In this episode of Industry Focus: Energy, we’re discussing agriculture stocks. Host Nick Sciple is joined by Motley Fool contributor Lou Whiteman to give an overview of the industry, and to share some agriculture stocks on their radar.
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This video was recorded on January 28, 2021.
Nick Sciple: Welcome to Industry Focus. I am Nick Sciple. Last week, we talked about dividend stocks and as part of that discussion, I told folks to write in if they wanted us to do a show on agriculture stocks. Well, I asked and you answered, so that’s what we’re talking about this week. Lou Whiteman is joining me to share some thoughts on the industry and discuss a couple of stocks on our radar. Lou, thanks for joining me.
Lou Whiteman: Pleasure to be here.
Sciple: Yeah, Lou, great to have you here as always. I’m excited to get into this topic today. Obviously, agriculture is a huge, complicated industry so we’re not going to be able to cover it all. But we’re going to do our best to give a high-level overview of the industry, spotlight a couple of companies that stand out to us as intriguing opportunities. As always, as I said at the intro, if there’s a topic you’d like to hear us cover that we’re not going to get into today, email us at firstname.lastname@example.org and we’ll do our best to get to it as soon as we can. But with that out of the way, Lou, let’s just get some background on the agricultural industry. When we look at the U.S. economy, how big of a chunk does agriculture make up of that?
Whiteman: This is a massive chunk of the U.S. economy. The U.S. Department of Agriculture is my source for most of these stats here. They say that Agan food is a $1.1 trillion, with a ‘t,’ industry. American farm output alone is worth about 136 billion. That’s sizable, about 1%, a little under 1% of GDP. Agan related also represents about 10% of total U.S. employment. This is also one of these rare sectors where the U.S. is a world exporter, about 25% of agriculture production is exported. That means without agriculture, all of those trade deficit numbers would look even worse. [laughs]
Sciple: Right. When you look at this industry, what does it look like? I know from my own bias, you hear about the farm aid thing with Willy Nelson and all these guys, who want to protect family farmers, this idea of the rise of the factory farm. Is that really who is owning agricultural assets today?
Whiteman: This is a surprise for a lot of people. There was a time in the ’80s where this trend reversed, and that’s where people like Willy Nelson set our expectations. But owner-operators own about 60% of U.S. farmland, and that number has been pretty stable for the last 50 years. There are fewer than 32,500 non-family health corporations that own farmland. These corporations own less than 5% of U.S. farmland. Where I think the confusion comes in is that these owner-operators have gotten a lot more sophisticated over the years. The average farm landowner owns 280 acres. These are not Ma’ and Pa’ and one field organizations anymore. These are sophisticated businesses. But a lot of them, it’s still very fragmented and it’s still a Ma’ and Pa’ industry.
Sciple: Right. The other thing we think about a lot with agriculture is the relationship with the government. There was this tit-for-tat back with China a while back, and we said, “Hey, China, you’re subsidizing your steel industry,” and then China came back and said, “Hey, you’re subsidizing your agricultural industry.” What role does the government plan in supporting some of the operators here?
Whiteman: Just to throw it back to you, I can’t think of an industry that Washington loves more, and I’d challenge to do that. But definitely, if you look at most states, most elected officials deal with farmers, and I think it shows in Washington. Direct government payments to farmers and ranchers in 2020 was forecast to finish around $37 billion. You’re adding CARES and all that, the Taxpayers For Common Sense estimates it will be well over $50 billion in direct aid this year alone. The $30-$40 billion number is pretty standard even without the CARES Act. This is an industry that gets a lot of support from lawmakers.
Sciple: It doesn’t hurt that the Iowa caucus is the first every year, so I want to make folks happy there and all those sorts of things. Helps put ethanol and fuel and all that. When we look at this agricultural sector, before we get into some of these companies, can you talk about the pros and cons of investing in the sector? What are the opportunities there and then what are some risks involved?
Whiteman: The opportunities, when things go right, this is a very income rich industry. This is a good industry to hold if you are in the portion of your investing life where you are looking for dividends, you’re looking for steady income. But there are risks you need to look into. This is a hugely cyclical industry and it doesn’t really follow the economic cycle, so it can catch you off guard. Again, from the USDA, net farm income was $134 billion in 2013. Four years later, that had dropped $80 billion. That’s a 40% drop in four years. That’s the second one of these cycles we have seen so far this century. A lot of things go into this. The weather in the U.S., the weather overseas where we’re competing against. Crop yields can lead to supply and demand getting out of whack. That means less money coming in. That means less money for farmers to invest in technology, chemicals, all of that. It ripples through for years and we do see, maybe not the great sort of thing, but we do see these boom and bust cycles. It is something to worry about, because you’re not going to see a steady stream year after year on this. There’s just too many macro factors that weigh into it.
Sciple: Right, an act of God literally, I think, can impact the whole area. Sometimes there can be something that’s correlated, and you mentioned the dust belt. I don’t know if we’re going to have something like that again in the future, but there can be things that are correlated across the whole asset that could impact things. I think one other thing to point out is just regulatory risks. One example folks to think about is Monsanto. When you throw out Monsanto now, Monsanto is the worst company ever. At one point in time, Roundup was a revolutionary chemical, and was really the game changer when it came to herbicide, that sort of thing, getting weeds out of farmland. But now, it’s this huge liability, it’s albatross around the company. Some of these long-lasting liabilities can impact some companies in this space.
Whiteman: Yeah, I’ll tell you, and I’m old enough. I was actually asked on one of the business news networks once, way back when, is Monsanto a tech stock? Should we think of it that way? You consider where it’s gone now. It’s a great point, there are a lot of regulatory risks. Even like, with genetically modified seeds, there’s a lot of really complex issues that go into this that can really impact these companies.
Sciple: You talk about genetically modified seeds, maybe some herbicide, pesticide, stuff that transitions us into this first company. I wanted to talk about it with you today, that’s Corteva (NYSE:CTVA), ticker C-T-V-A. It’s a company that hasn’t really been on the public markets very long. Came out of the Dow-DuPont spin-off in 2019, that would’ve been the last time we talked about it on the podcast. Can you tell us about what Corteva does?
Whiteman: Most of it is the old Dow Agrosciences businesses. As people may recall, the Dow-DuPont came together with the plan to shuffle the assets around and create three more focused companies. This is the combined scale agriculture business of those two chemical giants. The operations are pretty much split between seeds and crop protection, which they do a lot of these modified seeds, specialized seeds. Then the other side of it is not Roundup, they don’t own that, but a range of fertilizers and more importantly, herbicides and other products. We can get into it in depth, but there’s a lot of synergies here, because increasingly, we are moving toward crops that resist certain herbicides, which makes it easier to get rid of weeds. It’s a business that has a lot of potential, there’s all sorts of stories about it. If you’re a soybean farmer and you plant these herbicide-resistant soybeans, and then you spray the herbicide, your next-door neighbor darn well better have that too or they’re going to lose their crop. There’s almost a perverse way that once a product gets popular, it stays popular and grows. We’re in the early days, but that’s what Corteva is going for with soybeans and a lot of other products.
Sciple: These two sides of the business rhyme together. They will develop some type of, whether it’s pesticide or an herbicide, or what have you. Then they’ll also develop a proprietary seed that is resistant to those pesticides or herbicides. One thing you’re going to talk about the business, historically Monsanto has been so dominant in the industry that Corteva is actually paying significant amounts of royalties to Monsanto for using some of their trades. But there are some opportunities for Corteva, and you talked about the investment case here, as they move more and more of their products to their own proprietary seed trades and things like that. They can take out some of those licensing fees they’re paying to Monsanto, it really gives them an opportunity. You can project out over the next several years where they can expand their margins in a meaningful way.
Whiteman: The idea of it. If you have a better mousetrap, it will sell. Your customers are very reliant on getting the best yield they have. That has been the business model for these chemical companies, that’s why they are so involved, Nick. We have a company at scale, they’re one of a few, but are really trying to do this in a coordinated way at scale where they can really dominate a market.
Sciple: Just to throw some numbers out there. In 2018, about 18% of their portfolio was patented to their own existing in-house patents. They expect to have 34% of that by 2023, so really expanding the patent portion of their portfolio. Also introducing some new herbicide, pesticide products to the market. Hopefully, it can take some share from Monsanto, some of these other companies. I pulled a stat, two-thirds of Corteva’s pioneer soybean seed use Monsanto’s chemical trades now. A significant portion of their seeds that are subject to some of these licensing fees. But overtime, it can bring those down and hopefully expand margins as well as when they’re launching some of these new products. The other thing to think about as well is, since the spin, they’ve been trying to get some of their costs under control, reducing headcount, those sorts of things. Can you tell us some about their efforts there, Lou?
Whiteman: They’ve reduced their manufacturing footprint pretty substantially, I think from 29-20 facilities since 2017. Headcount is down 25%. Again, this is what you’d expect from a merger. There’s a lot of efficiency to be rung out here. Frankly, they’ve done a decent job of it. I don’t think they would say, we’re going to do the […]. They’re the first to say that the job isn’t over. But this is an early days company that they’re still trying to put together the pieces they have and develop it out.
Sciple: We talked about that margin expansion opportunity. If you look at their adjusted EBITDA margin, about half of their competitors, Bayer, Monsanto, have given about 26.9% FMC, and other competitors about 28% compared to about 14% for Corteva. We talked about this opportunity to expand margins as they introduce new products and get less reliant on some other licensed trades. However, for some investors, not happening fast enough, in particular, Starboard Value (NASDAQ:SVAC).
Whiteman: Starboard is a very well-known activist fund. We started getting hands back in November that they were going to get involved, and they have now nominated eight directors to the board for the 12 places and they are seeking to oust CEO Jim Collins due to what they call mediocre performance. We should note that, since this company went off on its own, June 2019, the stock is up 32%. That’s basically in line with the S&P 500 and it’s a lot better than either the other two, its sibling companies that came out of Dow-DuPont. DuPont is up about maybe 19% and Dow less than that, about 10%. It’s not that the company has underperformed, but there is, as you say, the margins aren’t what they want. Collins, the CEO, in response to Starboard said, “Probably the only question in the whole discussion is our view of the timing of the improvement.” They were first to say, there’s an improvement. It’s going to be interesting, as far as an investor, looking at the stock to see who’s in-charge in the next few months and whether or not there is an overhaul in the strategy which could be good, could be not so good.
Sciple: It’ll be interesting because the management has laid out, like we talked about earlier, a path to where you can see margin expanding over time, and given the nature of the business, once you get in with these farmers, this is your core business. You have to grow these crops. Once you’re in with these folks, it’s going to be very difficult to dislodge them. There’s clearly an opportunity there, it’s going to be interesting to see with Actavis coming in, whether that is something that accelerates the pace of this transition or whether this is a distraction that gets in place of their execution. We’ll see. I will say that Starboard historically has been a great allocator of capital. When they identify an opportunity, there tends to be real value there. We’ll see what happens.
Whiteman: I have a lot of respect for Starboard, definitely. I think for investors who are interested in this, it’s really important to note: February 4th is when Corteva is supposed to do earnings. Analysts are basically right at the top in terms of their estimates compared to Corteva’s range. It’s possible Corteva was low balling or was being conservative. Analysts also see 30% growth in 2021. It’ll be really interesting to hear what they say about that. I got to believe that they’re going to try to paint a positive message, whether it is or not. But it’ll be really interesting to see how the story progresses when they do release earnings and what they see for 2021 and beyond.
Sciple: I don’t own shares in Corteva today, but this is definitely one that’s going to go on my watchlist because you can see where the story plays out. You can see how they would be ingrained with their customers out. This is something that’s mission-critical to the business. Something I want to be watching and when earnings come out here next week, we’ll take a look at them. Another company I wanted to talk about today, Lou, was Gladstone Land (NASDAQ:LAND). We mentioned them briefly last week on the podcast with Matt DiLallo, the ticker is LAND. Pretty easy to follow. What can you tell us about that Gladstone Land?
Whiteman: This is a farming REIT. They own farmland in I believe about 13 states, they pay monthly dividends. The yield right now is about 3.3% annually, and it has been increasing. This is a business, it’s a pretty straightforward business. They buy the land, they lease it back to farmers. The interesting thing here is it gives you exposure to the farms without making a bet on an initial farm with a pretty standard but yet pretty attractive setup with the way they set up their leases.
Sciple: They mostly used triple-net leases, that’s just kind of a finance term. But just to explain that in common sense terms for you, it means the person who’s leasing the property treats it like they’re the owner. So, they pay the taxes on it. They pay the licensing or whatever. They pay the maintenance, all those sorts of things. From the perspective of the REIT Gladstone Land, they lease out the property. They collect their rent payments, and they are not responsible for any of those other kinds of expenses that go into maintaining the property, that’s distinguishable from another type of lease where the person who owns the property, the lesser, would be the one paying those sorts of expenses.
They also have some of their leases participating. They get their income from the firm, but primarily they’re doing these triple-net leases. Another thing that is interesting when you look at their focus, they talk about they’re focused more on two primary areas, which is annual fresh produce and permanent crops. What’s that? Annual fresh produce is stuff like fruits and vegetables, tomatoes, things like that, stuff that you plant and harvest every year. Then permanent crops are things like blueberries, nuts, things like that, that you plant and then you’ll have like a 10-year life once you have that orchard or what have you up and running. They’re focusing on these areas to the detriment of things like wheat and corn and those sorts of grains that are more commodity products. What they say is, for those fresh produce, you get both higher rents and lower risk than those commodity crops. They’re focusing on areas where they think there’s a little bit lower risk for themselves, and they can generate higher income by having that focus. Interesting opportunity to invest in farmland here in the U.S..
Whiteman: Yeah. I think one thing interesting in comparing it to other REITs, as a REIT investor, a lot of REITs are tied to the economic cycle, whether it’s industrial REITs, definitely retail. We saw that in 2020. Even some of the apartment REITS. As we said, the farm could be very cyclical, but it tends to be tied to a cycle other than the economic cycle. It may fall with it, but it may be an opportunity to keep yield coming in when other sectors are in trouble, which, as far as REIT diversification, I think makes it an interesting thing to think about.
Sciple: Yeah. Especially for someone looking for income, you want something that’s non-correlated. Then also, they’re paying dividends on a monthly basis. If you’re running the stock like this so you can get regular dividend income coming in to support yourself for retirement or what have you, this is the type of company that it’s unlikely you are going to experience volatility that’s in line with what goes on in the stock market. Obviously, demand for farmland doesn’t fluctuate in the same way that maybe the stock market does on a year-over-year basis, and they’re paying you dividends on a monthly basis. So you can get this kind of steady income coming in. If you’re someone who is an income investor, I think this is something you could put on your radar as something that can give you a steady, dependable income in a way that you can sleep at night relatively comfortably.
One last company I wanted to talk about, Lou, and this is one I think it’s — you pay attention to, but not one I’m super excited to run in and buy. It was a company called AppHarvest. It’s coming public via a REIT this year. This vertical farming space. We talked about Gladstone Land buying traditional farmland. AppHarvest is taking a very different approach, trying to lean into some of the ESG-type movements.
Whiteman: Yeah. Let’s look at this. It probably wouldn’t surprise you that the U.S. is the biggest global farm exporter as we said, but it might surprise you that the Netherlands, the tiny little country is No. 2. The way they do that is tech greenhouse farm structure. AppHarvest has taken that model and brought it to the U.S. They have, I believe, three farms in Appalachia. The pitches can produce 30X the yields using 90% less water. Right now, it’s mostly tomatoes and it is early stage. I don’t own this stock either. I loved this idea. There’s some reasons that I’m not buying in right now that we can get into. But this is fascinating to me. We talked about making the world a better place. This is the company that we need to be successful to make the world a better place. The warning on it is that it is a SPAC. So it’s not public yet. Right now, I believe N-O-V-S. That deal should close soon. I’m not the only one excited about it. I tend not to like to buy IPOs in new companies anyway. I think the caution around buying into the excitement applies here. There is a Martha Stewart video on their website talking up the company, which I love Martha Stewart, but that’s a hype level that makes me want to just watch and see what they produce. This is just three little farms in Appalachia right now and a great idea. This was all over my watchlist. I would imagine I would love to hold it at some point, but just be careful because this is, as we saw SPACs last year in other areas, people are very excited about this.
Sciple: Yeah. I think, like we’ve said, for a lot of these companies, the prospects are great. I think when you look at the produced water usage, better environmentally friendly, all those sorts of things. I like that they are in Appalachia, someone who is from the South. I like it when more rural areas get some people actually investing money there. But again, there’s a lot of execution between now and really getting to a place where this is the future of farming and they’re going to reach scale and all those sorts of things. But this is a company I’m definitely going to have my radar on and pay attention to as they continue to report earnings. Because you can tell yourself a story about how this type of vertical farming, indoor farming disrupts this traditional model, can be more efficient, cleaner, etc. Something to continue paying attention to as we have more information, because this company, like you said, Lou, isn’t all the way public yet. We still got to have this SPAC deal finalized and then we get all our fun SEC filings on quarterly calls and all those sorts of things. Once we have that, I will be very much looking forward to seeing what the company has to say.
Whiteman: Right. Just to finish up along too, the interesting thing here is that it is a proven concept because it has worked elsewhere. The downside of that is that it needed to work there. Netherlands just doesn’t have — and this is an expensive proposition to get started, to get going. There’s potential there, but in a country blessed with almost seemingly unlimited farmland for now, for long term it makes sense. But in the short-term, it could be a hard thing to really get up and running. I think you’re right, just one to watch.
Sciple: Yeah. I think that’s something I think about a lot with the history of the U.S. is like not a lot of countries over the past 200 years have had a lot of blank space on the map to expand into, but the U.S. has definitely been a beneficiary of that. That comes with farmland and lots of other things.
Whiteman: Not to mention that Mississippi River providing transportation, but yeah, but now I’m getting onto a tangent, so I’ll stop [laughs].
Sciple: Before we go away Lou, just any advice for folks who are interested in investing in this kind of agriculture space? If you don’t want to pick individual stocks, maybe ETFs to pay attention to, things like that.
Whiteman: Yeah. I think if nothing else, the point I think we’ve tried to make here today is that there is value here, especially for income. There’s the old expression that land is important, because they’re not making more of it. It still applies. Agriculture is key to our existence. They’re not making more land. This is a business that over the long term can work, but has a lot of risks. There are some interesting and awesomely tickered, I should say, ETFs in the sector. I’m really interested in the market vectors agribusiness, which has a ticker of MOO, M-O-O. I like that it’s got 60 or so stocks. You get some exposure to animal health, Zoetis and IDEXX, some of those which I know are popular here. But you also get a lot of the seeds and chemicals in a pretty diverse basket. There’s another one, VEGGIE, which is an ETF that’s a little more concentrated. Both of them have companies like John Deere and TU, which is when we didn’t get, but which is a service provider to Ag, which is very interesting. The Farmland REIT, I think looking at that, I like land. There’s also Farmland Partners, which is FPI, which I think is the same idea. I don’t know if it’s worked out as Gladstone Land, but this is just an area where the cloud isn’t working so much or if you’re looking for a little more income. Some way to get into this and have some exposure for a 20-30 year portfolio, I think makes a lot of sense and it’s worth looking at.
Sciple: Absolutely. It gives you exposure, as we said earlier. This is an industry that is not going to trade correlated with the rest of the markets or particularly for an income investor, an area to pay attention to. Again, I don’t think farming is going to go away. [laughs] An easy bet to predict. The beginning of civilization was farming. I think, if you’re betting on civilization sticking around, farming is going to stick around too. Interesting area to invest in if you’re looking for something uncorrelated that can give you some steady returns over time. Lou, as always, I love having you on the podcasts and I can’t wait to have you on again next time.
Whiteman: Always a pleasure, Nick.
Sciple: As always, people on the program may own companies discussed on the show and The Motley Fool may have formal recommendations for or against the stocks discussed, so don’t buy or sell anything based solely on what you hear. Thanks to Tim Sparks for mixing the show, for Lou Whiteman, I’m Nick Sciple. Thanks for listening and Fool on!
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