Down on the Farm
Sofia, Bulgaria–For much of the past week and a half, I’ve been on the KCI Communications, Inc. cruise down the Danube River in Central Europe. As part of this trip, I had the opportunity to meet US Embassy representatives, economists and fund managers primarily in two cities: Vienna, Austria, and Budapest, Hungary.
It doesn’t surprise me that these conversations frequently turned to energy. After all, the former Eastern Bloc is a rapidly developing, fast-growing region of the world. The economies of Eastern Europe as a whole grew at more than 6.2 percent last year and should post growth more than 6 percent again in 2007, considerably faster than in the US or mature, Western Europe. The obvious consequence of all that growth: more demand for energy of all sorts.
Equally important is the matter of supply. Most nations in the region are keen to reduce their historical dependence on imported energy commodities from Russia. Hungary, for example, imports 98 percent of its natural gas needs directly from Russia; there have already been several supply disruptions during the past few years. Countries in the region are keen to reduce that dependence and are receiving considerable European Union (EU) aid to further that goal.
What did surprise me somewhat was the focus on biofuels and alternative energy technology. Clearly, Austria is a developed country, but its historical role as the “Gateway to the East” means that Austrian firms are investing heavily in alternative energy projects in Central and Eastern Europe.
For its part, Hungary is among the most fertile countries in Europe with around 9.3 million hectares (35,900 square miles) of ideal, arable land. It’s long been a breadbasket, producing wheat, corn, rapeseed and a host of other crops. Many of these traditional crops can be distilled into ethanol or used as feedstock for biodiesel plants.
In fact, as part of Hungary’s agreement to enter the EU in 2004, the nation agreed to double its biofuels production capacity within four years. And the EU now has a plan to boost biofuels to 10 percent of total liquid fuel demand by 2020, powering further investment in the industry. Hungary even has plans to go further than its original agreement with the EU, pumping up ethanol production tenfold during the next three years, funded again, in large part, with EU monies.
Of course, the situation in Eastern Europe is just a microcosm for what’s going on globally. The US government also offers generous funding and subsidies for biofuels production. And the US, like the EU, has aggressive mandates for biofuels production. Even in fast-growing Asia, there’s plenty of growth to be found, aided by government largesse.
Roughly one year ago today in the Sept. 20, 2006, issue of The Energy Strategist, Fueled by Food, I wrote a detailed issue on biofuels and inaugurated the biofuels field bet.
My basic position remains unchanged: Biofuels won’t solve the world’s energy problems and will never substitute for crude oil. However, generous subsidies will power rapid growth in this industry; oddly enough, political parties from both the left and the right seem quite content to promote biofuels and alternatives even when they disagree on just about every other matter.
And the story goes far beyond biofuels; there’s a second pillar to the agricultural growth story. That’s, of course, rapidly growing demand for food from nations such as China and India.
It’s not only that consumers in these countries are eating more calories per day, but they’re upgrading their tastes, eating more meat and processed foods rather than basic staples like grains and rice. Producing such foods puts further pressure on the global agricultural industry and has helped power the bull market in agricultural commodity prices.
Demands for food and biofuels are in direct competition for the same commodities. And where there’s growth, investors can make money.
Although it may seem out of left field, food consumption—namely meat—is related to alternative energy. The supplies needed for more meat products compete directly with those for biofuels. As such consumption increases, more of the grain supply is depleted. See The Second Wave.
It’s time for a yearly review of my biofuels field bet. I’m providing a rundown on each stock recommendation and adding a new one to the mix as well. See How to Play It.
In this issue, I’m recommending or reiterating advice on the following stocks:
The US derives its ethanol primarily from corn while Brazil uses mainly sugar. Check out the chart “Global Ethanol Production” for a closer look at how rapidly these countries have ramped up production in recent years.
Source: BP
The US is currently the world’s largest ethanol producer, producing some 9.2 million metric tons of oil equivalent. US ethanol production jumped an amazing 24.2 percent from 2005 to 2006. That growth has been powered by two major events: the phase-out of methyl tertiary butyl ether (MTBE) and renewable fuels mandates.
I’ve discussed both programs at some length in past issues of TES, including the Sept. 20, 2006, issue. To summarize, MTBE was a fuel additive that fuel blenders use to oxygenate fuel and boost octane ratings. But MTBE has been linked to cancer, and the additive was phased out last year.
Ethanol is among the only feasible alternatives to MTBE. So the first wave of ethanol demand was simply as a replacement for MTBE.
Second, the US government has mandated that the US produce 12 billion gallons of ethanol by 2012, up from around 5.4 billion gallons in 2006. But President Bush and many on both sides of the aisle in Congress want to extend that mandate to a whopping 35 billion gallons by 2017.
To put that into perspective, there currently isn’t enough corn grown in the US to produce 35 billion gallons of corn-derived fuels even if we divert every last kernel to biofuels production. This mandate assumes one or more of three possibilities: a switch to so-called next generation ethanol, a rapid jump in planted acreage or big ethanol yield improvements for corn-based ethanol.
But whether or not the US ends up adopting and attaining that target, the government currently offers a 51-cent tax credit per gallon to blenders for using ethanol and well as incentives for corn farmers and companies doing research on biofuels production. All this has the effect of powering increased production.
That’s impressive from a growth standpoint. However, it isn’t truly helping the nation from an energy independence perspective.
Consider that the US consumed 939 million metric tons of oil in 2006. Therefore, ethanol production accounted for only about 0.98 percent, less than 1 percent, of US crude oil demand. Meanwhile, ethanol consumed 20 percent of the entire US corn crop last year.
Producing ethanol from corn isn’t terribly efficient; the energy yield isn’t high. In other words, it takes a tremendous amount of energy to plant, harvest and fertilize crops, as well as to run an ethanol plant. When you compare the energy costs of producing ethanol to the energy produced from burning the fuel, there’s, at best, only a small energy gain.
Ethanol in Brazil is cheaper to produce because sugarcane is a far better, cheaper and more efficient feedstock than corn. Unfortunately, countries like the US don’t have an ideal climate for growing sugarcane, at least not as much as will be needed to meet demand. And Brazil uses a great deal of the sugarcane it produces domestically; it certainly can’t be called upon to meet all of the world’s growing demand for ethanol.
The world’s big leap in production of ethanol isn’t free. Increased demand for corn to feed all those US ethanol distillation plants pushed up prices considerably last year.
Corn futures traded on the Chicago Board of Trade (CBOT) jumped from around $2 per bushel in late 2005 and early 2006 to well more than $4 per bushel early this year. And increased corn plantings certainly had effects on other crops; acreage that would have normally been used to grow soybeans, wheat or other crops was used to produce corn and take advantage of the higher prices.
And more intensive farming also has an impact on other global commodities. One of the most obvious is fertilizer. Check out the chart “Fertilizer Use per Acre” below.
Source: US Dept of Agriculture (USDA)
This chart shows US use of two key fertilizers, potash and nitrogen, per acre of corn planted. Two points are worth noting. First, the use of both fertilizers on a per-acre basis has increased since the mid-1960s.
Second, the USDA projects 93 million acres of corn were planted this year, up from around 80 million acres on average during the past few years. When you couple increased fertilizer use per acre with more acres planted, it’s not hard to see why fertilizer demand has been soaring so much in recent years. And remember that it’s not just the US that’s producing crops and using fertilizer; demand globally has been soaring.
Fertilizers aren’t produced out of thin air. Potash, for example, is a mineral containing potassium—typically potassium chloride—that’s mined from the earth. Economic mines are located in only a few places around the world.
That means that ramping up production isn’t seamless and requires building new mines and processing facilities; therefore, supply can only slowly rise to meet growing demands. This classic supply/demand squeeze has pushed potash prices sharply higher during the past few years.
The world’s largest potash producer–Potash Corp, a biofuels field bet pick–has seen prices for its potash rise from the $70 to $80 per metric ton range in 2003 to closer to $160 to $170 per ton more recently. And there’s no sign of that slowing down.
But I don’t mean to focus attention solely on ethanol and the US and Brazil. Biodiesel is produced from plant-derived oils–basically vegetable oil. It can also be mixed with conventional diesel or sold separately for use in specially fitted diesel vehicles. Some of the more common crops for producing biodiesel include soybean oil, rapeseed (canola) oil and, increasingly, palm oil.
Biodiesel production is ramping up particularly quickly in the EU. Check out the chart “EU Biodiesel Production” for a closer look at this trend.
Source: European Biodiesel Board
Total EU biodiesel production capacity has surged from just above 1 million metric tons in 2002 to more than 10 million today. That’s a tenfold growth in capacity in the past five years.
The majority of biodiesel production capacity is located in Germany. Again, this is largely the product of government policies in this nation. Germany has actively subsidized biodiesel production for years.
But the EU is also taking a more active role now on a regional basis. The EU is targeting biofuels at 5.75 percent of total transportation fuels by the end of 2010, up from around 2 percent at the end of 2005. In addition, the EU has mandated that each member state adopt targets for biofuels use.
Part of this policy is to encourage countries such as Hungary to produce more biofuels. As I noted above, this is clearly having an effect; in Hungary, there was a great deal of talk about new biofuel plants.
And the US Embassy in Budapest is trying to campaign for the nation to change its rules governing the use of genetically modified (GM) crops produced by companies such as biofuels field bet member Monsanto. GM crops have been specifically designed to boost yields of biofuels and to cut back on demand for pesticides and herbicides. Hungary, however, has a ban on GM seeds, so it’s not producing as much biodiesel and ethanol as it could, given current planted acreage.
But that’s not to say there isn’t growth. The EU has already funded significant biofuels capacity expansion, and nations have adopted aggressive targets. According to a report by the EU Commission released this summer, it’s unlikely that the region will attain its stated 5.75 percent goal on time by the end of 2010.
However, the EU believes that, given the recent acceleration in biofuels capacity, the region could meet an expanded 10 percent target by 2020. But the truth is that it doesn’t really matter whether the EU hits its targets or not; the point is there will be a lot of growth in this industry as it tries to do so. This offers us a great opportunity.
The key point to take away from this brief rundown of the biofuels industry is that biofuels output is projected to grow globally during the next 25 years. Check out the chart “Global Biofuels Production.”
Source: Energy Information Administration (EIA)
This chart is based on estimates of global biofuels production from the US EIA. As you can see, the organization is expecting global biofuels production to top 1.7 million barrels per day of oil equivalent by 2030, up from less than 0.4 million barrels in 2004. That’s a more than fourfold increase; meeting that demand or anything close to it will be a major challenge for the global agriculture industry.
Consider that China is already the world’s largest consumer of meat and demand is accelerating. Some 72 percent of Chinese consumers live outside of cities; the rural Chinese population tends to earn lower wages than their contemporaries in the cities. That’s a simple consequence of the fact that urban areas where manufacturing and emerging industries are based have been the engine of Chinese growth for years.
Historically, as a country develops and the population become wealthier, consumers boost their consumption of meats. In poorer countries, basic cereals such as rice and grains tend to make up the largest share of total caloric intake; food supply in a developed country like the US or UK is much more varied, including meat, alcoholic beverages, fruits and processed foods such as cheese.
A recent report from a Chinese government researcher specifically highlighted the Chinese pork industry. Right now in Chinese cities, the average consumer eats about 40 kilograms (88 pounds) of pork per year; that’s more than double what that number was 20 years ago.
That said, Taiwanese consumers eat more than 70 kilograms of pork annually (154 pounds). There’s room for Chinese urban dwellers to increase pork consumption toward the Taiwanese level as China grows wealthier.
But here’s the shocking part. Chinese rural dwellers eat, on average, less than 20 kilograms (44 pounds) of pork annually. City dwellers eat more than half the nation’s total pork supply, even though these consumers make up less than 30 percent of the population.
Over time, however, Chinese consumers have been migrating from rural areas of China into the cities. As this trend continues, more Chinese consumers will be taking higher paying jobs and earning larger incomes. You can bet that these new city dwellers will boost their pork consumption as it becomes economically feasible for them to buy more meat.
And pork consumption in the countryside is actually growing far faster, even for consumers who remain there and don’t migrate into cities. Therefore, pork consumption in the countryside has risen threefold during the past 20 years. Given the size of China’s population, you can imagine the wall of demand for pork products this all represents.
These statistics struck me. There’s an obvious likelihood that, despite China’s huge pork production, it won’t be able to meet all this demand with domestic livestock. In fact, the Chinese Ministry of Commerce has said that it will quadruple pork imports this year in an attempt to alleviate supply shortages.
You may be wondering at this point why I’m talking about pigs in a newsletter dedicated to the energy markets. The reason is simple: These markets are intimately related.
The very same commodities that are used to produce biofuels like ethanol and biodiesel are also used to feed livestock. Soybean protein and feed grains like corn are absolutely necessary to raise livestock to an age where they’re suitable for consumption.
And producing meat is a relatively intensive process, requiring significant quantities of grain. Consumers eating meat are indirectly consuming much more grain than consumers who eat only basic grains like rice and corn.
Therefore, increased pork consumption in China means rising demand for corn, soybeans and everything needed to produce these crops, such as fertilizer, seeds, pesticides and herbicides. And when the Chinese quadruple their meat imports, they’re also indirectly buying more grain.
And inside TES, we’ve been playing this bull market using what I call a field bet. Long-time readers will be familiar with this concept, but let’s review.
Instead of just picking one or two highly leveraged plays on biofuels, I recommend casting a much wider net. By buying several biofuel plays of differing risk levels, we can diversify our risk and maximize our chances of hitting a few big winners.
The key is to buy all of the plays in the field bet and account for the risk by placing a relatively small amount in each pick. Depending on your risk tolerance, I recommend placing a fifth to a third of what you’d normally put in a TES recommendation into each pick. I’m also careful to identify picks that I consider to be riskier.
This strategy has paid off in a big way in the past year. As you can see from the table below, the vast majority of the picks have performed well and the overall average return is 53.9 percent, trouncing the S&P 500’s 15 percent jump over the same time frame.
That said, one pick has been an absolute disaster. Earth Biofuels has lost essentially 100 percent of its value since my recommendation. (See the table below.)
This is exactly why I use field bets to play some of my big picture themes. In order to make some big gains, such as the homeruns we had in Potash Corp, Mosaic and Monsanto, you have to take risk.
This is particularly true in my aggressive growth Gushers Portfolio. By keeping your position sizes relatively small and casting a wide net, you can reduce the impact of any single recommended field bet position.
I keep updated tables of the field bets on the Web site. Simply click the asterisk (*) symbol next to the field bets in the Portfolio table.
I also periodically recommend taking some profits off the table in our big winners. Sometimes I recommend selling one of the picks or buying a new recommendation. When that happens, I will update the field bet tables accordingly.
Here’s a rundown of all my biofuels field bet picks, as well as some new recommendations:
Palm Oil Producers–Anglo-Eastern Plantations (London: AEP) and MP Evans (London: MPE)
Anglo-Eastern Plantations is up around 42 percent during the past year, about 33 percent because of the rise in the price of the stock and the remainder because of the rising value of the British pound against the US dollar.
Similarly, MP Evans is up a similar amount over the same time frame. Both companies produce a key type of edible oil known as palm oil.
Palm oil is produced from the fruit of a particular type of palm tree. As with most palms, this tree requires a tropical climate and is normally found near or around the equator.
Malaysia and Indonesia dominate production of palm oil, each producing around 16 million metric tons per year. The next-highest producer is Thailand, which produces around 1 million metric tons.
Palm oil has multiple uses. It’s used to make edible cooking oils; chances are you’ve eaten palm oil, which is an ingredient in some types of candy bars and margarines. It also has nonedible uses that include soap and detergent manufacture and, of course, biodiesel production.
Palm oil is a very efficient feedstock for biodiesel plants and has received considerable attention in the EU as a logical feedstock solution. The reason is simply that you can produce 5 metric tons of palm oil per hectare of land. For soybeans, a hectare of land will yield just 0.5 metric tons.
The prime consumers of palm oil include many nations located in Asia. This is logical because of the proximity of the supply in Malaysia and Indonesia.
China is, in fact, the No. 1 consumer of palm oil in the world; palm oil is the most popular edible oil in China. As noted earlier in this issue, consumption of fats and oils also tends to rise as consumers become wealthier. India is another huge customer for Malaysian and Indonesian palm oil.
Among developed countries, the EU (taken as a whole) is the No. 2 palm oil consumer in the world. The EU imports palm oil as an edible oil and, increasingly, as a source of oil for biodiesel plants. It’s often cheaper to import palm oil than to actually buy domestically produced rapeseed oil for biodiesel production.
As you might expect, palm oil prices have been on the rise. That’s a major benefit for companies such as Anglo-Eastern Plantations and MP Evans that own palm oil farms. Check out the chart below for a better look at palm oil prices.
Source: Anglo-Eastern Plantations
To make a long story short, Anglo-Eastern owns about 34,000 hectares of oil-producing land mainly in Indonesia (about 2,500 hectares in Malaysia). From this land, Anglo-Eastern produces more than 500,000 metric tons of fresh palm fruit bunches.
The company also owns processing facilities for converting this fresh fruit into actual palm oil. In total, Anglo-Eastern produces 160,000 metric tons of crude palm oil.
The company has been performing well. Operating profits essentially doubled in the first half of 2007, compared with the first half of 2006; the improvement was mainly the result of soaring crude palm oil prices.
On the downside, crop production so far this year has been coming in under expectations. But Sumatra has seen a serious drought; many of Anglo’s plantations are located in this part of Indonesia, so that’s hurt production. In addition, the company has seen some labor-related delays clearing land and planting crops at some of its newer properties.
Anglo has been growing somewhat via acquisitions as well. The company tends to buy older plantations that need to be cleared and at least partially replanted. Sometimes they also buy virgin land that’s suitable for production. In time, as these newly acquired lands are purchased and planted, this results in higher palm oil output. Anglo-Eastern Plantations is a slow but steady performer and continues to rate a buy at current levels.
Much of what I just outlined for Anglo also applies to MP Evans. But MP has been following a slightly different strategy.
The company has historically owned plantations in Malaysia and Indonesia, but it’s been gradually exiting the Malaysian market entirely and buying up additional properties in Indonesia. The company’s Malaysian plantations were relatively small, which made them less-than satisfactorily profitable. However, the land MP owns there is valuable; it’s realized solid prices on these sales in Malaysia.
Currently, MP Evans owns about 10,000 hectares of mature, producing palm plantations in Indonesia. It’s also bought in access to more acreage and is planning to plant those acres at a rate of around 6,000 hectares per year. Eventually, MP Evans has targeted a land position of 70,000 hectares of palm oil-producing properties all in Indonesia.
In addition to palm oil, MP Evans owns a considerable land position in Australia that’s used for raising beef cattle. As noted above, Asia is a region of rapidly growing meat demand, so cattle properties are another valuable asset to own.
In MP Evan’s fiscal year, ended June 30, the firm announced a more than 35 percent rise in operating profits. MP Evans remains a great buy at current prices.
Fertilizer Producers: Potash Corp (Toronto: POT; NYSE: POT) and Mosaic (NYSE: MOS)
I outlined the reasons for the bull market in fertilizer demand and prices in the text above. I won’t reiterate all those points here.
These two stocks have been by far my best plays in the biofuels field bet, returning 168 percent and 174 percent, respectively, during the past year. These are exactly the sort of big winners we’re looking for within the field bets.
Both firms should continue to benefit from strong demand and tight supply for fertilizer. And I don’t see that balance deteriorating much at least in the next year or so. Further, it’s encouraging that fertilizer prices continued to surge ahead in the seasonally weak early summer period.
My only concern is that both companies are now sporting valuations at historic highs. For example, Mosaic currently trades at 3.5 times sales; 1 to 1.75 is a more normal ratio for this stock.
I firmly believe that the fertilizer companies are now entering a new prolonged up-cycle, but the stocks have likely priced in a lot of good news short term and are vulnerable to any disappointment.
As a result, I’m cutting both Potash Corp and Mosaic to holds for now. I also recommend selling off at least half of your position in each stock to lock in some nice profits. This is only prudent after a move of this magnitude.
Finally, I’m setting stop recommendations for both stocks to lock in nice gains.
Seeds and Herbicides: Monsanto (NYSE: MON) and Syngenta (NYSE: SYT)
Monsanto’s main business is the production of GM seeds. GM seeds are designed to exhibit certain traits; examples might include drought, weed and pest resistance. The stock is up 67.5 percent since my recommendation one year ago.
Monsanto makes Roundup, a popular herbicide used to control weeds. The company also sells a GM corn called Roundup Ready corn, which is resistant to Roundup; farmers can essentially spray the herbicide on their crops and eliminate all the weeds without damaging the corn crop itself. The result is better yields per acre.
Monsanto is also a global leader in what’s known as stacked traits. This is the ability to engineer multiple beneficial GM traits into seeds. For example, Monsanto might sell seeds that are resistant to both Roundup and drought conditions.
And these stacked trait seeds are getting even more advanced. Recently, Monsanto announced a joint venture with Dow Chemical to produce a GM corn known as SmartStax corn. SmartStax corn will include traits invented by both companies–a total of eight separate GM traits in each seed.
Not surprising, given the strong growth in agriculture demand and the increasing prevalence of GM seeds across the US and South America, Monsanto’s profits have been on fire. This week, the company boosted its guidance for the rest of the year and said that pricing for its technology and Roundup herbicide had come in well above management’s original expectations.
Although the company recently broke to a new all-time high, the stock has a lot of growth ahead of it. I’m retaining my buy recommendation for Monsanto for now but establishing a stop and “buy under” recommendation to lock in gains on the stock.
Syngenta has also performed well, rising 41.3 percent since my recommendation one year ago. The company has a GM seeds division, but it’s not as advanced as Monsanto’s.
That said, the company is scheduled to launch a new triple-stacked corn next year and has an alliance with DuPont, another GM seed producer. New GM seed introductions should keep growth going at this division.
But around 80 percent of revenues are derived from Syngenta’s crop-protection business—basically, herbicides and pesticides. Sales of crop-protection chemicals have slipped industry wide as GM becomes more common.
The reason is that GM traits actually reduce the need to apply such chemicals by making the plants themselves resistant to the diseases and pests. But the market hasn’t and will never disappear, and Syngenta is a leader in advanced crop-protection technologies.
In addition, this Switzerland-based company has a strong position in Europe. European crop demand has been soaring because of the advent of biofuels subsidies.
Traditionally, the EU has set aside a certain number of acres in Europe to lie unplanted in a given year. The purpose of this policy was to reduce crop production and eliminate surpluses that were common in the late ’80s and through the ’90s. But it’s likely the EU will soon eliminate set-aside acreage because the region really needs to maximize crop production.
This additional demand is another likely short-term catalyst for the stock. I retain my buy rating on Syngenta.
Diversified Farming: Sipef (Belgium: SIP)
Sipef owns plantations quite literally all over the world, including Vietnam, Papua New Guinea, Indonesia and the US. It’s a broader play than the two palm oil-focused plantations listed above: The company produces bananas and other fruits, palm oil, tea, coffee, rubber and even fresh flowers. Sipef has soared 76 percent since my year-ago recommendation.
Nonetheless, palm oil is still the most important product for Sipef, accounting for roughly three-quarters of production. The company also recently built a giant storage facility for palm oil to facilitate its export into the fast-growing Asian markets.
All the products that Sipef produces are at the epicenter of demand growth in Asia. As a major producer of palm oil, Sipef has been benefiting from both increased production and rising palm oil prices.
In late August, Sipef announced strong results; profits doubled mainly because of higher palm oil prices. The firm also managed to boost production of palm oil at its own plantations to just shy of 94,200 metric tons in the first half of the year. Sipef is a buy at current levels.
High-Tech Players: Novozymes (OTC: NVZMY) and Metabolix (NSDQ: MBLX)
Novozymes wasn’t originally a play in my biofuels field bet; I added the stock in the May 2 issue of TES, King Coal. The stock is up 20 percent since that recommendation. I offered a detailed rundown of my rationale for recommending the company in that issue, but let’s review.
Novozymes is a world leader in the manufacture of enzymes. Enzymes are nothing more than proteins used to catalyze certain chemical reactions. Enzymes are used in the production of ethanol from corn, sugar or any other agricultural product. Novozymes is a world leader in producing enzymes for ethanol production.
A potential growth play for Novozymes is second-generation ethanol. This form of ethanol would be manufactured from agricultural waste or noncultivated products such as corn husks and a type of prairie grass known as switchgrass. It makes sense to make ethanol from useless products rather than the crops we also need to use as food or feed for livestock.
But there’s a problem with second-generation ethanol: The technology isn’t ready yet. Although you’ll often hear these technologies hyped, the reality is that second-generation ethanol is technologically possible but extraordinarily expensive.
The reason is that these waste products don’t have the concentrations of sugars and starches needed to efficiently make alcohols. Most realistic estimates suggest that commercial applications for second-generation ethanol are at least a decade away.
But one of the keys to making second-generation ethanol feasible will be advanced enzymes to catalyze the process. Novozymes is a leader in this research and has partnered with the Dept of Energy on various projects in the field; President Bush even visited its factory back in February of this year as part of his campaign to promote greater use of biofuels.
The company is a solid play on first-generation ethanol with a second-generation kicker. Novozymes remains a buy at current prices.
In this issue, I’m adding Metabolix to the biofuels field bet. The company makes natural biodegradable plastic as part of a joint venture with agribusiness giant Archer Daniels Midland (ADM). The plastics are actually made out of crops such as soybeans, corn and sugarcane; traditionally, plastics are made out of petrochemicals derived from oil and natural gas.
Consider that the global market for plastics is 500 billion pounds. This is a huge potential market in which to sell.
The stock is a speculative play, but I see the potential upside as worth the risk, particularly given ADM’s involvement in the project. Basically, ADM and Metabolix are 50/50 partners in Telles, a firm that develops, markets and sells these biodegradable plastics under the brand Mirel.
The advantages are obvious. Because plastics are typically made from oil, natural plastics would actually cut petroleum consumption. And a great deal of plastics, including plastic bottles and containers, end up clogging the world’s landfills. These products take thousands of years to degrade. But biodegradable plastics would disappear from the waste stream in a matter of months.
Metabolix doesn’t really sell anything at this time–hence the speculative nature of this play. However, the company recently expanded its test plant to produce as much as 50,000 pounds of natural plastics per year.
The company has 80 ongoing tests with customers in which it tries to formulate a natural plastic for a specific customer-specified use. It’s unlikely that all 80 products will pan out; however, if Metabolix can find just a few viable products and end-markets, the stock could soar.
The company has plans to build a commercial production facility next year that it will attempt to pre-load with customers. Retailing giant Target is already rolling out a gift card made of natural, biodegradable Mirel plastics. Metabolix is added to the biofuels field bet.
The final two picks in my biofuels field bet are Earth Biofuels and the Deutsche Bank Agricultural iShares (AMEX: DBA). As noted earlier, Earth Biofuels has fallen 98.5 percent since my recommendation, the only loser in the field bet.
The company makes and sells biodiesel in the US. As I’ve been saying for some time, I see little hope for this stock because its business never really panned out and margins in biodiesel production have been squeezed by rising crop-derived oil prices.
Fortunately, the other field bet recommendations more than made up for the loss in Earth Biofuels. This is the whole reason for the field bet.
I’ll continue to track the stock as a hold only because I see no reason to sell it here on the off chance it does recover somewhat. If, however, it would be useful for you to generate a tax-loss on the stock, consider doing so before the end of this year.
The Deutsche Bank Agricultural iShares is an exchange traded fund (ETF) that tracks toe performance of a number of different agricultural commodities. Note the ETF’s value is based on the value of the commodity itself, not stocks with exposure to these markets.
It’s a convenient way to play agricultural commodities in a diversified way. The Deutsche Bank Agricultural iShares is up 5.5 percent and remains a buy.
Note I typically don’t recommend ETFs because most investors can do far better picking individual stocks. I’m making an exception in this case only because many investors have no other means of playing commodity markets directly.
It doesn’t surprise me that these conversations frequently turned to energy. After all, the former Eastern Bloc is a rapidly developing, fast-growing region of the world. The economies of Eastern Europe as a whole grew at more than 6.2 percent last year and should post growth more than 6 percent again in 2007, considerably faster than in the US or mature, Western Europe. The obvious consequence of all that growth: more demand for energy of all sorts.
Equally important is the matter of supply. Most nations in the region are keen to reduce their historical dependence on imported energy commodities from Russia. Hungary, for example, imports 98 percent of its natural gas needs directly from Russia; there have already been several supply disruptions during the past few years. Countries in the region are keen to reduce that dependence and are receiving considerable European Union (EU) aid to further that goal.
What did surprise me somewhat was the focus on biofuels and alternative energy technology. Clearly, Austria is a developed country, but its historical role as the “Gateway to the East” means that Austrian firms are investing heavily in alternative energy projects in Central and Eastern Europe.
For its part, Hungary is among the most fertile countries in Europe with around 9.3 million hectares (35,900 square miles) of ideal, arable land. It’s long been a breadbasket, producing wheat, corn, rapeseed and a host of other crops. Many of these traditional crops can be distilled into ethanol or used as feedstock for biodiesel plants.
In fact, as part of Hungary’s agreement to enter the EU in 2004, the nation agreed to double its biofuels production capacity within four years. And the EU now has a plan to boost biofuels to 10 percent of total liquid fuel demand by 2020, powering further investment in the industry. Hungary even has plans to go further than its original agreement with the EU, pumping up ethanol production tenfold during the next three years, funded again, in large part, with EU monies.
Of course, the situation in Eastern Europe is just a microcosm for what’s going on globally. The US government also offers generous funding and subsidies for biofuels production. And the US, like the EU, has aggressive mandates for biofuels production. Even in fast-growing Asia, there’s plenty of growth to be found, aided by government largesse.
Roughly one year ago today in the Sept. 20, 2006, issue of The Energy Strategist, Fueled by Food, I wrote a detailed issue on biofuels and inaugurated the biofuels field bet.
My basic position remains unchanged: Biofuels won’t solve the world’s energy problems and will never substitute for crude oil. However, generous subsidies will power rapid growth in this industry; oddly enough, political parties from both the left and the right seem quite content to promote biofuels and alternatives even when they disagree on just about every other matter.
And the story goes far beyond biofuels; there’s a second pillar to the agricultural growth story. That’s, of course, rapidly growing demand for food from nations such as China and India.
It’s not only that consumers in these countries are eating more calories per day, but they’re upgrading their tastes, eating more meat and processed foods rather than basic staples like grains and rice. Producing such foods puts further pressure on the global agricultural industry and has helped power the bull market in agricultural commodity prices.
Demands for food and biofuels are in direct competition for the same commodities. And where there’s growth, investors can make money.
In This Issue
As noted above, I introduced the biofuels field bet last year as a way to play on the activity in this industry. Although my outlook remains unchanged, there have been some new developments, mainly from overseas. Take a look at what’s to come in this alternative energy sector. See Biofuels Outlook.Although it may seem out of left field, food consumption—namely meat—is related to alternative energy. The supplies needed for more meat products compete directly with those for biofuels. As such consumption increases, more of the grain supply is depleted. See The Second Wave.
It’s time for a yearly review of my biofuels field bet. I’m providing a rundown on each stock recommendation and adding a new one to the mix as well. See How to Play It.
In this issue, I’m recommending or reiterating advice on the following stocks:
- American Commercial Lines (NSDQ: ACLI)
- Anglo-Eastern Plantations (London: AEP)
- Metabolix (NSDQ: MBLX)
- Monsanto (NYSE: MON)
- Mosaic (NYSE: MOS)
- MP Evans (London: MPE)
- Potash Corp (NYSE: POT)
- Sipef (Brussels: SIP)
- Syngenta (NYSE: SYT)
Biofuels Outlook
The two biofuels that most consumers are familiar with are ethanol and biodiesel. Ethanol is a type of alcohol that can be mixed with conventional petroleum-derived fuels as an additive or burned in specifically modified flex-fuel vehicles. Two countries accounted for 90 percent of global ethanol production in 2006: the US and Brazil.The US derives its ethanol primarily from corn while Brazil uses mainly sugar. Check out the chart “Global Ethanol Production” for a closer look at how rapidly these countries have ramped up production in recent years.
Source: BP
The US is currently the world’s largest ethanol producer, producing some 9.2 million metric tons of oil equivalent. US ethanol production jumped an amazing 24.2 percent from 2005 to 2006. That growth has been powered by two major events: the phase-out of methyl tertiary butyl ether (MTBE) and renewable fuels mandates.
I’ve discussed both programs at some length in past issues of TES, including the Sept. 20, 2006, issue. To summarize, MTBE was a fuel additive that fuel blenders use to oxygenate fuel and boost octane ratings. But MTBE has been linked to cancer, and the additive was phased out last year.
Ethanol is among the only feasible alternatives to MTBE. So the first wave of ethanol demand was simply as a replacement for MTBE.
Second, the US government has mandated that the US produce 12 billion gallons of ethanol by 2012, up from around 5.4 billion gallons in 2006. But President Bush and many on both sides of the aisle in Congress want to extend that mandate to a whopping 35 billion gallons by 2017.
To put that into perspective, there currently isn’t enough corn grown in the US to produce 35 billion gallons of corn-derived fuels even if we divert every last kernel to biofuels production. This mandate assumes one or more of three possibilities: a switch to so-called next generation ethanol, a rapid jump in planted acreage or big ethanol yield improvements for corn-based ethanol.
But whether or not the US ends up adopting and attaining that target, the government currently offers a 51-cent tax credit per gallon to blenders for using ethanol and well as incentives for corn farmers and companies doing research on biofuels production. All this has the effect of powering increased production.
That’s impressive from a growth standpoint. However, it isn’t truly helping the nation from an energy independence perspective.
Consider that the US consumed 939 million metric tons of oil in 2006. Therefore, ethanol production accounted for only about 0.98 percent, less than 1 percent, of US crude oil demand. Meanwhile, ethanol consumed 20 percent of the entire US corn crop last year.
Producing ethanol from corn isn’t terribly efficient; the energy yield isn’t high. In other words, it takes a tremendous amount of energy to plant, harvest and fertilize crops, as well as to run an ethanol plant. When you compare the energy costs of producing ethanol to the energy produced from burning the fuel, there’s, at best, only a small energy gain.
Ethanol in Brazil is cheaper to produce because sugarcane is a far better, cheaper and more efficient feedstock than corn. Unfortunately, countries like the US don’t have an ideal climate for growing sugarcane, at least not as much as will be needed to meet demand. And Brazil uses a great deal of the sugarcane it produces domestically; it certainly can’t be called upon to meet all of the world’s growing demand for ethanol.
The world’s big leap in production of ethanol isn’t free. Increased demand for corn to feed all those US ethanol distillation plants pushed up prices considerably last year.
Corn futures traded on the Chicago Board of Trade (CBOT) jumped from around $2 per bushel in late 2005 and early 2006 to well more than $4 per bushel early this year. And increased corn plantings certainly had effects on other crops; acreage that would have normally been used to grow soybeans, wheat or other crops was used to produce corn and take advantage of the higher prices.
And more intensive farming also has an impact on other global commodities. One of the most obvious is fertilizer. Check out the chart “Fertilizer Use per Acre” below.
Source: US Dept of Agriculture (USDA)
This chart shows US use of two key fertilizers, potash and nitrogen, per acre of corn planted. Two points are worth noting. First, the use of both fertilizers on a per-acre basis has increased since the mid-1960s.
Second, the USDA projects 93 million acres of corn were planted this year, up from around 80 million acres on average during the past few years. When you couple increased fertilizer use per acre with more acres planted, it’s not hard to see why fertilizer demand has been soaring so much in recent years. And remember that it’s not just the US that’s producing crops and using fertilizer; demand globally has been soaring.
Fertilizers aren’t produced out of thin air. Potash, for example, is a mineral containing potassium—typically potassium chloride—that’s mined from the earth. Economic mines are located in only a few places around the world.
That means that ramping up production isn’t seamless and requires building new mines and processing facilities; therefore, supply can only slowly rise to meet growing demands. This classic supply/demand squeeze has pushed potash prices sharply higher during the past few years.
The world’s largest potash producer–Potash Corp, a biofuels field bet pick–has seen prices for its potash rise from the $70 to $80 per metric ton range in 2003 to closer to $160 to $170 per ton more recently. And there’s no sign of that slowing down.
But I don’t mean to focus attention solely on ethanol and the US and Brazil. Biodiesel is produced from plant-derived oils–basically vegetable oil. It can also be mixed with conventional diesel or sold separately for use in specially fitted diesel vehicles. Some of the more common crops for producing biodiesel include soybean oil, rapeseed (canola) oil and, increasingly, palm oil.
Biodiesel production is ramping up particularly quickly in the EU. Check out the chart “EU Biodiesel Production” for a closer look at this trend.
Source: European Biodiesel Board
Total EU biodiesel production capacity has surged from just above 1 million metric tons in 2002 to more than 10 million today. That’s a tenfold growth in capacity in the past five years.
The majority of biodiesel production capacity is located in Germany. Again, this is largely the product of government policies in this nation. Germany has actively subsidized biodiesel production for years.
But the EU is also taking a more active role now on a regional basis. The EU is targeting biofuels at 5.75 percent of total transportation fuels by the end of 2010, up from around 2 percent at the end of 2005. In addition, the EU has mandated that each member state adopt targets for biofuels use.
Part of this policy is to encourage countries such as Hungary to produce more biofuels. As I noted above, this is clearly having an effect; in Hungary, there was a great deal of talk about new biofuel plants.
And the US Embassy in Budapest is trying to campaign for the nation to change its rules governing the use of genetically modified (GM) crops produced by companies such as biofuels field bet member Monsanto. GM crops have been specifically designed to boost yields of biofuels and to cut back on demand for pesticides and herbicides. Hungary, however, has a ban on GM seeds, so it’s not producing as much biodiesel and ethanol as it could, given current planted acreage.
But that’s not to say there isn’t growth. The EU has already funded significant biofuels capacity expansion, and nations have adopted aggressive targets. According to a report by the EU Commission released this summer, it’s unlikely that the region will attain its stated 5.75 percent goal on time by the end of 2010.
However, the EU believes that, given the recent acceleration in biofuels capacity, the region could meet an expanded 10 percent target by 2020. But the truth is that it doesn’t really matter whether the EU hits its targets or not; the point is there will be a lot of growth in this industry as it tries to do so. This offers us a great opportunity.
The key point to take away from this brief rundown of the biofuels industry is that biofuels output is projected to grow globally during the next 25 years. Check out the chart “Global Biofuels Production.”
Source: Energy Information Administration (EIA)
This chart is based on estimates of global biofuels production from the US EIA. As you can see, the organization is expecting global biofuels production to top 1.7 million barrels per day of oil equivalent by 2030, up from less than 0.4 million barrels in 2004. That’s a more than fourfold increase; meeting that demand or anything close to it will be a major challenge for the global agriculture industry.
Back to In This Issue
The Second Wave
And biofuels are only part one of this story. The reality is that biofuels are a relatively new source of demand for corn, sugar and soybeans. These products have been grown for centuries as foodstuffs both for humans and as feed for livestock. But this leaves the world in a tight spot: Demand for food is booming just as biofuels production globally really takes off.Consider that China is already the world’s largest consumer of meat and demand is accelerating. Some 72 percent of Chinese consumers live outside of cities; the rural Chinese population tends to earn lower wages than their contemporaries in the cities. That’s a simple consequence of the fact that urban areas where manufacturing and emerging industries are based have been the engine of Chinese growth for years.
Historically, as a country develops and the population become wealthier, consumers boost their consumption of meats. In poorer countries, basic cereals such as rice and grains tend to make up the largest share of total caloric intake; food supply in a developed country like the US or UK is much more varied, including meat, alcoholic beverages, fruits and processed foods such as cheese.
A recent report from a Chinese government researcher specifically highlighted the Chinese pork industry. Right now in Chinese cities, the average consumer eats about 40 kilograms (88 pounds) of pork per year; that’s more than double what that number was 20 years ago.
That said, Taiwanese consumers eat more than 70 kilograms of pork annually (154 pounds). There’s room for Chinese urban dwellers to increase pork consumption toward the Taiwanese level as China grows wealthier.
But here’s the shocking part. Chinese rural dwellers eat, on average, less than 20 kilograms (44 pounds) of pork annually. City dwellers eat more than half the nation’s total pork supply, even though these consumers make up less than 30 percent of the population.
Over time, however, Chinese consumers have been migrating from rural areas of China into the cities. As this trend continues, more Chinese consumers will be taking higher paying jobs and earning larger incomes. You can bet that these new city dwellers will boost their pork consumption as it becomes economically feasible for them to buy more meat.
And pork consumption in the countryside is actually growing far faster, even for consumers who remain there and don’t migrate into cities. Therefore, pork consumption in the countryside has risen threefold during the past 20 years. Given the size of China’s population, you can imagine the wall of demand for pork products this all represents.
These statistics struck me. There’s an obvious likelihood that, despite China’s huge pork production, it won’t be able to meet all this demand with domestic livestock. In fact, the Chinese Ministry of Commerce has said that it will quadruple pork imports this year in an attempt to alleviate supply shortages.
You may be wondering at this point why I’m talking about pigs in a newsletter dedicated to the energy markets. The reason is simple: These markets are intimately related.
The very same commodities that are used to produce biofuels like ethanol and biodiesel are also used to feed livestock. Soybean protein and feed grains like corn are absolutely necessary to raise livestock to an age where they’re suitable for consumption.
And producing meat is a relatively intensive process, requiring significant quantities of grain. Consumers eating meat are indirectly consuming much more grain than consumers who eat only basic grains like rice and corn.
Therefore, increased pork consumption in China means rising demand for corn, soybeans and everything needed to produce these crops, such as fertilizer, seeds, pesticides and herbicides. And when the Chinese quadruple their meat imports, they’re also indirectly buying more grain.
Back to In This Issue
How to Play It
With two major sources of demand growth and limited scope to boost supplies rapidly, the fundamentals are bullish for the global agriculture industry. This has been reflected in agricultural prices, as I noted earlier.And inside TES, we’ve been playing this bull market using what I call a field bet. Long-time readers will be familiar with this concept, but let’s review.
Instead of just picking one or two highly leveraged plays on biofuels, I recommend casting a much wider net. By buying several biofuel plays of differing risk levels, we can diversify our risk and maximize our chances of hitting a few big winners.
The key is to buy all of the plays in the field bet and account for the risk by placing a relatively small amount in each pick. Depending on your risk tolerance, I recommend placing a fifth to a third of what you’d normally put in a TES recommendation into each pick. I’m also careful to identify picks that I consider to be riskier.
This strategy has paid off in a big way in the past year. As you can see from the table below, the vast majority of the picks have performed well and the overall average return is 53.9 percent, trouncing the S&P 500’s 15 percent jump over the same time frame.
That said, one pick has been an absolute disaster. Earth Biofuels has lost essentially 100 percent of its value since my recommendation. (See the table below.)
This is exactly why I use field bets to play some of my big picture themes. In order to make some big gains, such as the homeruns we had in Potash Corp, Mosaic and Monsanto, you have to take risk.
This is particularly true in my aggressive growth Gushers Portfolio. By keeping your position sizes relatively small and casting a wide net, you can reduce the impact of any single recommended field bet position.
I keep updated tables of the field bets on the Web site. Simply click the asterisk (*) symbol next to the field bets in the Portfolio table.
I also periodically recommend taking some profits off the table in our big winners. Sometimes I recommend selling one of the picks or buying a new recommendation. When that happens, I will update the field bet tables accordingly.
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Biofuels Field Bet
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Company Name (Exchange: Symbol)
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Entry Price (USD)
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Total Return Since 09/20/06 (%)
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Advice
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| Anglo-Eastern Plantations (London: AEP) | GBP2.99 | 42.3 | Buy under GBP4.35 |
| Earth Biofuels (OTC: EBOFE) | 2.17 | -98.5 | Hold |
| Monsanto (NYSE: MON) | 46.91 | 58.3 | Buy under 80.50, Stop@64.95 |
| Mosaic (NYSE: MOS) | 21.89 | 183.7 | Hold, Sell Half, Stop@37.50 |
| Metabolix (NSDQ: MBLX) | 23.94 | NEW | Buy under 27 |
| MP Evans (London: MPE) | GBP2.82 | 44.67 | Buy under GBP4 |
| Novozymes (Copenhagen: NZYMB, Frankfurt: NZMB, OTC: NVZMY) | 103.50 | 20.0 | Buy under USD130 |
| Potash Corp (NYSE: POT) | 33.30 | 167.6 | Hold, Sell Half, Stop@80 |
| PowerShares Deutsche Bank Agriculture (AMEX: DBA) | 26.05 | 5.5 | Buy under 28 |
| Sipef (Belgium: SIP) | EUR187.00 | 76 | Buy under EUR325 |
| Syngenta (NYSE: SYT) | 29.40 | 41.3 | Buy under 42 |
Here’s a rundown of all my biofuels field bet picks, as well as some new recommendations:
Palm Oil Producers–Anglo-Eastern Plantations (London: AEP) and MP Evans (London: MPE)
Anglo-Eastern Plantations is up around 42 percent during the past year, about 33 percent because of the rise in the price of the stock and the remainder because of the rising value of the British pound against the US dollar.
Similarly, MP Evans is up a similar amount over the same time frame. Both companies produce a key type of edible oil known as palm oil.
Palm oil is produced from the fruit of a particular type of palm tree. As with most palms, this tree requires a tropical climate and is normally found near or around the equator.
Malaysia and Indonesia dominate production of palm oil, each producing around 16 million metric tons per year. The next-highest producer is Thailand, which produces around 1 million metric tons.
Palm oil has multiple uses. It’s used to make edible cooking oils; chances are you’ve eaten palm oil, which is an ingredient in some types of candy bars and margarines. It also has nonedible uses that include soap and detergent manufacture and, of course, biodiesel production.
Palm oil is a very efficient feedstock for biodiesel plants and has received considerable attention in the EU as a logical feedstock solution. The reason is simply that you can produce 5 metric tons of palm oil per hectare of land. For soybeans, a hectare of land will yield just 0.5 metric tons.
The prime consumers of palm oil include many nations located in Asia. This is logical because of the proximity of the supply in Malaysia and Indonesia.
China is, in fact, the No. 1 consumer of palm oil in the world; palm oil is the most popular edible oil in China. As noted earlier in this issue, consumption of fats and oils also tends to rise as consumers become wealthier. India is another huge customer for Malaysian and Indonesian palm oil.
Among developed countries, the EU (taken as a whole) is the No. 2 palm oil consumer in the world. The EU imports palm oil as an edible oil and, increasingly, as a source of oil for biodiesel plants. It’s often cheaper to import palm oil than to actually buy domestically produced rapeseed oil for biodiesel production.
As you might expect, palm oil prices have been on the rise. That’s a major benefit for companies such as Anglo-Eastern Plantations and MP Evans that own palm oil farms. Check out the chart below for a better look at palm oil prices.
Source: Anglo-Eastern Plantations
To make a long story short, Anglo-Eastern owns about 34,000 hectares of oil-producing land mainly in Indonesia (about 2,500 hectares in Malaysia). From this land, Anglo-Eastern produces more than 500,000 metric tons of fresh palm fruit bunches.
The company also owns processing facilities for converting this fresh fruit into actual palm oil. In total, Anglo-Eastern produces 160,000 metric tons of crude palm oil.
The company has been performing well. Operating profits essentially doubled in the first half of 2007, compared with the first half of 2006; the improvement was mainly the result of soaring crude palm oil prices.
On the downside, crop production so far this year has been coming in under expectations. But Sumatra has seen a serious drought; many of Anglo’s plantations are located in this part of Indonesia, so that’s hurt production. In addition, the company has seen some labor-related delays clearing land and planting crops at some of its newer properties.
Anglo has been growing somewhat via acquisitions as well. The company tends to buy older plantations that need to be cleared and at least partially replanted. Sometimes they also buy virgin land that’s suitable for production. In time, as these newly acquired lands are purchased and planted, this results in higher palm oil output. Anglo-Eastern Plantations is a slow but steady performer and continues to rate a buy at current levels.
Much of what I just outlined for Anglo also applies to MP Evans. But MP has been following a slightly different strategy.
The company has historically owned plantations in Malaysia and Indonesia, but it’s been gradually exiting the Malaysian market entirely and buying up additional properties in Indonesia. The company’s Malaysian plantations were relatively small, which made them less-than satisfactorily profitable. However, the land MP owns there is valuable; it’s realized solid prices on these sales in Malaysia.
Currently, MP Evans owns about 10,000 hectares of mature, producing palm plantations in Indonesia. It’s also bought in access to more acreage and is planning to plant those acres at a rate of around 6,000 hectares per year. Eventually, MP Evans has targeted a land position of 70,000 hectares of palm oil-producing properties all in Indonesia.
In addition to palm oil, MP Evans owns a considerable land position in Australia that’s used for raising beef cattle. As noted above, Asia is a region of rapidly growing meat demand, so cattle properties are another valuable asset to own.
In MP Evan’s fiscal year, ended June 30, the firm announced a more than 35 percent rise in operating profits. MP Evans remains a great buy at current prices.
Fertilizer Producers: Potash Corp (Toronto: POT; NYSE: POT) and Mosaic (NYSE: MOS)
I outlined the reasons for the bull market in fertilizer demand and prices in the text above. I won’t reiterate all those points here.
These two stocks have been by far my best plays in the biofuels field bet, returning 168 percent and 174 percent, respectively, during the past year. These are exactly the sort of big winners we’re looking for within the field bets.
Both firms should continue to benefit from strong demand and tight supply for fertilizer. And I don’t see that balance deteriorating much at least in the next year or so. Further, it’s encouraging that fertilizer prices continued to surge ahead in the seasonally weak early summer period.
My only concern is that both companies are now sporting valuations at historic highs. For example, Mosaic currently trades at 3.5 times sales; 1 to 1.75 is a more normal ratio for this stock.
I firmly believe that the fertilizer companies are now entering a new prolonged up-cycle, but the stocks have likely priced in a lot of good news short term and are vulnerable to any disappointment.
As a result, I’m cutting both Potash Corp and Mosaic to holds for now. I also recommend selling off at least half of your position in each stock to lock in some nice profits. This is only prudent after a move of this magnitude.
Finally, I’m setting stop recommendations for both stocks to lock in nice gains.
Seeds and Herbicides: Monsanto (NYSE: MON) and Syngenta (NYSE: SYT)
Monsanto’s main business is the production of GM seeds. GM seeds are designed to exhibit certain traits; examples might include drought, weed and pest resistance. The stock is up 67.5 percent since my recommendation one year ago.
Monsanto makes Roundup, a popular herbicide used to control weeds. The company also sells a GM corn called Roundup Ready corn, which is resistant to Roundup; farmers can essentially spray the herbicide on their crops and eliminate all the weeds without damaging the corn crop itself. The result is better yields per acre.
Monsanto is also a global leader in what’s known as stacked traits. This is the ability to engineer multiple beneficial GM traits into seeds. For example, Monsanto might sell seeds that are resistant to both Roundup and drought conditions.
And these stacked trait seeds are getting even more advanced. Recently, Monsanto announced a joint venture with Dow Chemical to produce a GM corn known as SmartStax corn. SmartStax corn will include traits invented by both companies–a total of eight separate GM traits in each seed.
Not surprising, given the strong growth in agriculture demand and the increasing prevalence of GM seeds across the US and South America, Monsanto’s profits have been on fire. This week, the company boosted its guidance for the rest of the year and said that pricing for its technology and Roundup herbicide had come in well above management’s original expectations.
Although the company recently broke to a new all-time high, the stock has a lot of growth ahead of it. I’m retaining my buy recommendation for Monsanto for now but establishing a stop and “buy under” recommendation to lock in gains on the stock.
Syngenta has also performed well, rising 41.3 percent since my recommendation one year ago. The company has a GM seeds division, but it’s not as advanced as Monsanto’s.
That said, the company is scheduled to launch a new triple-stacked corn next year and has an alliance with DuPont, another GM seed producer. New GM seed introductions should keep growth going at this division.
But around 80 percent of revenues are derived from Syngenta’s crop-protection business—basically, herbicides and pesticides. Sales of crop-protection chemicals have slipped industry wide as GM becomes more common.
The reason is that GM traits actually reduce the need to apply such chemicals by making the plants themselves resistant to the diseases and pests. But the market hasn’t and will never disappear, and Syngenta is a leader in advanced crop-protection technologies.
In addition, this Switzerland-based company has a strong position in Europe. European crop demand has been soaring because of the advent of biofuels subsidies.
Traditionally, the EU has set aside a certain number of acres in Europe to lie unplanted in a given year. The purpose of this policy was to reduce crop production and eliminate surpluses that were common in the late ’80s and through the ’90s. But it’s likely the EU will soon eliminate set-aside acreage because the region really needs to maximize crop production.
This additional demand is another likely short-term catalyst for the stock. I retain my buy rating on Syngenta.
Diversified Farming: Sipef (Belgium: SIP)
Sipef owns plantations quite literally all over the world, including Vietnam, Papua New Guinea, Indonesia and the US. It’s a broader play than the two palm oil-focused plantations listed above: The company produces bananas and other fruits, palm oil, tea, coffee, rubber and even fresh flowers. Sipef has soared 76 percent since my year-ago recommendation.
Nonetheless, palm oil is still the most important product for Sipef, accounting for roughly three-quarters of production. The company also recently built a giant storage facility for palm oil to facilitate its export into the fast-growing Asian markets.
All the products that Sipef produces are at the epicenter of demand growth in Asia. As a major producer of palm oil, Sipef has been benefiting from both increased production and rising palm oil prices.
In late August, Sipef announced strong results; profits doubled mainly because of higher palm oil prices. The firm also managed to boost production of palm oil at its own plantations to just shy of 94,200 metric tons in the first half of the year. Sipef is a buy at current levels.
High-Tech Players: Novozymes (OTC: NVZMY) and Metabolix (NSDQ: MBLX)
Novozymes wasn’t originally a play in my biofuels field bet; I added the stock in the May 2 issue of TES, King Coal. The stock is up 20 percent since that recommendation. I offered a detailed rundown of my rationale for recommending the company in that issue, but let’s review.
Novozymes is a world leader in the manufacture of enzymes. Enzymes are nothing more than proteins used to catalyze certain chemical reactions. Enzymes are used in the production of ethanol from corn, sugar or any other agricultural product. Novozymes is a world leader in producing enzymes for ethanol production.
A potential growth play for Novozymes is second-generation ethanol. This form of ethanol would be manufactured from agricultural waste or noncultivated products such as corn husks and a type of prairie grass known as switchgrass. It makes sense to make ethanol from useless products rather than the crops we also need to use as food or feed for livestock.
But there’s a problem with second-generation ethanol: The technology isn’t ready yet. Although you’ll often hear these technologies hyped, the reality is that second-generation ethanol is technologically possible but extraordinarily expensive.
The reason is that these waste products don’t have the concentrations of sugars and starches needed to efficiently make alcohols. Most realistic estimates suggest that commercial applications for second-generation ethanol are at least a decade away.
But one of the keys to making second-generation ethanol feasible will be advanced enzymes to catalyze the process. Novozymes is a leader in this research and has partnered with the Dept of Energy on various projects in the field; President Bush even visited its factory back in February of this year as part of his campaign to promote greater use of biofuels.
The company is a solid play on first-generation ethanol with a second-generation kicker. Novozymes remains a buy at current prices.
In this issue, I’m adding Metabolix to the biofuels field bet. The company makes natural biodegradable plastic as part of a joint venture with agribusiness giant Archer Daniels Midland (ADM). The plastics are actually made out of crops such as soybeans, corn and sugarcane; traditionally, plastics are made out of petrochemicals derived from oil and natural gas.
Consider that the global market for plastics is 500 billion pounds. This is a huge potential market in which to sell.
The stock is a speculative play, but I see the potential upside as worth the risk, particularly given ADM’s involvement in the project. Basically, ADM and Metabolix are 50/50 partners in Telles, a firm that develops, markets and sells these biodegradable plastics under the brand Mirel.
The advantages are obvious. Because plastics are typically made from oil, natural plastics would actually cut petroleum consumption. And a great deal of plastics, including plastic bottles and containers, end up clogging the world’s landfills. These products take thousands of years to degrade. But biodegradable plastics would disappear from the waste stream in a matter of months.
Metabolix doesn’t really sell anything at this time–hence the speculative nature of this play. However, the company recently expanded its test plant to produce as much as 50,000 pounds of natural plastics per year.
The company has 80 ongoing tests with customers in which it tries to formulate a natural plastic for a specific customer-specified use. It’s unlikely that all 80 products will pan out; however, if Metabolix can find just a few viable products and end-markets, the stock could soar.
The company has plans to build a commercial production facility next year that it will attempt to pre-load with customers. Retailing giant Target is already rolling out a gift card made of natural, biodegradable Mirel plastics. Metabolix is added to the biofuels field bet.
The final two picks in my biofuels field bet are Earth Biofuels and the Deutsche Bank Agricultural iShares (AMEX: DBA). As noted earlier, Earth Biofuels has fallen 98.5 percent since my recommendation, the only loser in the field bet.
The company makes and sells biodiesel in the US. As I’ve been saying for some time, I see little hope for this stock because its business never really panned out and margins in biodiesel production have been squeezed by rising crop-derived oil prices.
Fortunately, the other field bet recommendations more than made up for the loss in Earth Biofuels. This is the whole reason for the field bet.
I’ll continue to track the stock as a hold only because I see no reason to sell it here on the off chance it does recover somewhat. If, however, it would be useful for you to generate a tax-loss on the stock, consider doing so before the end of this year.
The Deutsche Bank Agricultural iShares is an exchange traded fund (ETF) that tracks toe performance of a number of different agricultural commodities. Note the ETF’s value is based on the value of the commodity itself, not stocks with exposure to these markets.
It’s a convenient way to play agricultural commodities in a diversified way. The Deutsche Bank Agricultural iShares is up 5.5 percent and remains a buy.
Note I typically don’t recommend ETFs because most investors can do far better picking individual stocks. I’m making an exception in this case only because many investors have no other means of playing commodity markets directly.