Profit from Soaring Food Prices

01/14/2011 11:17 am EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

The prices of some basics, including wheat and rice, have risen by more than a quarter and are near historic highs. As your budget tightens, these stocks benefit.

Recent headlines tell the story of a global spike in food prices. In the last few weeks, we've seen riots in Algeria sparked by the cost of sugar and wheat. Mexico's government bought corn futures to hedge against rising tortilla prices. Indian prime minister Manmohan Singh was forced to arrange onion imports from traditional enemy Pakistan. In a visit to a supermarket in Inner Mongolia, Chinese premier Wen Jiabao promised shoppers that the government will control food price inflation now running at better than 11% annually.

It sure sounds like we're headed back to the bad old days of 2008, when soaring food prices sparked riots around the globe. According to the food price index kept by the Food and Agriculture Organization of the United Nations, the prices of traded food staples such as wheat, corn, and rice climbed 26% from June to November and are near the historic highs set in 2008.

What the world is seeing isn't an anomaly, in my opinion. The peaks of 2008 and 2010 aren't unusual events caused by a coincidence of bad weather and terrible (but common) government decisions to hoard key grains behind export bans. Those peaks are indeed extreme, but the long-term trend in food prices is upward. It's the dip from the highs of 2008, as global consumers tightened their belts in response to the Great Recession, that's actually the anomaly.

Absent a return to global recession, I think the upward trend in food prices is going to continue. The forces pushing prices higher are simple and massive, and the policy responses from governments that might temper the trend are too limited. If you're a long-term investor, the rise in food prices is one of the safest trends you can invest in for the long term.

A Good Food Stock Is Hard to Find

It's also one of the most frustrating trends, because of the difficulties in finding good stocks positioned to take advantage of rising food prices. Eliminate those that don't trade publicly or in the United States and the number gets even smaller. For example, one of my favorites is Marfrig Alimentos, a Brazilian processor of beef, pork, chicken, and lamb, as well as frozen vegetables, prepared meals, and pasta. But while volumes are above a million shares a day in Brazil, the stock (MRFG3.BZ) trades hardly at all on the US over-the-counter (OTC) market.

But I think you can expand the universe—a bit anyway—if you go back to the root causes of rising food prices.

Demand for staple grains, for example, is forecast to rise by 2% in 2011. Where's that demand coming from? A larger global population is certainly contributing, but rising global incomes also play a role. As incomes rise, even modestly, people clamor to eat more meat. Turning grain into pork or chicken or (corn-fed) beef is a very inefficient way to produce protein. And, at least in the United States, there's further competition for grain for energy production. The International Monetary Fund (IMF) estimates that 70% of the increase in corn prices in 2008 was due to demand from ethanol production.

The solution would seem simple: Grow more food. But increasing the food supply isn't easy. First, the world isn't producing any additional good farmland. In fact, we're losing farm acres every year to causes that range from desertification to urban development. Second, while increasing the productivity of much of the world's farmland is certainly possible, we've got a mismatch in much of the world between the cost of the inputs that would raise productivity—better seeds, more fertilizer, better irrigation—and the ability of poor farmers to pay for them. Third, many of the cheapest and easiest methods for raising productivity have hit real limits, given the absence of investment capital. For example, cheap forms of irrigation have depleted the water table in many farm areas of India, while at the same time adding near-toxic levels of salts from fertilizers to the soil. That situation is certainly fixable, but deeper wells, drip irrigation, and soil restoration all require investments beyond the capacity of most of the area's farmers.

“Global Weirding” Isn't Helping Matters

Fourth, global climate change is making weather less predictable. For example, it looks like what I think is best referred to as "global weirding"—and not global climate change or global warming—is in the process of changing the patterns of South Asia's monsoon rains and the oscillations between La Niña and El Niño patterns in the Pacific.

To think about how this all plays out for investors, break it into two parts. First, the rise in food prices means that farmers will earn more income (however, inequitably distributed in the world) that they can then reinvest in growing more food. Second, consumers—and the companies that supply them—will be looking to find ways to cut their cost.

So which companies prosper as farmers have more to spend?

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The classic play, of course, is farm equipment maker Deere (NYSE: DE). Deere's sales closely track farm income. Its shares popped Jan. 12 when the US Department of Agriculture announced that US corn, soybean, and wheat inventories had fallen by 10.5%, 15.2%, and 4.7%, respectively. Lower inventories translate to higher prices for US farmers and higher sales for Deere. (Deere is a member of my long-term Jubak Picks 50 portfolio.)

Seed makers are a slightly longer-term investment, because the next big payoff is from drought-resistant seeds that require less water, and that research is just starting to yield results. My two favorites here are DuPont (NYSE: DD) and Europe's Syngenta (NYSE: SYT).

Investing in Fertilizer Is Another Way to Play

You can't grow plants, no matter how drought resistant, without nutrients. And in many countries, applying more fertilizer is the best way, in the short term, to increase yields. My picks here are Potash of Saskatchewan (NYSE: POT), Agrium (NYSE: AGU), and Yara International (OTC: YARIY).

In that group, I'd probably give the lead to Yara International because of its recent moves on bulk liquid fertilizers. The company is in the process of acquiring the part it doesn't yet own of Yara Nipro, the market leader in bulk liquid fertilizers in Eastern Australia. Liquid fertilizers are particularly well-suited to farming in areas where water is scarce; in many of these markets, liquid fertilizers are just establishing a foothold. Only 3% of fertilizer in Eastern Australia is supplied in liquid form, for example.

Speaking of water, irrigation emerges as a growth industry as weather becomes less predictable. Lindsay Corporation (NYSE: LNN), a stock I added to Jubak's Picks in December, is a leader in big, center-pivot irrigation systems. Jain Irrigation Systems, which specializes in extremely efficient drip irrigation systems, is the other irrigation pick I'd make. Unfortunately for US investors, the company trades only on the Indian stock market. (The ticker is JI.IN, in case you can buy it there.)

Bigger Is Better Among Suppliers

Now let's go to the other side of the trend and look at companies that will profit as consumers and consumer-facing companies look to avoid the worst effects of rising food prices.

Brazil's Marfrig Alimentos is an example. In the last year, the company has become a supplier to US fast-food restaurants, and I think that's a likely growth opportunity as those outlets look for cheaper supplies. I'd also add Bunge (NYSE: BG), the big soybean supplier. Bunge has the global contacts to source the soybeans it processes at the best global price of the moment—and that will give the company the ability to ride the changing currents of rising food prices. (The stock is also in my Jubak Picks 50 portfolio.)

Following this same logic, I'd favor the biggest of the global food companies, because they can source their ingredients from whatever part of the globe is cheapest at the moment. Here, my pick would be Nestlé (OTC: NSRGF).

That list of ten stocks (not counting Jain Irrigation) doesn't exhaust the opportunity. But it should be enough to get you started.

At the time of publication, Jim Jubak did not own shares of any of the companies mentioned in this post in his personal portfolio. The mutual fund he manages, Jubak Global Equity Fund (JUBAX), owned shares of Agrium, Deere, Lindsay, Marfrig, Nestlé, Syngenta, and Yara International as of the end of November. For a full list of the stocks in the fund at the end of November, see the fund's portfolio here. The portfolio at the end of December will be posted in a few days.

Jim Jubak has been writing "Jubak's Journal" and tracking the performance of his market-beating Jubak's Picks portfolio since 1997 on MSN Money. He is the author of a new book, The Jubak Picks, and he writes the Jubak Picks blog. He is also the senior markets editor at MoneyShow.com.

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