Two Ways to Ride the Ag Commodity Bull

10/27/2010 1:00 pm EST

Focus: COMMODITIES

Elliott Gue

Editor and Publisher, Energy and Income Advisor and Capitalist Times

Elliott Gue, editor of Personal Finance, and editorial director David Dittman say agricultural commodities are in a multiyear bull market, and two stocks should profit nicely from it.

The recent surge in the price of agricultural commodities represents the early stages of a multiyear bull market, a product of strong demand from emerging markets and ongoing supply challenges.

Food upgrading in emerging markets continues to pressure already strained supplies; higher household incomes translate into diets that include more meats, sugar, and fats. Meanwhile, the amount of arable land is shrinking, pressured by water shortages and the relentless march of urbanization.

Bunge (NYSE: BG) offers exposure to the dietary shift under way in emerging markets. The firm’s agribusiness division, which accounted for 73% of sales in 2009, processes soybeans and other oilseeds to produce edible oils and animal feed.

Greater demand for meat increases the need for animal feed (it takes about seven pounds of feed to produce one pound of beef and four pounds to produce one pound of pork), and consumption of fats and oils also rises sharply with income. Meanwhile, improved demand and pricing for soybeans and related products will boost results in the short term.

Bunge’s sugar and bioenergy division processes sugar cane into sugar, ethanol, and other products. Brazil is the world’s top sugar cane producer, and Bunge has become a leading player in the country, amassing eight mills through a series of acquisitions.

Using sugar cane to produce ethanol is more than twice as efficient as [using] corn; increased biofuel blending targets ultimately will mean a larger export market for Brazil. And rising incomes in countries like China and India will result in rising demand for sweets and sweeteners.

With strong leverage to food upgrading in emerging markets and improving near-term profitability, Bunge rates a Buy under $65. (It closed above $62 Tuesday—Editor.)

AGCO (NYSE: AGCO) is the third largest global manufacturer and distributor of agricultural equipment, selling everything from tractors and combines to irrigation equipment and diesel engines in more than 140 countries.

While AGCO is based in Georgia, North America accounts for only 7% of its operating income.

AGCO is a much larger and stronger competitor in key markets across Europe and South America, and many of its products enjoy pole position in the all-important Brazilian market.

In addition, AGCO is a pure play on agriculture; the firm has no significant exposure to construction or forestry markets, unlike competitors Deere (NYSE: DE) and CNH Global (NYSE: CNH).

High grain prices and tight global supplies of agricultural commodities are likely to keep farm incomes high for at least the next few years, driving growth.

Trading at [around] 15x forward earnings estimates, AGCO’s valuation is in line with its peers, but the stock often commands a significant premium in bull markets. Buy AGCO under $44. (It closed below $43 Tuesday—Editor.)

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