Agribusiness is an industry that readers of the Van Trump Report know. Conceivably it’s one where we have a competitive edge. The purpose of this periodic report is to discuss opportunities in agribusiness equities. During the next 12 months, several large interdependent events, including the U.S. November elections, the Ukrainian war, Israeli war, oil prices, China/U.S. tensions, inflation, etc., may sway markets. This and future installments of this report will delve into the implications of these events and possible strategies for equity trades around them.
Inflation Up, Down or Sideways
The first macro variable we’ll explore is inflation, regardless of its direction. Inflation and unemployment directly affect U.S. interest rates, and by extension, world interest rates. The ramifications of U.S. inflation are felt broadly. The current Fed Funds Rate is effectively 5.33%, according the St Louis Fed, which is the highest it’s been in 22 years. And even Nobel laureates don’t know where it’s headed. Arguments in favor of both a return to low pre-pandemic levels (1.5-2.5% rates) and a higher-for-longer outcome (above 4%) are equally probable. Paul Krugman, one such laureate, told Bloomberg recently, “Anyone who claims to know for sure what [interest rates will do] is deluding themselves.”
Inflation investing
High inflation can accelerate investor returns—positive and negative. Managed improperly, inflation can turn real returns negative and dilute savings. High interest rates sap businesses of capital in two ways: cost of debt and lower demand for equity. Managed effectively, though, inflation can accelerate returns upward and compound wealth. Farmland investors know this firsthand. In the past 25 years, U.S. farmland prices have quadrupled on average…an annual compound growth rate of nearly 6%. Inflation over the same period has averaged just 2.6%, providing farmland investors a greater than 3% inflation-adjusted return. Just how much longer and higher this trend will continue is the key question.
An inflation-beating alternative to farmland is Treasury Inflation Protected Securities (TIPS). First auctioned by the U.S. Treasury in 1997, these securities theoretically provide inflation protection by indexing returns to the Consumer Price Index (CPI). Unlike farmland, though, TIPS returns have beaten inflation by only fractions of a percent. Average premiums TIPS pay over the CPI can range from 0% to 0.5%, certainly not the 3% premium farm owners have enjoyed.
A Third Compelling Strategy
Given the high price of farmland and the low premium return offered by TIPS, your author is interested in other categories of investments for beating inflation. One category is high-dividend agribusiness equities. Out of a survey of 89 publicly traded agribusinesses, 51 pay dividends on their common stock ranging in annual yield from 0.27% at Seaboard Corporation (SEB) to a whopping 13.54% from New Zealand-based Livestock Improvement Corporation (LIC.NZ).
High yields, though, can point to problems in the underlying business. Boards of directors of many companies, including stalwarts like General Motors, J.C. Penney, and RadioShack, have disappointed investors by slashing dividends to preserve cash in hard times. In General Motors’ case, the company paid a reliable dividend for decades, but by the mid-2000s was in trouble. Declining demand for the stock sent its dividend yield to more than 10%, making it seemingly an attractive investment to some. By February 2006, though, the board cut the dividend by half. Then, on May 15, 2008, it eliminated the dividend altogether. In an attempt to save GM, management sold some $7 billion in assets and cut salaries by 20%. By 2009, the company declared bankruptcy, requiring a government bailout and illustrating the risk of high-dividend investing.
In contrast, though, Kellanova (formerly Kellogg’s) went through a similar downcycle, but emerged victorious. In 2009, its stock had fallen in price to $35/share, giving investors an opportunity to buy its dividend at a yield of 4% over inflation. Over the next seven years, Kellanova (K) was able to improve the business and raise its dividend from $1.40 to $2.04/share. The stock price doubled to $75. Investors who bought in 2009 and sold in 2016 beat annual inflation by 12% per annum, earning a compound annual rate of return of 13.6% while inflation averaged just 1.6%. In your author’s mind, Kellanova exemplifies how dividend-paying agribusinesses can help investors beat inflation.
Of the 51 agribusinesses identified by your author that pay dividends, 15 yield above the latest consumer price index rate of 3.36%. The chart below ranks these companies along two axes: dividend yield (y-axis) and dividend percentage of EBITDA (x-axis). Dividend percentage of EBITDA (earnings before interest, taxes, depreciation and amortization) provides a quick assessment of the company’s ability to use cashflow to continue its dividend. The less cash flow used to pay dividends, the more likely the company is to continue paying it.
As a dividend investor, your author is more interested in acquiring companies with a high dividend yield but low EBITDA payout percentage…companies trending toward the upper left corner of the chart. As an offset, an aggressive investor might also take short positions in companies with low dividend yields and high EBITDA payout percentages…companies in the lower right of the chart. Fresh Del Monte Produce (FDP), CNH Industrial (CNHI), General Mills (GIS) and BrazilAgra (LND) are four long candidates that we’ll discuss here. Of course, further investigation is required before executing trades.
Fresh Del Monte Produce (FDP) ranks well among its piers: Herbalife Ltd (HLF), Calavo Growers, Inc. (CVGW), Dole (DOLE) and Post Holdings Inc (POST), although FDP has had challenges growing sales and meeting market expectations during the past year. Net Sales in 24Q1 came in at $1.1b, below estimates of $1.15b. Nonetheless, cash flow provided by operations increased to $18.7m from $15.5m in the prior-year period. To pay its 25-cent-per-share annual dividend, FDP requires about $12m. This is only 21% of its latest annual EBITDA. I also like the fact the Del Monte is a strong long-lived and well-known brand.
CNH Industrial (CNHI), a major ag equipment manufacturer, also is intriguing with its dividend yield of 4.1%, well above inflation. Valued at $13.4b, CNH designs, produces, sells and finances agricultural and construction equipment worldwide. Van Trump Report readers will know its brands, Case IH and New Holland. Competitors, Caterpillar (CAT) and John Deere’s (DE’s) dividend yields are much lower at 1.5% and 1.6%. Presumably, their financial performances have been superior to CNH and are fully valued. In a stagflation environment, I would expect to see CNH hold its value and rally should interest rates fall due to lower inflation. CNH has also been a leader in autonomous equipment. Its developmental technology may lead to future growth. To pay the dividend, CNH uses less than 20% of its EBITDA. The cautionary story of General Motors (GM) bankruptcy in 2009, though, is ever on my mind with large manufacturers.
General Mills (GIS), a large food products company, pays a dividend rate of 3.5% slightly above the latest CPI. Along with ADM, it ranks among investment-grade agribusinesses that pay dividends over the CPI rate. General Mill’s brands include such widely known labels as Pillsbury, Betty Crocker, Häagen-Dazs and Cheerios. For more conservative investors, GIS and ADM could offer better credit ratings, but strong returns in a falling interest rate environment.
The most speculative inflation hedge in agribusiness discussed here is BrasilAgro – Companhia Brasileira de Propriedades Agrícolas (LND). It is slated to pay in October a 65-cent dividend on its stock, which trades for less than $5/share, giving it a dividend yield of nearly 13%! In October 2023, the company paid a 62-cent dividend. In 2022, it paid two dividends for a combined value of ~$1/share. Previous dividends, however, didn’t exceed $0.25/share. LND uses just a third of its reported EBITDA to pay the dividend and offers a chance for those interested in farmland to diversify ownership into South America. It also offers non-U.S. trade routes to China should trade relations worsen. The company in my mind deserves a look.
Currently, your author has light positions in GIS, CNH, and FDP. No short positions in any of the fifteen companies listed above. But what do I know! This analysis comes to you from b@brokebob.com. Special note:This is not an equity research report, only a commentary on selected market trends. Nothing herein should be considered investment advice. Your author does not necessarily represent the opinions of Kevin Van Trump, The Van Trump Report or its affiliates. With any investment decision, independent due diligence and professional advice is strongly recommended.