Sector Watch: Agriculture stocks
Grain prices are soaring and farmers, in turn, are investing more in seed, fertilizer, pesticides and equipment, which plays nicely into the hands of American Vanguard Corporation (NYSE:AVD) and KMG Chemicals (Nasdaq:KMGB), two companies that will likely report strong double-digit earnings growth this year.
Fertilizer spending rose 20%, or $14 billion, last year and is forecast to rise another 18%, or $3 billion, this year. Spending on crop pesticides is forecast to increase 11%, or $1 billion, this year.
Rising demand from India and China, low grain stockpiles and the increased use of grain for ethanol and other biofuels have fueled huge increases in grain prices. A flood of new investors have entered the agriculture commodity markets in search of high returns and total index fund investments in corn, soybeans, wheat, cattle and hogs are up nearly five-fold to $47 billion today, from $10 billion in 2006.
Good news for American Vanguard Corporation, a developer of crop protection products, turf products and insecticides. The company has grown by acquiring niche products from larger companies such as BASF, The Dow Chemical Company (NYSE:DOW), Bayer and DuPont that divest some of their mature products to focus more resources on newly discovered molecules. Through this strategy, American Vanguard has acquired 13 new products since 2000 and produced 20% annual income growth over the last five years. In 2006, American Vanguard launched a new corn herbicide, Impact, which it believes will become a top five product in this $200 million market.
American Vanguard’s sales grew 12% to $216.7 million in 2007, from $193.8 million in 2006. Net income rose 21% year over year to $18.7 million, from $15.4 million, and per-share earnings improved 19% year over year, to $0.68 from $0.57. The company benefited from robust sales of Impact and anticipates additional sales gains this year resulting from a worldwide shortage of glyphosate, a chemical compound used in most conventional herbicides, but not Impact. The company also enjoyed strong sales of its corn soil insecticides Counter and Aztec in 2007, acquired new fungicide and insecticide product lines and expanded its manufacturing capabilities in the Midwest and Pacific Northwest. While first-quarter 2008 revenues and per-share earnings were unchanged compared to prior-year first-quarter results mainly due to weather-related planting delays, the company anticipates expanding herbicide and insecticide sales over the next several quarters. Analysts predict 30% annual growth for American Vanguard this year and next year. My $21 price target for American Vanguard is 31% above Tuesday’s closing price of $16. Over the last 52 weeks, shares have ranged between $11.51 and $20.30.
KMG Chemicals makes animal health pesticides. It is the only North American producer of several key products for livestock and poultry applications and has an estimated 20% market share of the U.S. livestock and poultry insecticide market. The company successfully launched a major new product last year called Avenger, an insecticidal ear tag for cattle containing an innovative ingredient for superior insect resistance. The company also has a dominant market share in industrial wood treatments and preservatives used to treat railroad ties and utility poles. This business provides a relatively predictable revenue stream. In early 2008, KMG further diversified its operations by acquiring a supplier of high-purity process chemicals for semiconductor manufacturers.
KMG Chemicals has a growth strategy similar to American Vanguard’s in that it acquires mature specialty chemical products from larger companies. By acquiring products in consolidating markets, KMG Chemicals is able to realize margin gains as price competition declines. The company has made seven acquisitions since 2002, five of which involved new products.
During the first six months of fiscal 2008, KMG Chemicals’ sales increased 47% year-over-year to $52.8 million from $35.9 million. However, net income growth was more modest with net income rising to $3.1 million, or $0.28 per share, in the first six months of 2008, from $3 million, or $0.27 per share, in the same period one year ago. Gains were limited by losses from a discontinued operation and integration costs for a January 2008 acquisition. Animal Health segment revenues, which were $14.2 million last year, are expected to exceed $17 million this year and are forecast to reach $40 million to $50 million within five years. Much of the growth will come from Avenger, the insecticidal ear tag for cattle. There are an estimated 92 million cattle in the U.S. and at present fewer than 10% are protected by ear tag insecticides. The company also plans to add three new products in its Animal Health segment and is pursuing sales in Latin America. In addition, KMG Chemicals recently doubled the size of its animal health segment sales team.
The company anticipates 2008 revenues in a $135 million range and double-digit per-share earnings growth. Analysts forecast 23% annual growth over the next two years. My $23 price target for KMG Chemicals represents a 69% premium to Tuesday’s closing price of $13.62. Shares have ranged between $12.57 and $28.25 over the last 52 weeks.
About the Author
Contributing author Lisa Springer is an equity research analyst with nearly 20 years of investment research experience.
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