Here is the Secret Recovery Stock
Steven is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The current state of the economy isn’t quite ready to spawn the next bull market. That’s because it’s missing the key ingredient of housing. Without a healthy appetite for housing, the economy will likely continue puttering along with more signs of anemia.
According to the National Association of Realtors, for every two homes sold, one job is created in the US. Each home sale touches over eighty different occupations and accounts for an average of $60,000 in new spending over its lifetime. As a whole, housing makes up more than 15% of our Gross Domestic Product. Considering these factors, it’s not surprising the US economy thrives on housing demand.
Ultimately, housing will become popular again and a much stronger recovery will happen. Investors looking to capitalize on this opportunity should do so. Markets like to anticipate moves in advance of economic developments.
I’ve isolated one behind-the-scenes winner well positioned for a housing recovery. Look no further than seed giant Monsanto (NYSE: MON). Their corn seed business is positioned to greatly improve under such a scenario.
Connecting the Dots
As the economy expands, it means aggregate demand is rising, and a lot of that demand surprisingly goes into corn. Let me explain.
Corn is a magical starch that scientists utilize to create new applications. It’s well-known that corn is used in our food, animal feed, and as a fuel source. But this is just the tip of the iceberg. Less known uses include drywall, varnish, car tires, medicine, glue, ceramics, explosives, plastics, soaps, insecticides, paper, and then some. Entire industries rely on ample supplies of corn and a healthy economy to prosper.
The Key Driver
Interest rates are certainly low enough to fuel a housing recovery, but that doesn’t tell the whole story. The Great Recession was so severe that it damaged sentiment towards home ownership. Some of this was warranted, given the mania that fueled the housing bubble. The good news is that we’re starting to see improvements in sentiment.
Last week, homebuilder confidence rose to the highest level in six years. Homebuilders were encouraged by an increase in serious buyers interested in new single-family homes. However, the index level remains below 50, indicating that homebuilders still view conditions as poor.
Improvements in sentiment take a long time to manifest, especially after a severe recession. If we use the Federal Reserve’s low interest rate policy as our guide, sentiment isn’t likely to notably improve until mid-2015. That’s when the Fed plans on ending the “exceptionally low” interest rate period. Given the Fed’s record of changing their timing, I wouldn’t be so set on this time horizion. With that being said, I’m more certain that a big lift in homebuyer sentiment will do wonders for the housing market.
Corn is Monsanto’s biggest profit center, making up over 50% of their total gross profit last year. With 21% revenue growth for the year, it’s safe to say that this business is strong. In terms of the seed business, Monsanto is the leader of the pack and the world’s largest. Because corn is such a vital part of their profitability, it has made them the most effective way to get exposure to a corn boom.
In terms of the competition, Syngenta’s (NYSE: SYT) business is the most similar to Monsanto’s. They are the world’s third largest seed producer and are based out of Switzerland. The key difference between the two is related to exposure to the US seed market. Less than 2% of Syngenta’s revenue came from seed sales in North America, where over 53% of Monsanto’s came from the US. For Syngenta to benefit from a US housing recovery and subsequent corn boom, they would have to beef up their exposure in the US.
Du Pont (NYSE: DD) isn’t an effective corn-centric investment, even though they are the number two leader in seeds. That’s because their agricultural division makes up only 16% of total revenues. Any benefit from increased corn demand may not be realized by shareholders due to the broader nature of the company.
Dow Chemical (NYSE: DOW) is just beginning to gear up for battle in the corn seed business. At this time, their exposure to corn seeds is negligible.
Like Dow, BASF (NASDAQOTH: BASFY.PK) has an insignificant share of the corn seed business. In terms of agriculture, they operate primarily in the chemical business. It’s conceivable that BASF could benefit from a corn boom because it would mean a higher demand for chemicals. But like Du Pont and Dow, they are a chemical conglomerate that operates in many different industries. It’s not a very effective way to take advantage of this trend.
Clearly, corn is a big business. And where there is big business, there is big competition. But in the context of a US housing recovery where corn is poised to benefit, Monsanto is by far in the best position to capitalize.
Risks & When to Sell
- The US Supreme Court is hearing a case related to the patentability of self-replicating technologies like genetically modified (GM) seeds. Monsanto’s business currently restricts farmers from replanting seeds spawned from future generations. Instead, farmers must pay Monsanto the right to replant a second-generation seed. The outcome of this review may become detrimental to Monsanto’s business.
Before getting fearful, keep in mind that Monsanto is well prepared for this outcome. They are constantly developing new generations of seeds that offer improvements over predecessors. In other words, the outcome may not be as severe as the case implies.
- In the state of California, Proposition 37 may force food labels to specify if ingredients are of GM origin. If passed, about 80% of non-organic foods would have to change their labeling. This could influence shoppers away from GM foods.
The economy hinges on a resilient housing market. You can’t have a strong economic recovery without a strong housing recovery. Poor homebuyer sentiment is still getting in the way of this necessary resilience. When sentiment finally turns around in the years ahead, the housing market and economy will follow suit.
In the meantime, Monsanto has a strong corn business, and will get even stronger when housing recovers. Investors should watch out for a Supreme Court ruling and what happens in California with GM labeling. Both may have material impacts to their business. In the end, Monsanto may very well be that secret recovery stock investors have been searching for.
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