Planting Seeds for Future Yields: 3 Stocks From the Farm Industry

Victor is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

When looking at the farm industry, analysts are usually very pessimistic. It is said the industry carries an inherently large risk. This may be true, but why is so much emphasis placed on this risk? It's because most analysts focus on the short run instead of the long haul. However, this industry has always paid dividends in the long run, some better than others, but it has always paid. The argument is simple: there may be bad seasons with poor yields, but, in general, they are ever-increasing. So, let us point out the firms that prove the argument is right: Cosan (NYSE: CZZ), Archer Daniels Midland (NYSE: ADM), and Bunge (NYSE: BG).

Prepared to excel

Brazil is leaving an interesting phase. The upcoming FIFA World Cup and Olympics created the need for infrastructural investments, increasing the demand for energy and logistics. Cosan has taken note of the opportunity and posted a 28% increase in year-to-year net revenue for 4Q12, setting a trend started in the previous fiscal year that the company hopes will continue.

Cosan is the world’s largest producer of bioenergy. The company also has expanded onto the logistics, agricultural properties, petrol products, and gas business. The group’s structure is a loyal reflection of its motto, "Crescimento com diversificaçao" (diversified growth). What caught my attention is how the firm pursued an aggressive acquisition strategy when the world economy entered a recession. Leaving aside its logistics business (Rumo), the firm bought Exxon Mobil’s Brazilian venture (Cosan) and started an agricultural real-estate company (Radar) in 2008, entered a partnership with Shell (Raízen) in 2010, and bought Companhia de Gás de Sao Paolo (Comgas) in 2012.

Today, Cosan is Brazil’s largest gas distributor and logistics services conglomerate. Such characteristics provide the company with a clear, dominant position, especially when looking at the conglomerate’s vertical structure and intelligent acquisitions.

Rising inflation has been an issue for the firm, but the government has taken notice and has been working on a solution. On the flip side, the company has managed to reduce risks by engaging on ventures abroad, in Europe, through its acquisitions.

Financially, Cosan has had better times, particularly regarding debt-to-cash levels. Nevertheless, its stock price has been dropping, opening a good opportunity for future investors since the company is expected to continue growing thanks to its vertical business model and risk diversification, coupled with the end of economic recession and Brazil’s sporting catalysts. Currently trading at 22.5 times its earnings, slightly below the 26.8 times industry average, it is recommended to buy Cosan stock before the price starts to rise again.

Much more for less

When a stock’s price begins to take a dive, a common interpretation is that the firm’s performance has been cut short. Nevertheless, earnings can still be generated even if the company is undervalued. Archer fits this description; stock price variations have not changed its shareholder rewards policy. The company has worked as a middleman between farmers and suppliers, while adding value to raw materials.

Archer’s first quarter outcomes fell below estimates due to a drought in the U.S. that limited farm production and exports, limited the company’s activities, and led to a reduction in cocoa margins. With production returning to normal levels, the firm will recover previous activity volumes for input and output. Having diversified sources and operations, and experiencing margin increments for corn processing and ethanol, the company has eased the effect of both the drought and smaller cocoa margins.

The international market has been of great interest for Archer as well. GrainCorp’s acquisition is telling evidence about the company’s growing competitive standards. Now, the firm has a strong presence in the most important cereal production markets: the U.S., China, Brazil, Argentina, and Australia. Interestingly, the business's activities have remained the same, with the company acting as middleman between farmers and consumers. This business model has proven to be successful and guarantees that the corporation will be around for awhile.

Financially, Archer is not going through its best, either. The firm’s current situation is, however, explained by temporal and permanent market shifts and business expansion. So, there is a good reason for its rising debt and cash flow reduction.

Besides all this, analysts remain positive about the firm's future prospects, and its stock price remains reasonable at 16 times its earnings, versus the 26.8 times the industry average. In the end, it is recommended to buy this stock, as the company has tested itself against tough winds and survived, while showing a great degree of product innovation.

Riding on its legacy

Last, but not least, is Bunge. This company represents a landmark for the agribusiness in general. It is about to reach its bicentenary, and is still presenting competitors with tough battles. The company has championed the middleman role between farmers and consumers, while subsequently entering new grounds and leaving old ones.

Bunge’s specialization as a middleman has allowed it to exploit an economic niche. The position is, however, very unstable. Market leverage is questionable because of little pricing power and increasingly effective competition. Also, small changes in cereal prices, currency valuation, and harvest yields can have devastating effects on the firm’s cash flow. Moreover, its debt-to-cash ratio has almost reached an all-time high, while the firm presents an average operating margin.

On the other hand, given that the world economy continues to recover, population continues to grow, and developed countries (especially India and China) will increase demand for commodities, Bunge holds promising future prospects. Additionally, the firm has not yet been able to reap benefits from sugar investments made in Brazil due to climate anomalies. Such positive outlook has resulted in an increase in cash dividends.

Bunge has demonstrated the ability to sustain itself against poor yields and reductions of operational volumes with small cash margins, leaving behind an upstream legacy since the last economic recession. Valued at 24.6 times P/E, compared to the 28.6 times industry mean, while offering promising estimates and, especially, a long and strong history, it is recommended to buy this stock.

Botton line

Price, dividends, and prospects are the main differences among the stocks presented. Bunge is the most expensive stock, and Cosan the cheapest. Bunge is still coming out of the storm, while Cosan is navigating safe waters. Nevertheless, all three hold positive outlooks as the world economy returns to normal. It is just a matter of how much you want to spend, or faith that one will outperform the other. So, choosing one the three is a matter of investor preference.

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Victor Selva has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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