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3 growth stocks with room to grow
Rising commodity prices ordinarily are a good sell signal, but the ongoing boom is likely to continue for years. These poultry and soybean producers are in just the right spot.
By Jim Jubak
Looking for growth stocks at reasonable prices? Youll find them down on the farm.
On Feb. 3, Bunge (BG, news, msgs), the worlds top oil-seed processor, announced earnings of $4.07 a share for 2003, up 43% from 2002. What produced this earnings surge? The highest soybean prices in seven years sure helped, the company said.
Just the week before, Pilgrims Pride (PPC, news, msgs), the countrys second-largest chicken processor, reported that quarterly net income for the last three months of 2003 had tripled and net sales had climbed 66%.
Usually, news like this is a reason to sell farm stocks. The sector is notoriously cyclical because high prices in the previous year lead farmers to increase their production of corn, soy beans, hogs or chicken the next. In a few years, increased production becomes overproduction, crushing prices and profits for farmers and farm stocks. Overproduction forces farmers to cut back on production. In time, production cuts turn into shortages that drive up farm prices and farm profits. And the cycle begins anew.
This time is different. While the farm sector remains fundamentally cyclical, market factors are likely to extend this boom phase. I think were looking at another two or three years of rising prices and rising profits before farmers and investors have to even start worrying about the return of the bust.
If thats true, this is a good time to buy farm stocks -- and the shares of those companies that make their money selling to the farm industry. Companies that grow things -- or process them -- look like theyll be among the best growth stock plays for the next year or more.
I suggest that you look at Bunge and Pilgrims Pride, and Sanderson Farms (SAFM, news, msgs) among farm producers and processors. In fact, Im adding Bunge, one of my hell-in-a-handbasket" stocks, to Jubaks Picks with this column.
Its easy to understand whats different this time: China and the rest of the developing world are sopping up supply in commodities that range from iron to oil, and that same appetite is gobbling up soybeans, corn, chicken and cotton.
In fiscal 2004 (the 12 months that end in September), China will import 22 million tons of soybeans from all sources, the U.S. Department of Agriculture estimates. That will be a record, slightly surpassing one set in fiscal 2003.
China will also import 7 million 480-pound bales of cotton in fiscal 2004, also a record.
U.S. exports of chicken broiler meat are forecast to climb to 2.3 million tons worth $1.6 billion in fiscal 2004, up from $1.37 billion in 2003. The reason: growing demand from the Caribbean, Central America, Africa and Eastern Europe.
You get the picture. The Department of Agriculture projects that the value of all U.S. agricultural exports will climb 6% in fiscal 2004.
All that means great revenue growth for the U.S. farm industry. The good times, however, wont shower profits on all farm businesses evenly. Thats because the key isnt the volume of an agricultural commodity sold or even its end price. Instead, the key is the spread -- the difference between the cost of the inputs required to produce the commodity and the price that the commodity commands in the market.
The case for chicken producers
For chicken producers who must buy soy feed for their birds, the rise in soybean prices isnt good news.
But spreads have complex effects. Chicken production historically has fluctuated wildly with price and demand (the modern mass-produced chicken takes far less time to grow than a soybean or corn crop), but production has been extraordinarily slow to expand recently.
Some agriculture analysts speculate that the high price of feed and the possibility of higher prices has kept new growers from entering the market. That, in turn, has kept chicken prices -- and the spread -- higher than expected at this point in the good-news cycle.
Chicken farmers are also getting other breaks on the spread between the cost of feed and the price of their chickens in the market. The U.S. corn crop is expected to hit a record 10.3 million bushels in 2003-2004. The giant crop will keep feed prices stable and more than offset production cutbacks in Argentina. And beef and chicken producers have discovered they have more pricing power because the mad cow scare and the avian flu outbreak have dampened meat and poultry imports from Europe, Canada and Asia.
Sanderson Farms is likely, on my calculations, to grow earnings to $3.90 in fiscal 2004 (which ends in October). That would be a 10% increase over the record earnings recorded in fiscal 2003. (In a cyclical sector like this, a companys ability to beat record earnings counts big.)
That puts the stock, at a recent price of just about $55 a share, at 14 times projected fiscal 2004 earnings. Industry leader Tyson Foods (TSN, news, msgs) trades at that same multiple on projected fiscal 2004 earnings. But Sanderson Farms wrings far more profit out of its invested capital than Tyson does. Sanderson shows a 27% return on capital and a 25% return on equity while the comparable figures at Tyson Foods are 5% for return on capital and 9% for return on equity. To me, that makes Sanderson Farms very reasonably priced.
Pilgrims Pride is a far more complex and far more leveraged opportunity. Last November, the company acquired the chicken division of ConAgra (CAG, news, msgs). The companys earnings growth depends on how quickly it can turn that operation around and how quickly it can fix persistent problems in its Mexican turkey operations. That unit showed a $15 million operating loss in the December 2003 quarter. Overall, the company reported earnings of 20 cents a share, a huge improvement from the 16 cents a share it lost in the fourth quarter of 2002. So the numbers are definitely headed in the right direction.
Wait a bit before buying
But its worth waiting a bit before buying. The avian flu that has led to massive slaughters of Asian flocks has recently shown up in Delaware and Pennsylvania chicken flocks. So far, the outbreak seems extremely limited, but testing hasnt been completed. So, it is impossible to reliably predict the extent of the problem. If the outbreak turns out to be limited and controllable, then the recent pullback in chicken stocks on the news is a buying opportunity. If the problem is bigger than now expected, the stocks are likely to fall further.
Thats not the case with Bunge, however. Just about everything seems to be breaking right for this processor of soybeans and oil seeds. For example, higher soybean prices encouraged U.S. farmers to sell soybean stocks, pumping up volumes in Bunges soy crushing plants. Ordinarily, this would spell trouble down the road for Bunge. A smaller-than-expected U.S. harvest in 2003 plus those extra 2003 sales by soybean farmers have left U.S. stocks depleted. Fewer beans to process means lower revenues for Bunge, but the company operates in Latin America as well, where the Brazilian harvest has been solid.
Bunges diversification into the fertilizer business enables the company to reap extra revenue from any increase in farm production. In the December quarter, fertilizer volume climbed 18%; Bunges fertilizer revenue grew by 68%.
In 2004, I predict Bunges earnings per share will come in at $3.20 a share and then climb to $3.60 a share in 2005. If Im right, cash flow will grow to $5.33 in 2004 from $5.20 in 2003 and to $5.60 in 2005. I regard cash flow a more reliable performance indicator, especially at a company such as Bunge. The company regularly shows special charges and one-time gains as it adds and subtracts plants and deals with a plethora of national tax codes. Im adding the shares to Jubaks Picks with a target price of $43 a share by September 2004.
Those numbers for 2005 would put Bunge at Year 6 of a swing that has seen earnings grow steadily from 34 cents a share in 2000. Thats an extraordinarily long run as agricultural boom-and-bust cycles go, and I think cautious investors are well-advised to keep an eye peeled for signs that the boom is aging more quickly than I expect. After all, as any farmer knows, nothing is certain in agriculture.
But the long-term historical trends do argue that this time it is different. As incomes rise, people in China and Indian will add more protein to their diets. As jobs beckon in urban areas, fewer people will want to stay on farms. And as the markets for agricultural products become increasingly global, efficient producers in the United States will take jobs away from marginal producers farming marginal land in China and the rest of the developing world.
These trends wont play out over the next few quarters, but over years and decades. Over that time span and despite the boom/bust cycles, U.S. agriculture looks like one of the best bets for investors looking for long-term growth.
Changes to Jubak's Picks
Buy Bunge
Thanks to growth and rising incomes in rapidly developing countries such as China and India, demand for U.S. agricultural products is soaring: U.S. exports will climb another 6% this year above last years record, the U.S. Department of Agricultural projects. Bunge (BG, news, msgs), a processor of soybeans and other oil seeds that also owns a significant fertilizer business, is positioned to profit from that trend. Earnings climbed 42% in 2003 from 2002 and look ready to settle into a long term growth rate of 12% or so. Investors always need to beware of the boom/bust cycle that dominates the agricultural sector, but, with demand from the developing world so strong, it looks like the current boom will run longer than usual. As of Feb. 17, Im adding Bunge to Jubaks Picks with a target price of $43 by September 2004.
New developments on past columns
Clean enough for Buffett, clean enough for me
On Jan. 29, the Washington Post Co. (WPO, news, msgs) reported earnings of $8.53 a share, once you take out all the special items. That was a significant improvement on the $7.74 Wall Street had expected. Revenue climbed a very solid 13% in the quarter over the same quarter in 2002. The companys traditional publishing and television businesses continued their recent revenue recoveries: Newspaper revenue was up 5% in the quarter. Both its magazine and cable TV businesses saw revenue grow 7%. The growth star, once again, was the Kaplan educational unit, which posted a 47% increase in revenue over revenue in the fourth quarter of 2002. As of Feb. 17, Im raising my target price to $990 by September 2004 from the previous $900 target price. (Full disclosure: I own shares of The Washington Post Co.)
Now, only cheap stocks will make you money
Schlumbergers (SLB, news, msgs) Jan. 23 earnings report confirmed that the turn around at the company has arrived. Underperforming divisions such as WesternGeco went to a profit ($32 million) in the fourth quarter from a loss ($36 million) in the third quarter. After months of sounding dour about future prospects, management said it saw improving business conditions in the Middle East, Russia, parts of Asia and the region around the Caspian Sea. And the company told analysts that it was on target to divest all non-oil service businesses, as promised, by the middle of the year. As of Feb. 17, Im raising my target price on Schlumberger to $68 by June 2004. (Full disclosure: I own shares of Schlumberger.)
Editor's Note: A new Jubaks Journal is posted every Tuesday and Friday.
E-mail Jim Jubak at jjmail@microsoft.com.
At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: Schlumberger and The Washington Post Co. He does not own short positions in any stock mentioned in this column.
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