The prolonged drought in the Midwest that has sent prices for agricultural commodities soaring could be a boost to related stocks in the agribusiness sector. Even though the sector could be considered a niche for many investors, there is a wide range of companies that make it up. They range from chemical companies to farm equipment to the food producers.
One strategy for finding stocks in a specific sector is to analyze the top holdings of a related ETF. In this case I will focus on the Market Vectors Agribusiness ETF (MOO).
Four of the top five holdings in MOO are based in the U.S. and they make up a total of 35% of the entire portfolio. The lone non-U.S. stock is Syngenta (SYT), a Swiss agricultural chemical company. SYT is not my "best" stock of the sector that will be highlighted today, but my firm does own shares for clients.
The top holding is a name that most investors are familiar with because of its Roundup herbicide that is widely utilized. Monsanto (MON) is a nearly $47 billion company that has performed well this year and recently traded at its best level in three years. The reason MON is not the top pick is due to its current valuation. The stock trades with a PEG ratio of 2.0, above most of its peers. This suggests MON is far from a value play and even though the chart is bullish I will stay clear at the current levels.
A top five holding that has struggled this year is Deere & Co. (DE). The stock has not been able to join the overall market rally due to its close ties to growth in the emerging markets, in particular China. As China slows it is being felt by the large machinery names such as DE and Caterpillar (CAT). I expect this to be a temporary slowdown and with the PEG on DE falling down to 0.78, there will be a time in the near future that the stock will be considered a very attractive buying opportunity. As far as a price, I would look at the $70 area as the first entry point.
The stock that was able to rise above its peers, in my opinion, is CF Industries Holdings (CF). The company manufactures and distributes fertilizer products that are used by agriculture and industrial customers around the globe. The chart of the stock is bullish and after a recent breakout to a new all-time high the stock has pulled back to support near the $200 area. Combine the technicals with the valuation (PEG of 0.71) and the stock passes the test.
There is also the bigger picture that was mentioned earlier regarding the drought in the U.S. this year and the increasing demand for more agricultural commodities worldwide. The fertilizer companies will be pushed to the limit to increase crop yields and as a leader in the industry, I expect CF to continue its bull run.
If you are the type of investor who does not want to take the risk of buying into a single stock, there is an option for you. MOO will give investors exposure to 50 stocks in the agribusiness sector and will remove the stock specific risk of owning a single company. It will also offer exposure to the niche sectors within the larger sector, decreasing the concentration risk even further. For a reasonable expense ratio of 0.53%, MOO is a solid option for the risk adverse investor.
Keep in mind that there is always a risk factor when buying a stock. With the agribusiness sector the risk will be associated with a slowing global economy, in particular China and Europe. If the two regions continue to drift lower it will have a direct affect on the demand for agricultural commodities and hurt the agribusiness sector. The one silver lining is that a large portion of the slowdown is already priced in so if the global economy begins to turn later this year it should be a big boost to the sector.