Vital resource stocks remain under selling pressure as worries about the US economy grow. As we wrote last week, gains and losses are typically reversed in the blink of an eye in these volatile markets. The key is to build positions at low prices in solid companies that can take advantage of inexorable demand growth and supply pressures, both of which are being exacerbated by lower prices now.

Investing in food-related companies has been a major theme for VRI since we began the service more than 11 months ago.

The bad news is prices have been quite volatile since. The far more powerful good news, however, is the bullish fundamentals are intact–the world needs to increase production from existing and, in some cases, diminishing arable land.

As incomes around the world rise, so does demand for food. And the explosive growth in population is aggravating the situation even further. Moreover, feeding more people is critically dependent on technology, particularly if the earth’s population rises faster than expected.

The upshot is the big cycle in food demand has begun, and long-term-oriented investors will be rewarded handsomely. And the best plays are still our Portfolio recommendations in the sector.

Below, we take another look at our four agricultural recommendations.

For more on the details regarding the global food situation, see VRI, Nov. 8, 2007, Hungry Like the Wolf, and May 1, 2008, Food Is the Word.

The Picks

Monsanto (NYSE: MON) is the undisputed leader in the genetically modified (GM) seed industry. Its business consists of two segments: Seeds/Genomics and Agricultural Productivity. The Seeds/Genomics segment consists of the company’s global seeds and traits business, and genetic technology platforms, including biotechnology, breeding and genomics. The Agricultural Productivity segment consists primarily of crop protection products, residential lawn-and-garden herbicide products, and the company’s animal agricultural businesses.

Monsanto shares have been affected by the market’s shorter-term gyrations, but the underlying business is extremely healthy. In fact, the seed business is currently in a sweet spot as global food demand changes dramatically.

The upshot is industry leader Monsanto is virtually guaranteed greater earnings growth and solid pricing power. This, in turn, means high cash flows and enhanced financial strength, a condition that gives the company the opportunity to allocate more funds toward research and to strengthen its product pipeline.

The latter issue is key to understanding the company’s business. Monsanto should be viewed the same way one would examine a pharmaceutical company, with close attention to research and development (R&D) commitments and, consequently, the potential of the product pipeline and the company’s ability to execute.

Not surprisingly, R&D is one of the company’s great assets. Between 1995 and 2007, Monsanto spent approximately USD6.8 billion on R&D, and in the next 10 years close to USD20 billion will be spent.

There are three main ways the company’s products can make a difference for a farmer: increased yield (revenue growth), greater farm efficiency (time/cost savings) and decreased use of agricultural inputs (cost savings). As a result, the pricing of these products is first and foremost based on the value of these advantages.

The company’s future operational performance isn’t just a factor of agricultural prices, but also of its ability to offer farmers the product for covering their needs. In this regard, the company has the characteristics of a pharmaceutical/biotechnology firm rather than of a company that just makes seed and other agricultural products.

Monsanto’s stock has underperformed this year, and now it’s playing catch-up. The recent selloff, with the stock trading at an attractive valuation, provides a strong entry point. Buy Monsanto at current prices for leveraged exposure to agricultural efficiency.

Source: Bloomberg

EI du Pont de Nemours (NYSE: DD) is the second-largest US chemical company in terms of market cap and sales. It offers strong exposure to the seed business and the global chemical market. The company is divided into five segments:

• Agriculture/Nutrition
• Coatings and Color Technologies
• Electronic and Communication Technologies
• Performance Materials
• Safety/Protection
  

DuPont’s main appeal is its strong global presence and diversified market exposure. This was seen clearly when the company reported first quarter 2008 earnings; sales were up by 9 percent despite weakness in the US auto and housing market. More than 60 percent of sales come from outside the US, at least 25 percent of which is generated in emerging markets.

By 2010 the company expects almost half of its revenue growth will come from emerging markets, contributing to around 30 percent of total revenue.

DuPont is one of the world’s largest producers of corn, soy seed and crop protection chemical products.

Agricultural sales should surpass USD7 billion this year mainly because of better expected sales of triple stacks (roundup resistance and protection against corn borer and corn rootworm) corn seeds. DuPont is gaining momentum in the triple stack race, but is still second to Monsanto because of its late entrance into the arena.

There are still many regions in the US where farmers don’t use stacked traits, but DuPont still holds a big lead with farmers in those locales. According to the US Dept of Agriculture, 52 percent of corn farmers in Illinois, Iowa and Indiana used multiple-stack corn seed. Penetration is much lower, at 33 percent, in states such as Kansas, Michigan and Nebraska. Furthermore, farmers must still plan 20 percent of their fields with non-insect-resistant corn to foster breeding of susceptible insects. 

DuPont has aggressively picked up market share in corn seeds in Brazil and has also realized strong growth in insecticides in Europe and South America. In the US, the company is the leader at 29 percent market share, but has lost a lot of ground to Monsanto (26 percent market share).

Like Monsanto, DuPont also allocates a lot of resources to R&D, focusing on new technology in corn traits that can offer triple herbicide resistance to increase productivity gains.

The big potential of the agricultural business has sparked talk of potential separation of the agricultural arm of the company. Until now, management has maintained that shareholders are better served under the current arrangement.

We expect DuPont to be challenged this year because of higher costs in sulphur and urea raw materials used in herbicides as well as high natural gas costs and soybean commodity prices. But management’s commitment and successful implementation of cost control offers confidence. Buy EI du Pont de Nemours.

China Green Holdings (Hong Kong: 904, OTC: CIGEF) is a vertically integrated grower and processor of fruits and vegetables for export and domestic markets.

The company sells its products both domestically and internationally through a highly integrated business, operating large-scale standardized plantations, food processing units and a distribution network of supermarket and retail outlets. Its ownership of every segment ensures stable supplies and a rare degree of control over raw material price fluctuations.

China Green doesn’t have control over essential raw materials such as seed crops, fertilizers and pesticides. Nevertheless, product quality is more easily maintained and costs curtailed as many layers of middlemen are removed. In addition, the gradual need for better quality and safer food in China is also playing to the company’s strengths.

One of the company’s big advantages is its well-established and large-scale position in the industry. The Chinese vegetable industry remains fragmented, but a company that’s able to work with farmers, build the infrastructure network needed to improve farmlands, efficiently transport is products and market the entire package is a formidable opponent.

China Green has transformed itself from an export-oriented vegetable supplier to one with a growing presence in domestic China, and management remains committed to a balance between domestic and export businesses. It’s also improved its profitability because it put more weight behind its processed business, which offers higher margins.

In the past year, domestic business accounted for 53 percent of sales, with exports at 47 percent. In the same period, from a product standpoint, 33 percent of fresh produce and 96 percent of processed products were exported overseas.

The overseas business remains important to the company, and it has diversified its exposure to include Japan, the US and the EU. Japan still accounts for 27 percent of total sales.

The company continues to expand into new provinces and gain better access to supermarkets, retail outlets, restaurants, and fast-food chains (Pizza Hut is a new addition). Sales growth for the next fiscal year should be in the 30 percent range.

China Green is in expansion mode; execution is of paramount importance. The potential reward is even greater if the company is successful, ups and downs along the way notwithstanding. Buy China Green Holdings at current prices.

The Andersons (NSDQ: ANDE) can be viewed as a small-scale conglomerate with an agricultural bias. The diversification of its business allows it to benefit from a growing economy. It also provides relative protection on the downside as the company cashes in on the rapid growth of global food demand.

The company employs 3,000 workers. 2007 was its best year on record, with revenues of USD2.4 billion (up 63 percent) and profits of USD68.8 million (up 89 percent).

The most recent earnings report showed profits jumping 79 percent, easily surpassing market expectations, thus allowing the stock price to recover instantly from its early summer weak performance. Operating income in the company’s very important grain and ethanol group jumped to $20 million from $12 million, due in part to improved grain sales margins and service fee income that more than doubled. The company is divided into five business divisions; the most important is the Grain and Ethanol Group.

Grain and Ethanol includes 13 terminals in the Midwest that handled approximately 151 million bushels of grain and oilseeds (primarily corn, soybeans and wheat) in 2007. The facilities store and condition the grain then ship it via rail or vessel to customers. The division also owns 47 percent of Lansing Trade Group, which should continue to benefit from higher and more volatile grain and ethanol volumes. The main risk for the division is that high corn prices could lower margins that higher fuel prices might not be able to offset.

The other important division of the company is its rail division (23,000 cars and locomotives). The division’s main functions are to lease rail cars and provide fleet management services on a contract basis. The division also operates steel fabrication and manufacturing facilities. Its fleet of cars expanded by 8 percent last year, and it currently enjoys one of the highest utilization rates in the industry as demand for grain and ethanol transport services continues to grow.

The Andersons is a relatively small company, which is why we group it with our potential homerun bets. But it’s also been run well for years and–thanks to ongoing strategic repositioning–should be in prime position to profit from the next up-cycle in the economy. Buy The Andersons at current prices.

Source: Bloomberg