Should You Bet the Farm on Ag Stocks?

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Monsanto also appears to be more aggressively going after market share. Licensing its Roundup Ready 2 Yield technology for soybeans to Anglo-Swiss competitor Syngenta (SYT) may help it get a jump on DuPont's (DD) Optimum Gat soybeans, whose full market launch could be delayed until 2011, analyst Mark Connelly wrote in a Credit Suisse (CS) note on May 23. (Credit Suisse does and seeks to do banking with the companies covered in its research reports.)

And while the U.S., Brazilian, and Argentine markets are fairly saturated with biotech seeds for corn and soybeans, their proven qualities of higher yields and lower reliance on fertilizers opens the door to Europe, China, India, and many other countries that have so far resisted genetically modified crops, says John Baize, president of John C. Baize & Associates, an international agricultural trading and policy consulting firm that specializes in oilseeds.

"Once you've got prices as high as you have today for agriculture products and governments are in jeopardy because of high food prices, their reluctance goes away," he says.

The 100% surtax that China imposed on all fertilizer exports from April through September has caused the market for nitrogen fertilizer to tighten much more than for phosphate plant food, analyst Edwin Chee wrote in a research note for BMO Capital Markets (BMO) on June 11. Potash Corp. is one of the few producers able to meet higher demand when other producers lack adequate supply to do so, Chee said. Every hike in potash prices of $20 per metric ton or more adds 34¢ to Potash's EPS, according to Chee, who also noted that the company's phosphoric acid sales will benefit, with prices expected to surge from $366 per metric ton in the first quarter of 2008 to $1,500 to $1,800 per metric ton in 2009, he said.

Smaller-Cap Choices

But after enormous gains over the past few months, some of these ag stocks may be a little pricey for some investors. At 141.50, Monsanto shares are trading at more than 41 times projected earnings for fiscal 2008, while Potash is valued at 21 times fiscal 2008 estimated earnings.

Smaller-cap names may be a better choice for investors, given that the prices of these stocks have been hindered by fragile and uncertain economic conditions, which typically put pressure on smaller companies with less access to capital.

Cal-Maine Foods (CALM) has been heavily shorted by investors but actually benefits from a sluggish economy that lowers consumer spending because the shell eggs it produces are a relatively cheap source of protein. The largest publicly traded U.S. egg producer, it has a roughly 16% market share in a fragmented market and has grown through acquisitions in recent years. The U.S. market accounts for more than 95% of its sales, but the export market has improved this year because of a weak dollar, says Daniel Lew, one of the managers of the $224 million SunAmerica Focused Small-Cap Value A Fund (SSSAX).

Since egg producers don't have contracts with their customers, egg prices are set on a weekly basis. "So everyone in the industry is disciplined to not overproduce," he adds. Now that the health benefits of eggs are more widely recognized and Cal-Maine's growth is no longer tied to the once-popular Atkins high-protein diet, the valuation could double from 5 to 10 times earnings, says Lew. Egg prices are up about 40% from last year.

Another carrot for investors: the company's new dividend policy, under which it pays out one-third of its quarterly earnings as dividends.

Amber Waves of Grain

In the wheat market, a series of supply disruptions—droughts in Australia, and production shortfalls in the U.S. and parts of Europe—have resulted in a more traditional supply-led bullish outlook, says Lewis Hagedorn, agricultural commodities strategist at JPMorgan Chase (JPM). Wheat prices have more than doubled in the past two years.