For Ken McCauley, it's not just corn's color that's golden. With government-mandated ethanol purchases sending corn prices soaring, the White Cloud (Kan.) farmer and president of the National Corn Growers Assn. is optimistic. And that's no small thing in his famously feast-or-famine line of work.
It's not the first time McCauley has seen expensive corn; bad storms or drought can lead to meager harvests—and resultant price spikes. But there's a giddiness surrounding the recent climb in the price of the commodity. The cash price for central Illinois was $3.53 per bushel in December, up from $1.89 in 2005.
Why should anyone who doesn't drive a tractor care? The price action in corn can have widespread implications—from the gas pump to the frozen-foods aisle and, ultimately, the bottom line of big consumer-products companies. A look at the ripple effects can identify opportunities—and pitfalls—for investors.
Future's in Fuel
What's driving the boom? In a word, ethanol. The alt-fuel has become enshrined as part of U.S. energy policy, if mainly as a gasoline additive (see BusinessWeek.com, 5/19/06, "Ethanol Myths and Realities"). Corn farmers see it as a life preserver—one that will ensure a steady demand for the crop in the years to come. McCauley aims to capitalize further through his stake in a small ethanol plant now under construction. For the upcoming planting season, he's shifting more of his 4,000 acres to corn from soybeans this year.
"The increase in prices has helped us get our profit from the market now," he says, instead of government programs. It amounts to a nice payoff after several years of corn prices below what they needed to be for farmers to break even. Additionally, for McCauley, the ethanol boom reassures him that his son, a graduate of Kansas State University, can become a farmer.
Ethanol's benefit to corn farmers notwithstanding, the fuel's environmental and practical merits remain controversial. And a tariff that shelters U.S.-produced ethanol from foreign competitors—thereby propping up prices for the fuel—drives its opponents into hysterics (see BusinessWeek.com, 9/12/06, "A Slow Burn for Ethanol"). But in an age of global tensions over energy, domestic renewable fuels appeal to voters. So for the moment, corn growers are in a strong position.
Tricky Choice for Investors
But can investors benefit from corn's pop? Finding an opportunity to profit on the price rise can be tricky. First of all, the smart play isn't necessarily ethanol. Yes, the agriculture giant Archer Daniels Midland (ADM) saw ethanol production as a driver of its record profits last year. But shares in "pure-play" ethanol outfits like VeraSun Energy (VSE) and Aventine Renewable Energy (AVR) have been less successful, with their shares recently trading below their IPO prices.
Amid rising production, producers can still get squeezed between volatile ethanol prices—they tend to fluctuate parallel with oil—and expensive corn. They'll also confront more competition as production capacity expands. The 2005 Energy Policy Act requires the purchase of about 7.5 billion gallons of ethanol by 2012. However, industry observers expect the actual total to grow faster, raising the possibility that supply outpaces demand.
As farmers increase their corn production, prices could drop, but market signals point toward at least a plateau. Tim Hannagan, head grain analyst at Chicago brokerage Alaron, says corn growers, at least, think "this isn't going away." Commodities can be a puzzling play, but he says investors who agree should consider going long on corn futures.
If that sounds a touch exotic, Hannagan says agricultural-equipment plays like John Deere (DE) prosper when farmers feel flush.
Another segment that might grab investors' attention is corn seeds. Monsanto (MON) is a market leader in selling genetically modified corn seeds and has the potential to gain market share. Even so, analysts are tepid on the stock's growth potential. Meanwhile, rival DuPont (DD) is too diverse a company to be considered a strict corn play.
At the other end of corn's life cycle, refiners could be a focus as well. A major shift away from corn-based sweeteners is unlikely. But just as soft-drink makers initially abandoned sugar for high fructose corn syrup to lower costs, there's the possibility of some motion in the other direction.
Late last year the niche beverage producer Jones Soda (JSV.D) said it plans to replace high fructose corn syrup with sugar in all of its product lines. Don't expect to see the same from soda titans like Coca-Cola (KO) or Pepsi (PEP). Craig Ruffolo, vice-president of food consultancy McKeany-Flavell, says the U.S. lacks the sugar-refining capacity for such a massive shift, but he says the large companies could add sugar-sweetened product lines.
Like Jones, they'd aim to gain on the common but unproven perception that sugar is healthier than corn syrup, Ruffolo says. If this happens, sugar companies could be the beneficiaries; Imperial Sugar (IPSU) is a rare public company in that closely held sector.
Meat Industry Troubles
As with refiners, cereal companies may be able to sidestep the brunt of climbing corn prices. According to the National Corn Growers Assn., a 12-oz. box of breakfast flakes contains less than a penny's worth of grain.
But meat producers are finding corn prices harder to swallow. Every quarter-pound of hamburger meat produced requires 13 cents of corn in the form of animal feed. The exact ramifications for the chicken, pork, and beef industries differ, but investors should watch their step in the feed lot.
"There are some long-term changes that need to happen" in the meat industry says Morningstar analyst Ann Gilpin. And none is perfect. She says meat producers need to work on changing the diets of their animals. Tyson Foods (TSN) plans to make its own move into the energy business by pursuing initiatives to convert its vast supplies of chicken fat into renewable fuels. It's a nifty idea but an unproven one in a troubled industry.
Ethanol's Impact May Expand
In a November conference call, O.B. Goolsby Jr., chief executive officer of Tyson rival Pilgrim's Pride (PPC), summarized the industry mood: "While Americans may realize some marginal benefit, if any, from ethanol at the fuel pump, they will end up paying higher prices at the grocery store." Both Pilgrim's and Tyson reported a net loss for the last fiscal year. Smithfield Foods (SFD), the market leader in pork products, remains profitable but has had a tough year as well.
John Nalivka, president of consulting firm Sterling Marketing, says corn prices are increasing risk for the beef industry and its investors. And that uncertainty is self-perpetuating. Hedge funds in the futures market further complicate the picture. "It's not just ethanol," he says. "It's all the speculation around ethanol."
So, while manufacturers and financial wizards fret about the price moves, the clear winners in all this are the folks who pull in the harvest.