Sarhan in Investors Business Daily: Grain Stocks Growing High As An Elephant’s Eye

7.29.16 –11:16 AM ET

To a great extent, 2016 has been the year of commodity stocks, with resources like gold, coal and iron ore leading the boom. But the small group of grain-related stocks has also been joining the party, which has become something of a pile-on, according to the buy side.

“Agriculture commodities (and their corresponding stocks) have been in a multiyear bear market, so any hint of good news led new value buyers to emerge,” Matthew Tuttle, head of Tuttle Tactical Management, told IBD in an email. “This was a big shift for the industry, because investors were hoping that these stocks could now enjoy better earnings and sales growth in future quarters.”

Grain-processing and merchandising giant Archer Daniels Midland (ADM) is the prime example of this. Its profit has declined year-over-year for the last four reported quarters, and its stock fell more than 30% last year. The stock-price slide continued for a few weeks into January, but since then the shares have gained almost 50%. Analysts are projecting a return to profit growth in the current quarter, continuing into double digits next year. ADM is due to report results on Tuesday.

“Fundamentally, earnings for this group have been horrid over the past few years,” said Adam Sarhan, CEO of 50 Park Capital. “Eventually, earnings will improve, and investors are trying to get in early.”

Improving supply/demand metrics in the grain business are clearly part of the story. But ADM has also been making a strategic shift toward higher-margin food ingredients, a business that is the focus of IBD’s Food-Grain & Related industry group’s two highest-rated stocks, Ingredion (INGR) and MGP Ingredients (MGPI). That segment of the industry largely bypasses the whims of global commodities markets by focusing on the leading edge of consumers’ changing tastes.

Bottom Of The Corn Cycle

On the commodities side, the earlier bear market was driven by the fact that several years of bumper grain crops worldwide pushed supply up at the same time that the growth in corn demand eased due to the economic troubles in China, collapsing currencies in several breadbasket countries and reduced biofuel mandates, wrote analyst Heather Jones of BB&T Capital Markets in her July 11 initiation report on ADM.

While the latter problems persist, supply was hit this year by bad weather in South America and Southeast Asia. In North America, meanwhile, the fields are looking good.

“For 2016 particularly, we saw a strong increase in corn acres (in the U.S.) and a strong increase in soybean acres as well,” said Mark Welch, economist in grain marketing at Texas A&M University. “The weather we’ve been having this year has been hotter than normal in a lot of places, but the yield prospects look really good.”

Corn prices rose 21% from March to June. They then plummeted 27% to mid-July. Analyst Jones reckons that while Q2 was likely still soft for processors, North American companies have passed the turning point.

“Although the overall climate is still relatively depressed, we do believe the cycle bottomed,” Jones wrote in her report. “While corn demand growth has slowed globally, it is still expanding at a low-single-digit clip. Vegetable protein demand has been robust, and soybean meal global consumption has expanded 5%-9% a year since calendar year ’13/’14, due to growing meat demand.”

More Sophisticated, Healthier Ingredients

ADM started downsizing during the lean years, selling off its global cocoa and chocolate businesses, as well as its Brazilian fertilizer and sugar operations. At the same time, it’s been building its presence in the specialty-ingredients business. In 2014, it bought WILD Flavors, maker of flavors and seasoning as well as juice concentrates, cheese powders and food coloring. Last year, ADM created a new specialty-ingredient division to absorb more acquisitions, such as natural-flavor maker Eatem Foods.

In a December report on Ingredion, Jefferies analyst Akshay Jagdale estimated the global specialty-ingredient market at $42 billion and growing about 5% a year. In contrast to the bulk grains and simple products such as alcohol and high-fructose corn syrup (the latter being Ingredion’s legacy business), specialty ingredients are sophisticated compounds with a high value-add. They include texturants that can make a product feel right in the mouth even if it’s got, say, reduced fat, artificial sweeteners or nutritional supplements that blend in with the food, as well as various colorants and flavor-boosters.

Ingredient demand changes with consumer trends, and Ingredion’s recent acquisitions reflect a move toward the healthy and wholesome. Penford Corp., which Ingredion acquired last year, provides natural alternatives to synthetic ingredients. Kerr Concentrates, also acquired last year, focuses on fruit concentrates and essences that can be turned into smoothies and other products.

In the first quarter, these buyouts helped drive 8% volume growth in North America, offsetting the shrinkage in Ingredion’s South American operations due to the aforementioned weather problems. Profit grew 34% in the quarter, even as revenue grew only 2%, reflecting margins boosted by specialty ingredients.

Second-quarter results, reported Thursday, showed earnings growth slowed to 13% above flat year-over-year revenue. Both numbers topped expectations, and management raised its full-year EPS guidance to a range of $6.70-$6.90, vs. consensus views for $6.70. Analysts estimate revenue for the year will rise 0.5% to $4.65 billion.

Ingredion holds the highest Composite Rating from IBD in the six-stock group, a 96. MGP is close behind with a 95 rating, while ADM earns a weak rating of 44.

 

A Whiskey Revival And The Weather

MGP Ingredients has also been building out its specialty-ingredient portfolio as it attempts to restructure after a management change in 2014. It returned to modest sales growth last year after two years of shrinkage, and its stock is trading near all-time highs.

But what’s really driving its current good fortunes is that it bought Seagram’s old distillery just in time for a revival of popularity in whiskey.

“For the industry, this meant mid- to high-single-digit growth for the past five years, growing international demand for U.S. whiskey, and the explosion of 300-plus new craft distilleries,” SunTrust Robinson Humphrey analyst William Chappell wrote in his June 23 initiation report. “For MGP, it meant a rapidly growing demand for its distilled spirits in a market that had seen capacity decline for more than 30 years.”

Such food fashions come and go, but aside from the occasional burp or hiccup, grain consumption has been showing long-term growth, according to economist Welch.

“If you look at grain use on a world per-capita basis … we’ve been on a strong growth trend since the early 2000s,” Welch told IBD. “We’re growing a little over 1% per person per year for the last 15 years now. And of course, that’s in addition to (the fact that) the world population is growing at about 1% a year. For those that handle and process grain, these have been very positive trends.”

While he expects the consumption increase to continue, the supply side is still subject to Mother Nature, making longer-term predictions difficult.

“At this point, it’s all about the weather,” Welch said.

LINK: http://www.investors.com/research/industry-snapshot/grain-stocks-growing-high-as-an-elephants-eye/

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