With Corn Prices in Flux, What Does It Mean for Agriculture Companies?
Gerelyn is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
What a difference a year can make. Last year, the U.S. was experiencing a drought that destroyed crops while the price for agricultural products skyrocketed to record levels. Today, the farming community, is bracing for a corn glut, with prices of the commodity falling to their lowest levels in almost three years, according to a recent article in The Wall Street Journal. For instance, last year corn was selling for more than $8.00 per bushel; in recent days, the price was less than $5.00 per bushel.
While this spells trouble for farmers, who are likely to see profits plummet, it is a boon for agricultural companies like Tyson Foods (NYSE: TSN) that are going to benefit from lower feed costs. Indeed, corn is generally considered the priciest livestock feed ingredient, and the price reversal should permeate throughout the agricultural industry.
Tyson pays a quarterly dividend of $0.05 per share, offering investors a modest yield of less than 1%. But it has also been buying back shares and has 24 million shares authorized for repurchase under a current program. In terms of returns, shares are up 57% year-to-date. The question becomes, 'is there more room for Tyson's stock, with an earnings multiple of 16, to run?' The answer is yes. Let's take a look.
Costs and profits
For 2012, Tyson's feed expenses for ingredients such as corn, soybean meal, and other commodities, represented nearly 70% of the company's total cost of growing chickens. Tyson is vulnerable to the price of corn and unexpected cost increases could eat into its bottom line.
The good news for Tyson is that with the price of corn falling, the company now projects feed costs to be $500 million lower in 2014 versus 2013. Simultaneously, Tyson has already raised its own prices on its products to reflect higher investment costs, and it could take time for those prices to come down again, which means that its margins are likely to benefit.
Tyson is already projecting sales of $34.5 billion in 2013 and $36 billion in 2014, compared to sales of $33 billion in 2012. In its third quarter, it reported an operating margin of 4.8% (boosted by record earnings in the chicken segment of $220 million) compared to 4.1% in the year-ago period.
Despite the recent run-up in its stock, Tyson still trades at a discount to others in the food industry such as Kraft. I think there's more upside potential due to a favorable pricing environment.
Fill 'er up
Archer Daniels Midland (NYSE: ADM) is also likely to benefit from the price of corn, and the reason is ethanol, which can be mixed with gasoline to make alternative fuel for vehicles.
Last year, it was hurt by weak ethanol prices. But now, in a more favorable pricing environment for corn, things are looking up. The company expects there will be more of an incentive to blend ethanol, specifically for fuel. Add to this the expectation for additional ethanol fueling stations throughout the U.S. and Archer Daniels Midland could be very well positioned.
It is "very optimistic" about the prospects for ethanol in the U.S. for 2014 and 2015, according to Chief Operating Officer Juan Luciano. Last year, depressed margins in the ethanol market hurt its performance in its corn-processing segment where sales fell 4% to $6.2 billion; look for that trend to reverse in the near term.
A bumper corn crop is not good news for everyone. The anticipated oversupply of the commodity is eating into farmers' profit margins, and this could spell bad news for the makers of farming equipment. While it is still early to tell what the impact, if any, will be, let's take a look at one company that could be affected.
Deere (NYSE: DE) is the other side of the corn-price pendulum. As U.S. farmers' profits come under pressure, buying new equipment is not going to be first and foremost on their minds.
Deere, however, has its sights set on growth opportunities around the world, particularly in emerging markets. Indeed, the company's goal is to generate "$50 billion in mid-cycle sales by 2018," according to Deere's annual report. To do it, it is building facilities across all the BRIC nations -- Brazil, Russia, India and China -- with expectations for production to commence either this year or next.
Nonetheless, it is the U.S. and Canada that represent 60% of Deere's sales, and the company continues to invest in North America. Indeed, it was the North American agricultural market that led it to worldwide equipment sales of $33.5 billion last year driven mostly by a strong commodity-price environment and strong incomes in the farming community. Deere paid a company record $700 million in dividends last year and completed $1.6 billion in share buybacks.
But with the lion's share of its sales linked the farming community, it is going to be affected by the agricultural market's response to the pricing pressure in corn. If farmers postpone upgrading or replacing older equipment, Deere is likely to feel an impact. So shareholders might prepare for some near-term volatility, although over the long term, Deere's focus both on growth and its investors make it a solid play.
If you are going to invest in companies that have exposure to commodities, you are going to have to be willing to put up with volatility. Look at the difference a year made for Tyson. The good news is that right now, the pendulum is swinging in favor of agricultural companies like Tyson and Archer Daniels Midland.
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