Over the top
Aug 1, 2008 12:00 PM, By Mark Moore
At CNH, first quarter net income was $112 million, compared to net income of $95 million in the prior year, which according to CNH President and CEO Harold Boyanovsky, was the ninth consecutive quarter of year-over-year improvement. The company expects the agricultural equipment market to remain above 2007 record levels.
Within the general rosy picture in agriculture, there are the “haves” and “have nots,” according to Halpert, the analyst at Van Eck Global. “The ‘haves’ are definitely the fertilizer and seed sectors,” he says. “More specifically, fertilizer stocks are unbelievable. Prices are very high, and they seem like they are too high, but I only see lower corn prices making them come down, and I don't see that this year.”
That's barring some unforeseen macro economic factors, such as a worldwide economic slowdown or change in the U.S. dollar's value. Or a simple market adjustment might lower prices in that sector.
The seed market is also strong, even though “stocks in that sector are not cheap,” Halpert says. “But that sector is showing that it can deliver higher-yielding products, and I don't think that is going to change.”
The machinery sector, while having shown general strength over the past few years, is also grappling with a surge in input costs, especially for steel, which has doubled in price in six months. “I don't know how equipment manufacturers are going to pass along such a large steel price increase,” Halpert says. “And even though the five-year returns have been good, the sector could struggle to maintain the good returns.”
Michael Boehlje, distinguished professor in the Department of Agricultural Economics at Purdue University, says it's not surprising that agriculture is appealing to the investment market. “You see a lot of interest in agriculture, because it has good income and good profits — all those things that draw investors to a sector,” he says.
In the 1970s, strong commodity and land prices drew investments to agriculture. “But then we ended up with increased production and saw lower prices. A lot of those strong prices eroded, and interest in land waned,” Boehlje says.
Fundamentally, the agriculture sector is cyclical in nature. “That is common with most commodity and natural resource industries,” he adds. “That spills over into the companies that provide support for those commodities.”
Better stock prices translate into additional money for capital investments in agriculture, added incomes for the sector, better profits for input supply companies, and more value across the value chain. “The immediate impact through the production end of the value chain is pretty positive — if you happen to be in the grains market,” Boehlje explains. “The immediate impact if you're in the animal protein production market is exactly the opposite.”
Will the euphoria in certain sectors of the agricultural market be maintained? Perhaps, but one should tread cautiously. One area of concern is profit margins. “We have excess profit margins compared to normal in much of the agriculture sector,” Boehlje says. “I'm not trying to be a pessimist, but I would be cautious about expecting the agriculture sector to have eliminated the fundamental cycles in the commodities industry or have gone to an environment where we can maintain margins that are abnormally high for a long period of time.”
And the implications of narrowing profit margins will have a direct impact on the performance of agricultural stocks. “Investor money is not very patient capital,” Boehlje says. “And it's not loyal to any one sector. It will move. You don't have to look very far back in the history of other industries.” For instance, the dot.com market saw tremendous gains, only to be wiped out when those stocks fell out of favor. “And at some point, commodities may not be as attractive,” he says.
Not so long ago, machinery and fertilizer stocks limped along, and quarterly reports saw a lot of red ink. But for now, ag stocks are very attractive. And company reports forecast additional growth. For example, in a report to investors, Monsanto forecasts that its gross profits from seeds and genomics will reach $6.5 billion to $7 billion by 2012, compared to the fiscal year 2008 targets of $3.6 billion to $3.7 billion in the same sector.
“Driven by the growing demand for food, feed, fiber and fuel, the agriculture industry is currently enjoying a favorable market environment,” says Berschauer from Bayer CropScience. “Prices for key crop commodities are expected to remain high, and growers are willing to invest more on inputs, including crop protection products and seed.”
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