Digging into agriculture stocks

As crop prices have declined, so too have the valuations of many agriculture stocks, creating what Fidelity's Sean Gavin considers fertile ground.

• Although the agricultural market has recently faced somewhat of a perfect storm—characterized by oversupply of crops and a drop in demand, leading to falling prices for staples such as corn and soybeans, with many agriculture-related stocks following suit—Fidelity Portfolio Manager Sean Gavin sees a silver lining in the opportunity to acquire what he considers excellent franchises at an attractive price.
• "The backdrop for companies dependent on the agriculture market has been both cyclical and challenging, but I anticipate conditions to normalize in the next year or two," says Gavin, who manages Fidelity Advisor^® Equity Value Fund. "As a result, I've been able to purchase some excellent franchises at a great price."
• In leading the large-cap, value-oriented strategy, Gavin favors companies experiencing significant price dislocation, believing that, over time, a stock's market value will move toward its intrinsic, or fair, value.
• He explains that as commodity prices have declined, farming operations have become less profitable, meaning farmers have been forced to curtail spending, particularly on new equipment, such as tractors. In turn, this has led to lower profits and diminished stock-market valuations for firms serving the agricultural industry, he adds.
• That said, Gavin is optimistic about a recovery in commodity prices because he has seen restraint from farmers in terms of the acreage they are planting, which he believes should help cap supply. At the same time, he notes that long-term demand trends for corn and soybeans appear robust.
• "As a result, I'm expecting an uptick in profits for the average farmer," notes Gavin. "If that comes to pass, it should enable farmers to purchase tractors and make other discretionary business purchases, directly benefiting agriculture-focused companies."
• Following his bottom-up—stock-by-stock—investment approach, Gavin has capitalized on current market conditions to invest in several agriculture-related stocks at prices he believes offer a large margin of safety.
• One of the stocks he's favored is Deere, the largest manufacturer of agricultural equipment and a sizable fund holding on September 30.
• "I've followed Deere for about a decade and believe it's a fantastic franchise with strong returns and a great competitive position within the industry," Gavin contends. "I've long hoped I could someday buy it for the fund at an attractive enough price to offer a nice margin of safety—a scenario that recently came to fruition."
• In Gavin's eyes, one of Deere's many competitive advantages is its roadmap for incorporating new technology into its products. "From machine vision to GPS tracking or automation, Deere is at the forefront of technological innovation in every part of the farm machinery industry," he points out. "By 2030, the firm aims to fully automate all its equipment, a shift that should translate to a significant boon for farmers facing a severe labor shortage."
• The fund counts other agriculture-focused stocks among its investments at the end of September, including CF Industries Holdings, a supplier of nitrogen—a key component in fertilizer—and Nutrien, a commodity supplier for farmers. He sees both as industry leaders with an attractive valuation and compelling upside potential relative to their risk.
• "Although the exact timing of a recovery in commodity prices is uncertain, my process is designed to find stocks priced low enough that not that much has to go right for it to see a meaningful gain, an inherent cushion I feel very good about," Gavin concludes.