Buy, Sell or Hold: Monsanto Will Reap Big Rewards as Demand for Agricultural Products Accelerates

As the U.S. Federal Reserve and other central banks around the world pursue policies of quantitative easing, essentially devaluing their currencies, the specter of inflation is slowly creeping back into the U.S. economy.

And because none of the world’s policymakers seem to know exactly how much monetary expansion will be necessary, or when it will be time to again tighten the reins by raising rates, I have been successfully playing the re-flation trend.

I believe that this trend will be the most important source of profits, not just through this year, but throughout 2010, as well. So, today, I am going to give you one of my preferred plays: Monsanto Co. (NYSE: MON).

There are many important reasons why I love agricultural commodities, and by extension, love Monsanto. 

First, on the demand side, there is a natural bottom for them, since we all need to eat.  And, as the price of the PowerShares DB Agriculture Fund ETF (NYSE: DBA) that tracks these commodities clearly indicates, the bubble in these prices is already gone and prices are back to long-term base levels. 

The correction has been significantly less severe than in equities, due to the nature of the need these commodities fulfill.  But remember that the population of the world keeps growing. And populations in emerging markets, particularly those in the densely populated countries of China and in India, have seen their real incomes grow over the last five years, despite the recent bust. 
China’s economy, for instance, actually grew at 6.1% in the first quarter.  So the drop has been in the rate of demand growth in China, rather than in total demand.

In fact, the drop in commodities prices has been exacerbated by inventory liquidation.  While people and businesses are liquidating inventories, they are actually buying less than they are consuming.  Inventories were liquidated because, as financing became scarce, commodity buyers wanted to reduce the cost of financing and carrying those inventories, and also to reduce price risks by moving to “just-in-time” (JIT) purchases. 

The problem is that, once you’ve liquidated your inventories. you have to hurry to order more as soon as demand for your products accelerates. And that’s already starting to happen as a wide range of global-stimulus measures gain traction.  Thus, you see the beginning of a new bull market in commodities.

My strong contacts with agricultural exporters in Argentina, a top wheat and soybean exporter, confirmed to me that the Europeans are buying hand over fist right now, just to fulfill their just-in-time needs.  Furthermore, China is using the recent market implosion to secure long-term commodity supplies around the world.  Many believe that China’s demand alone is causing strains in the entire system.  But the story does not end there.

China, knowing of the strategic nature of these supplies, has implemented huge reforms in its own agricultural sector.  China’s legacy of communist agriculture has left the nation saddled with millions of unproductive single-family operations. So, in order to achieve economies of scale, they have:

  • Made farming activity tax-free.
  • Allowed farmers to sell or lease the agricultural rights to their land. This not only helps the farmers generate income, it encourages them to move into the city, freeing up large tracts of land for agricultural development.
  • And allowed corporations to buy or lease farmland. This will result in huge productivity gains from mechanization, intensive farming, use of sophisticated seeds and fertilizers and corporate financing.

China is spending $9.5 billion on infrastructure and services in the poor countryside to help farmers cope with the economic downturn, The Associated Press reported.

And I am not alone in this line of thinking. I recently heard legendary investor Jim Rogers saying he is sticking with his “C.C.” trades: China and commodities. 

But rather than buying the DBA exchange-traded fund (ETF), which tends to be volatile, I’d rather turn to the premier supplier of seeds for this global farming revolution: Monsanto. 

Monsanto provides genetically modified seeds that are more resistant to specific weather and pest conditions and deliver superior yields. The company also produces the biotechnology and herbicides needed to control insects and weeds. 

Monsanto dominates the industry in these very profitable, long-term niches, and therefore enjoys a sustainable competitive advantage that vastly differentiates it from other, “me-too” agricultural companies.  This huge technological lead over the competition keeps opening up and will keep leading to increased market share and profit margins. These advantages also  open up partnership opportunities for Monsanto.

You see, the unequaled research-and-development capabilities of Monsanto have enticed firms like Cargill Inc. and BASF SE (OTC: BASFY), which have signed on to co-develop new products. 

Monsanto just beat earnings estimates, accomplishing record sales and minimal margin erosion. What other business has achieved that kind of success in this environment?  Very few, for sure. 

What’s more, at a Price/.Earnings to Growth (PEG) Ratio of about 1.0, this company’s stock is a steal.  Consider the company’s stellar 25% return on equity (ROE) and similar operating margin.

The stock will likely double over the next 12 months, even without considering the coming commodities bonanza. 

Recommendation: Buy Monsanto Co. (NYSE: MON) at market and hold it for at least 12 months (**).  Traders should also be rewarded short term.

(**) - Special Note of Disclosure: Horacio Marquez holds no interest in Monsanto Co.

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