Hackett Advisors in the News

Commodities: Food for thought

By Bryan Borzykowski | April 11, 2011

Vijay Viswanathan knows, perhaps more than most, that when he goes to the grocery store to buy his fruits and vegetables over the next few months, his bill will steadily increase. The associate portfolio manager with Calgary's Mawer Investment Management has been keeping a close eye on the agriculture and food production sectors, and has seen futures for foods such as wheat and corn soar by 64% and 82%, respectively, in the past 12 months. That's caused Canadian economists to estimate that food prices in this country will jump between 5% and 7% by the end of the year. Rising food costs is a scary proposition for those with a family to feed, especially those already struggling to make ends meet. Investors face a growing grocery tab, too, but many plan also to make some cash on the commodity sector's volatility. "It's never good when you go to a grocery store and it costs more," says Viswanathan, "but investors should benefit from food inflation."

One of the best ways to capitalize on food inflation is buying fertilizer stocks like Potash Corp. and Agrium, or seed companies such as Monsanto. "They're the obvious beneficiary," says Norman Raschkowan, chief North American investment strategist at Mackenzie Investments. As demand for food rises, farmers will have to increase supply by planting more crops, and it's impossible to yield more without fertilizer and seeds. "There's no doubt that farmers will have to sell more of whatever it is they are producing," says Brahm Spilfogel, an RBC vice-president and senior portfolio manager of Canadian equities.

Historically, food demand and supply have kept pace with each other, growing at a compounded rate of about 1% a year. But Spilfogel says if more people begin to eat the way North Americans do, it'll likely begin to increase. "Technology won't be able to keep up with the demand," he says, and that means it'll become increasingly difficult to squeeze higher yields from crops.

Already, stock prices from fertilizer companies have benefited. Calgary-based Agrium has seen its share price climb by nearly 19% since this time last year, while Illinois-based CF Industries' price has risen 33% year-over-year. The reason for the stock's increase is simple: the more demand for fertilizer, the more money the company will make. "We could see significant increases in profitability," says Viswanathan.

When looking for a company to purchase, make sure it's in an area of a sector that has limited competition and requires large capital investments. "If anyone could get into the seed business, everyone would make them, and prices would go to zero," says Spilfogel. That's why the portfolio manager stays away from food processing and farm equipment companies. While these sectors may also benefit from rising prices, the lower barriers to entry make them less attractive buys. Also look for fertilizer companies that have large reserves. Potash Corp. has decades of resources, so they'll be able to capitalize on increasing demand for years to come.

Unfortunately, these companies aren't cheap -- valuations are between 15 to 20 times price-to-earnings. But Spilfogel expects valuations to become more reasonable over the next decade, as prices and pressure on food production increase. "They'll have to grow into their earnings," he says. "But we think it'll happen."

While fertilizer stocks are good for the long term, shorter-term investors may be able to profit from rising rice prices. Most food commodities have seen their prices skyrocket over the past few months. Sugar futures have climbed 81% over the past year; soybeans have increased 41%, and many others have seen similar spikes. Rice, however, hasn't seen such drastic movements, increasing only 8%, to $13 per 100 pounds, over the past 12 months. That could change soon. "Rice is one of the few opportunities that's been mispriced to the downside, so it has a lot of upside to go," says Shawn Hackett, president of Hackett Financial Advisors in Boynton Beach, Fla.

While other commodities have been damaged by poor weather and politics -- droughts in Russia and a subsequent ban on exports pushed wheat prices up -- rice crops have been fairly unscathed. Asian governments have also made a concerted effort to keep prices down by dumping supply on the market. That's kept prices stable -- a plus for emerging-market populations where rice is a frequent meal -- but most farmers want to make money on higher-cost crops, not spend cash producing cheap grains. Ron Lawson, founder of Logic Advisors in Sonoma, Calif., explains that farmers have the ability to plant whatever crops they want in a given season. With corn and wheat proving to be more lucrative these days, it's likely many will skip growing rice this year. Hackett expects American rice production to fall by 30%, and that could have a devastating affect on supply. "If you assume demand remains pretty consistent with a 10-year average, we'll likely run out of U.S. rice," he says.

Hackett predicts prices will reach $20 or more per 100 pounds. That could lead to riots in emerging markets, where the grain is so important. Governments have to figure out a way to keep prices in the $16 to $18 range, which Hackett thinks is high enough for farmers to make money, and low enough to keep people fed. Instead of the current norm of hoarding, selling and depleting reserves when prices are low, governments should sell into the market when prices benefit everyone. "They can't let stocks run thin when the price is cheap, because when it takes off they won't have anything left," says Hackett.

Investing in rice takes a little more savvy than buying a fertilizer stock. There are almost no listed rice-producing companies, so people can't play the equity market. It is possible to get exposure to rice through agriculture-focused exchange-traded funds, but there are no pure rice ETFs. The Elements Agriculture Total Return product, for example, has 2.1% of its holdings in rice, compared to 13.6% in corn. The best way to buy the commodity is to sign up to an online futures brokerage and trade rice futures contracts. Hackett suggests buying shorter-term futures, especially if prices increase as significantly as he expects in the coming months. The longer-term premium -- about $3 a contract -- isn't worth it, he adds.

Canadians should consider putting less than 50% of their portfolio in fertilizer stocks or rice futures; good weather, an increase in rice production or political intervention could make this a bumpy ride in the short term. Ultimately, though, long-term investments will grow. "The world needs everything from fertilizers and seeds to chemicals to meet demand," says Spilfogel. "All investors will be able to benefit from this trend."

Our picks

Want to take advantage of food's volatility? Here are some investments to consider.

Potash Corp. (TSX: POT)
The Saskatoon-based fertilizer company's stock price soared after BHP Billiton tried to buy it last year, but takeover or not, this is a good buy for investors. Mawer's Vijay Viswanathan says it's one of four players that control the market, which means it can set prices. It also has deep reserves, so the company should be in business for decades. It's trading in the 20-times price-to-earnings range, but increasing fertilizer demand makes it a solid long-term buy.

Agrium (TSX: AGU)
Brahm Spilfogel, an RBC portfolio manager, likes Calgary-based Agrium for its diversified product line. While it distributes potash, it also sells nitrogen and phosphate, and distributes seeds among other products. "It has more exposure to everything," Spilfogel says. All its offerings should benefit from higher food prices, while its diversified lineup makes it less volatile.

Monsanto (NYSE: MON)
As demand for food rises, more seeds will have to be planted to maintain supply. That's why Spilfogel likes this St. Louis???based seed manufacturer. He points out that the company sells seeds for a number of crops, while its robust R&D division should be able to produce better-yielding products down the road. It also has scientific knowledge that would be difficult to replicate. "I like that in a company," he says. "I'm looking to add it."

Syngenta (NYSE: SYT)
Like fertilizer and seed companies, chemical businesses stand to benefit from climbing food prices, too. This Swiss company's main products are herbicides, but it also sells seeds. Spilfogel points out that farmers must kill bugs to grow crops, so the company should benefit as farmers get more aggressive. Chemicals are relatively cheap, too, so it's a cost farmers won't have problems affording. The company's multiples are similar to our other stock picks, but again, a likely boost in profits will help the stock price long term.

Rice Futures
Since there are no pure rice ETFs or rice companies to invest in, buying rice futures is the best way to gain access to the market. Investors have to sign up to a futures brokerage, but once there, buying and selling contracts is no different than trading equities. People can access futures that have rollover dates from a month up to a year. Longer contracts are more expensive -- extra months of storage often add a few dollars to the price -- but less volatile.


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