (particularly the Indian and Chinese markets), retail sales rose 8 percent producing an aggregate percentage increase in sales of 3 percent to $3.26 billion.
The decrease in demand for potash also hit other agricultural players such as Potash Corp. of Saskatchewan (POT) and the Mosaic Company (MOS). Protection products are expected to have better prospects in 2013. The global demand for potash will seem to recover as Chinese markets have committed purchases to Canpotex, a company that facilitates offshore sales for Agrium, as is Potash Corp of Saskatchewan and Mosaic. The global demand for nitrogen, similarly, is expected to increase 2 to 3 percent this year as high crop prices are enticing farmers to elevate agriculture production. High crop prices are due to the scarce supply for global grain and oilseed. CF Industries (CF) rivals Agrium in the nitrogen production segment. CF Industries has reported a record $7.40 per diluted share in the fourth quarter of 2012 compared to $6.66 per diluted share on the same quarter one year earlier. It also commenced expansion of its nitrogen segment worth $3.8 billion as the agricultural outlook for 2013 seem optimistic.
It's not all positive news for Agrium. The company has been accused by JANA Partners, its largest shareholder, of continuously releasing false accounts of the settlement talks between the two companies. Barry Rosenstein, Managing Partner from JANA, said, "We are sure that Agrium would love nothing more than to spend the remaining weeks before the shareholder vote debating its fabricated version of our settlement discussions rather than the substantive issues. This would spare Agrium from addressing the market's overwhelmingly negative reaction to its new directors who were hand-picked just weeks before a shareholder vote and who lack the industry experience and independence necessary to help unlock Agrium's full value, and its refusal to engage on the issues." Rosenstein also highlighted how Agrium's tactics continue to prevent the company from building shareholder value. JANA summarized the recommended areas for improvement that Agrium should undertake under the 5 C's namely: Costs, Controls, Capital Allocation, Conglomerate Structure and Corporate Governance.
Some agriculture stocks are trading at low price multiples:
EPS Growth Next 5 Years
Agrium trades at an attractive price-to-earnings multiple, as does CF Industries. Both are cash flow positive and have manageable levels of debt. Deere is highly levered and is not cash flow positive, making it less interesting since its low valuation seems to come at the cost of financial risk.
Financial results for CF Industries and Agrium have been promising and these companies are trading at discounts to the broader stock market. This is not true of all agricultural stocks. Hence, being selective in picking particular agricultural companies rather than a diversified basket of soft commodity futures or agriculture stocks may be appropriate. Market Vectors Agribusiness ETF (MOO) is one such agricultural stock fund which holds stocks such as the Potash Corp of Saskatchewan, Monsanto, and Deere & Co.
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