Should You Bet the Farm on Ag Stocks?

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Two of Amit Wadhwaney's top five holdings in the $2.0 billion Third Avenue International Value Fund (TAVIX) he manages are companies that have survived droughts and are poised to gain more control of their local wheat markets, from farmers to end-customers.

Viterra (VT.TO) has the most efficient network of grain elevators in Canada, after buying Agricole United in May, 2007, says Wadhwaney, whose fund helped finance the acquisition. With its geographic reach extending beyond Saskatchewan to the neighboring provinces of Manitoba and Alberta, Viterra now handles about 45% of Canadian prairie grain shipments, he says.

Viterra's market share could grow if the government deregulates those shipments. The Canadian Wheat Board, which allocates railcars to various grain elevators based on historic market share instead of efficiency, is considering deregulating barley this year and could cede control over wheat sometime later, says Wadhwaney.

Consolidation in Australian Wheat

Growth prospects for ABB Grain FPO (ABB.AX), an Australian buyer and distributor of wheat, are less apparent, but the stock may be an even better bet than Viterra just on valuation, says Wadhwaney. Its recovery from Australia's drought has been more recent, and while there has been more rain, it's not yet clear whether the drought has completely passed, says Wadhwaney.

"You buy these companies when there's a drought. If the drought continues, the weaker competitors are going to be wiped out," he says.

Once the Australian Wheat Board loses its monopoly as a wheat exporter in July, there's potential for consolidation that will give the bigger companies more geographic reach. They'll also gain the financial clout to expand into domestic transport logistics and to deal with customers overseas. It's not clear yet whether ABB Grain will be a consolidator or will itself be bought, but Wadhwaney believes it can work either way for investors in the stock.

The argument for food conglomerates such as Archer Daniels Midland (ADM) and Bunge (BG) is a bit more complicated.

After a projected loss of 3 million acres of corn to the floods in the Midwest, supply shortages will force ADM and Bunge to pay higher prices to farmers in order to beat out competitors—from rival food companies to livestock and ethanol producers—for the crops, says Allendale's Victor.

Amid Global Economic Currents

ADM's ethanol venture, still a small part of its total business, appears to be at risk from higher corn prices. But the fact that it owns barges, railcars, and ships helps it save on transportation costs and gives it a competitive edge on pure-play ethanol producers such as Verasun Energy (VSE), says Victor. With ethanol prices tied to crude oil prices, however, a drop in oil prices would pull down ethanol revenue and reduce ADM's earnings by 6¢ a share for every $2 a barrel that oil prices were to fall, Citigroup (C) analyst David Driscoll said in a May 29 note. (Citigroup does and seeks to do business with the companies covered in its reports.)

Bunge has assets around the world, a strong cash position, and risk management operations that enable it to benefit from greater market volatility, Credit Suisse analyst Robert Moskow wrote in an April research note. Expecting further positive earnings surprises, he raised his profit forecasts to $7.50 a share for 2008 and $8.40 a share for 2009.

Deere (DE) and other farm equipment manufacturers are also benefiting from higher crop prices, as farmers use higher revenues to replace old equipment, says Victor. But Deere's profits are being squeezed on the other side by rising input costs, chiefly from higher steel prices caused by tight supply worldwide. Even as prices for their precious products soar on world markets, ag companies—and their investors—still have to navigate the tricky crosscurrents of a global economy.

Bogoslaw is a reporter for BusinessWeek's Investing channel.