Many analysts are forecasting lower food prices this year, and that's taken a toll on many agricultural stocks.
But there are two reasons why investors shouldn't be so quick to abandon the sector.
In fact, two stocks, Deere & Co. (NYSE: DE) and AGCO (NYSE: AGCO) are poised to reap gains now that ag stocks have pulled back.
Here's why.
- Much of the pessimism surrounding crop prices is overdone.
- Many ag stocks are still excellent long-term plays - despite any short-term trepidation.
I'll explain.
It's true that farmers currently are planting more staple crops in an effort to exploit high prices. But as we've seen in just the past few months, floods, droughts, and rapidly rising demand could easily intercede to keep prices near record levels.
The most important crop to watch right now is corn.
Preliminary USDA data suggest that farmers this year will plant the biggest corn crop since World War II. However, that's exactly what will be needed, since corn is facing the greatest supply constraints of any staple crop.
Indeed, even a bumper crop will first have to compensate for the shortages of the current crop year, which are significant. By this year's autumn harvest, global stocks of corn as a share of consumption will have fallen to the lowest level since 1974.
"There has been no rebound in global corn stocks," Ed Allen of the USDA's economic research service told the Financial Times. "This has maintained very tight markets for corn."
And while global corn production is expected to rise, there's still a chance bad weather will damage the harvest just as it has in the past two years.
Last year, wet weather early in the season delayed planting while hot weather in the summer scorched young stalks. That contributed to two consecutive years of shrinking supplies.
Analysts say a third straight year would be rare, but according to economists at the University of Illinois, there is a 40% chance corn yields will fall short in any given year.
"The odds slightly favour a corn yield above trend in 2012, but there is certainly precedent for another year below trend," the economists wrote last month. "More specific expectations about the 2012 average yield will depend on how the planting and growing season unfolds."
Good News for Agricultural Stocks
Corn isn't the only crop facing supply constraints, either.
January droughts in Argentina and Brazil reduced global soybean production by 7.2% this year. And with farmers focusing on corn there's less land available for soybeans. The USDA anticipates soybean production will fall by 12.7 million metric tons this year.
On Oct. 1, the start of the next season, soybean inventories will be 20% lower than they were last year, according to Jefferies Bache LLC. As a result, soybean prices, which are up nearly 9% year-to-date, will gain another 6.7% by June, the New York-based commodities trader estimates.
Meanwhile, demand for these staple crops continues to grow in emerging markets - particularly China. While rice is the preferred grain in that country, more affluent Chinese consumers are increasing their intake of meats.
Raising pigs and cattle requires corn and soybeans used in feed.
Meal consumption in China has tripled since 2002, and soybean imports will have to rise 62% in the next decade to provide enough feed to satisfy pork demand.
"There's been that ongoing concern around the drought conditions in South America and on top of that you've got fairly strong demand for oilseeds coming out of China," Michael Creed, an agribusiness economist at National Australia Bank Ltd., told Bloomberg News. "The market has clearly tightened and has become a lot more bullish the past few days."
China has 21% of the world's population and less than 9% of its arable land, so it's likely that demand there will remain high for the foreseeable future.
And that's good news for agricultural stocks.
Two Ag Stocks Ready to Reap Gains
Take Deere & Co. (NYSE: DE), for example. Deere stock is down nearly 8% since the company lowered its forecast for U.S. farm income on Feb. 15. Deere said farm income in the United States, its largest market, will fall 6.5% in 2012 from last year's record $98.1 billion as rising crop acreage and costs trim profits.
Still, the company said sales of its farm, forestry and construction equipment would increase 15% for the full year. Overall, the farm-equipment industry's sales in fiscal 2012 will rise about 10% in the U.S. and Canada, and 5% in Europe.
Additionally, Deere is broadening its international exposure, with plans to build seven factories in China, Brazil and India to produce farm and construction equipment.
Finally, Deere raised its fiscal 2012 profit forecast to about $3.28 billion from $3.2 billion previously.
Clearly, Deere is in a position strong enough to weather any short-term setbacks. And in the long-term, global demand for crops and farm equipment will increase as the world's population grows and emerging markets add more meat to their diet.
Smaller Deere rival AGCO Corp. (NYSE: AGCO) also stumbled last month after offering up a weaker-than-expected first-quarter outlook.
However, the company also reported a blowout fourth quarter in which income more than tripled. AGCO experienced double-digit sales growth in several markets, including Eastern Europe, Africa and North America.
Also like Deere, the company is expanding its presence overseas. Germany, Finland, Scandinavia and France all represented strong regions during the quarter.
AGCO said it expected sales to rise about 14% to more than $10 billion in 2012.
News and Related Story Links:
- Financial Times:
Corn set to stay tight despite US crop hopes
- Money Morning:
Soybean Prices Approach Record High