Investing in Food (Barrons)

MONDAY, OCTOBER 19, 2009
UP AND DOWN WALL STREET



A Whiff of Reality By ALAN ABELSON


.........What especially piques his interest in ag is that voracious consumer of everything, China. And, more specifically, that nation's likely problems in securing enough grain to meet the explosive growth in demand it's destined to experience in the years ahead. For, Dylan notes, as countries become more industrialized, which is happening by leaps and bounds in China, their citizens' consume more protein. In particular, rising incomes and urbanized lifestyles invariably lead to higher meat consumption, which, of course, means higher grain demand.
China, he points out, has 22% of the world's population (which is one heap of a lot of mouths to feed) but only 8% of the planet's arable land and 7% of its water. It has been losing nearly 1,400 square miles to desert every year, and industrialization has been taking an increasingly big bite, as well.

Meanwhile, water is becoming a major headache, and one needn't be an old farm hand to know that it's tough to grow anything, even cactus, without H2O. Using World Bank data, Dylan reports that half of China's cities face water problems, most of its fresh water comes form Himalayan glaciers, which have been disappearing (climate change, anyone?), and tillers of the soil are being forced to drill for new sources that frequently prove unsustainable.

All of which underscores the likelihood that China will need huge imports of grain to satisfy inexorably rising demand. However, global grain inventories hover around record lows, despite bumper harvests the past two years, and agricultural markets remain tight, Dylan observes, highly sensitive to virtually any kind of disruption.

The simplest way to invest, Dylan offers, is one of the grain indexes or ETFs. That approach has the advantage of being the purest way of gaining exposure, provides liquidity and, as a bonus, if you're worried about the long-term consequences of recent easy money and stimulus and all that, rates as a decent inflation hedge.

Personally, he prefers investing in equities and, further, in the equities of companies "whose business is to boost agricultural productivity." While he allows as he's aware of the advantage of buying indexes, he shies away from doing so because "you risk being saddled with a load of stocks whose business models you don't understand or whose valuations you don't like. So rather than buying the universe of agricultural stock, why not instead buy the value stocks within that universe?"

He has a few straightforward rules on how investors should uncover those value stocks. To wit: The shares of a company whose operations earn only the cost of capital isn't adding any value and should sell no higher than book value. A stock should trade at a discount to book if its operations return less than the cost of capital because it is destroying value. And a stock of a company with a very high return on equity should see that high return capitalized by the market at a premium to book value.

Any commodity bull market, he reflects, "is in its essence a bottleneck, and mankind has a good track record of figuring out ways around such bottlenecks." So buying companies whose business is to boost agricultural productivity, and buying them on the cheap, he believes, will furnish decent returns regardless of what happens to grain prices. Obviously, if commodity prices go up, so, as night follows day, will returns.

Adorning Dylan's analysis is a table listing various agriculture-related stocks, their return on equity and book value. He rates them according to how far the stock is from what he considers fair book value. The half dozen cheapest include Golden Agri-Resources of Singapore, Chaoda Modern Agriculture of Hong Kong, Yara International of Norway, Incitec Pivot of Australia, Global Bio-Chem of Hong Kong and Agrium of Canada. All are burdened by a slug more debt than the rest of the list, but their average return on equity is 25%.

The home team (in this case the U.S.) is represented by Bunge and Archer Daniels Midland , both selling at a discount to "fair book." Somewhat pricier is Mosaic , and even more so -- we'd say deservedly -- is Monsanto .