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How to Build Wealth From Farming

By Declan Fallon - Aug 29, 2013 at 1:05PM

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Slow economies are often a boon to the farming industry. Fertilizer manufacturers are well placed to take advantage, but they are not the only stocks to benefit.

The sharp rise in the number of farmers markets around the country reflects an increased demand for locally sourced produce. This also represents a source of revenue and opportunity for smaller farms, often excluded from the traditional supply chain of larger supermarkets served by industrial-scale farming.

Slow economies also bring benefits for large-scale farming, with cheaper labor and energy costs. For example, dairy farming is having a strong year with the USDA forecasting record milk yields, helped by falling feed prices. Dairy analysts suggest there is enough of a margin on offer to keep dairy farmers in business, with 2014 likely to be even better. However, corn and soybean farmers are having to contend with low prices, with concerns as to the amount of crop needed to be produced in the current year to generate sufficient income to plant next season's crop. Furthermore, futures prices for the 2014 crop are also depressed, which will likely lead to a repeat of the problem next year.

Farming is an industry that depends on a number of important sectors in the provision of seed, livestock, fertilizers and (organic) pesticides. The rise in produce prices has generated windfalls for many farmers, fueled jobs, and increased interest in agricultural-related university courses .

However, this boom hasn't filtered to all sectors equally. For example, Monsanto Company (MON) serves the $78 billion corn farming industry, but its GMO seed and related products are effectively limited to large monoculture farming. The cool, wet spring has magnified the distress to monoculture farming which, because of its scale, has little room for maneuver: DuPont lowered guidance on its agribusiness due to the large number of unplanted seeds. Monsanto reported similar impacts, but compensated losses from its seed division through sales of its higher-priced Roundup weed killer. Earnings for Monsanto and DuPont are likely to be hit again if corn and soybean farmers are unable to sell at high enough prices to support next season's crop.

The Candidates
Component fertilizer companies like Dow Chemical (DOW) and Potash Corp. (POT) are well positioned to benefit from the growing interest in farming. Dow's Agricultural Sciences division achieved "record second quarter sales with double-digit growth": a 10% year-over-year increase in sales and a 14% growth in new products in crop protection. Despite a drop in R&D expenditures, there has been an increase in ag-related investment with research in its seed division an important driver for the future.

Potash Corp. is in flux because of the fallout from the collapse of the Russo-Belarusian potash cartel with a potential 40% drop in potash prices. However, the company anticipates demand for potash could approach the previous record of 56 million tonnes, with North America to lead this "demand resurgence." Sales volume outpaced the previous year for both the quarter and the first six months. It was a similar story for rival Mosaic, while Agrium is expecting a rise in demand for fertilizers in the current quarter as good weather extends the growing season.

A more offbeat stock to benefit from the renewed interest in fertilizers is Airgas (NYSE: ARG). The company distributes bottled gas for the medical, industrial and retail sectors. CEO Peter McCausland talked about the "$100 billion wave of chemical and fertilizer investments that's coming." He followed with mention of "big" new starts in the construction pipeline with a "tremendous number of new projects" on the books. In further comments, Airgas anticipates it could expect revenues from each new fertilizer plant built over a period of up to five years; each plant having the potential to add "$1 million or more a year" in revenue .

The biggest enemy for this sector is weather: it's unpredictable, and impacts can be severe or mild depending on when and where it hits. Seed manufacturers took the brunt of this year's late start to the growing season. A repeat of a cool, wet spring next year may deliver better prices for farmers, but it won't necessarily sell more fertilizer. However, weak demand in one quarter is often compensated by higher demand the next. 

Regulatory factors can draw out and/or freeze the development process of new chemical and fertilizer plants, influencing supply. Airgas and fertilizer manufacturers would be more vulnerable to such delays, although Airgas would likely be compensated with higher fertilizer prices from reduced supply. Dow Chemical's and Monsanto's developments in GMO crops have run into a more cautious USDA, with further testing of environmental impacts required by the government agency.

Fertilizer producers are currently benefiting from the extended growing season from a late spell of good weather. In addition, fertilizer producers have some protection against weak crop prices as inputs are independent of final yields -- although acreage planted can vary. Despite this, agricultural prices have steadily improved over the past 10 years and it's this growth that makes this sector so interesting.  


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