Agribusiness companies have been hit hard by this past summer's record drought. Consequently, the Market Vectors Agribusiness ETF (MOO 0.24%) has underperformed the S&P 500 this year and currently has an average P/E of only about 13, suggesting that investors have low expectations going forward. However, I believe this outlook is a mistake, and while I already have an outperform CAPScall on the ETF, if I could I would renew it. Read on to learn why I think this is a good opportunity to invest in agriculture.
The lay of the land
It's important to understand how the drought has affected agribusiness companies. If we were talking about a recession instead of a drought and, say, restaurant companies instead of ag companies, their decline would be intuitive. Higher unemployment means fewer and poorer customers, which means declining sales and a long, slow recovery. This isn't a perfect comparison, however.
Farmers in many countries enjoy government-subsidized multi-peril crop insurance. Basically, what this means is that if you're a corn farmer and your field is too dry to plant, or if you do plant the field but can't grow a healthy crop, you don't have to go bankrupt because you have no product to sell. Depending on what coverage you have, your insurance will reimburse you for the crops you lost at a price similar to the going market rate at the time of would-be harvest.
The point is, farmers won't be going into 2013 broke from this year's fallow fields. Not all farmers have crop insurance, and the insurance payouts aren't always as good as if the farmer had sold actual crops, but for the most part, farmers will be flush for next year, especially those whose insurance is based on current crop prices, which are near record highs.
Looking to the horizon
Unfortunately for companies that sell fertilizer, tractors, and the like, farmers this year had little incentive to invest in a crop that was likely to fail. When farmers give up on or don't even bother to plant a crop because of poor weather conditions, it's referred to as abandoned acres. According to the USDA, farmers abandoned the most acres this year since 1993.
Thus, Agrium (NYSE: AGU) reported a 6% drop in sales for its recently ended quarter; PotashCorp (POT) reported an 8% decline; and Monsanto (MON) reported a 10% fall in seed sales in its fourth quarter.
But sales declines this year are short-sighted reasons to sell these stocks. Corn supplies are at their lowest level in 17 years, and the drought depleted supplies of many other important crops. As farmers look to rebuild those supplies, they will need more fertilizer, more pesticides, more tractors, and any other tools they can use to eke out a better harvest.
Some companies even offer products to help deal with future droughts. Irrigation company Lindsay (LNN -0.47%) unsurprisingly experienced record profits this year, and Monsanto (MON)will soon start selling a strain of drought-resistant corn. The adoption of these seeds will not only provide Monsanto a buffer against bad years, but the whole industry will also benefit from having crops to fertilize and harvest.
The Foolish bottom line
I'm no weatherman, but I think I can safely predict that the weather will get better. A combination of high crop prices and low supplies means that farmers have a strong incentive to invest in their fields next year, and for a long time to come if the world's population keeps growing. Buying this important industry at just 13 times earnings seems like a no-brainer to me.
