You can't deny that the markets love a good story, and ethanol is a great story. Grow our own gasoline, you say? Great! Where do I buy?
That basic line of thought has led to some pretty impressive stock runs in ethanol-related plays. Andersons (NASDAQ:ANDE) has quadrupled, Pacific Ethanol (NASDAQ:PEIX) nearly has, SunOpta (NASDAQ:STKL) is up more than 150%, and the Big Three of farm equipment --Deere (NYSE:DE), AGCO (NYSE:AG), and CNHGlobal (NYSE:CNH) -- are up about 45%, 52%, and 70%, respectively. Unfortunately, reality doesn't always move at the pace of buy orders.
Take the case of AGCO. For the recently completed quarter, the farm machinery company announced that sales were down about 7% (down about 4% without currency impacts) and adjusted net income per share was down about 21%, while income from continuing operations dropped 17%.
What's wrong? Are the farmers of the U.S. in cahoots with those evil hedge funds and trying to short ethanol into oblivion?
Uh, no.
But what is happening is called reality (as opposed to hype, promise, and potential). Farmers are seeing higher interest rates, higher fuel and fertilizer prices, and uncertainty in farm subsidies. What's more, for all the talk about ethanol as the great American hope, the spot price of corn is up all of 3% from the beginning of this year (and down about 12% from the start of 1998).
And here's the thing that East Coast columnists don't always get: Farmers are stubborn and conservative. I grew up in farm country, and I can tell you that your average farmer is going to be far more concerned with the reality of those interest payments today on a new tractor than the potential that ethanol might increase crop demand and prices at some point.
Now, I'm not trying to crush the spirits of the ethanol crowd. Rather, I just think those folks expecting instant gratification need a reality check. After all, in the case of AGCO at least, nearly 60% of its sales come from Europe right now. What's more, dealer inventories are a little high, and the process of working those down is possibly going to keep a lid on financial performance for this year.
On the other hand, this might be as bad as it gets. Adjusting the dealer inventory situation will be painful, but shouldn't be permanent. Likewise for the concerns about demand in Brazil. And if ethanol really does get moving in the U.S., that would ultimately lead to higher prices, more planted acres, and more demand for equipment.
My concern, though, is that the stock price has already jumped in anticipation of something that'll take a little time to work out. Do your own due diligence, of course, but just remember that trends sometimes have a few more ups and downs than the advocates would have you think.
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Fool contributor Stephen Simpson has no financial interest in any stocks mentioned (that means he's neither long nor short the shares).
