Two investment themes have emerged over the last few months that are very positive for our portfolio. First, merger and acquisition activity has increased substantially. Secondly, the price of many agricultural commodities have increased and U.S. exports are booming – all very positive for the agricultural sector.
Mergers - With regard to merger and acquisitions, we think the acquisition landscape is as promising as we have seen in the 11 year history of our portfolio based on: (1) attractive market valuations, (2) impressive company growth rates, (3) good business niches, (4) multiple financing options, and (5) the slow growth status of the global economy. MarketWatch published a column last month that noted as follows:
McKinsey & Co . . . in a report in July called "A singular moment for merger value?", the consultancy said the scene was set for not "just another turn in the acquisition cycle", but that "the landscape for strategic acquirers hasn't looked this promising for decades". That's right, decades.
The wave of merger activity in the energy, agriculture, technology, banking, and other sectors might set records in 2010 according to the Wall Street Journal and Financial Times—a development that would be very positive for the markets and our portfolio.
In a slow growth economy one way to expand is to buy growth by acquiring firms that are publicly traded and have a good business niche, especially when many such companies are grossly undervalued. In some of the large company acquisitions we saw last month the ’premium’ has been 25% to 70% over market rates—and the premiums may be pushed higher if alternative bidders emerge.
Note that merger and acquisition activity in the U.S. oil and gas sector reached its highest level in more than two years during the second quarter. The U.S. oil and gas sector saw a total of 142 announced deals in the second quarter, the highest volume for deals seen since before the recession began. Total value for the second quarter of 2010 amounted to .9 billion compared with .7 billion in the second quarter a year ago, representing a 169% increase year over year. More than 25% of the LSGI Fund portfolio is invested in the oil and gas sector – so the acquisition activity is positive for sector valuations.
Also, note that merger and acquisition deal activity in the global industrial manufacturing industry showed marked improvement from the first quarter of 2010. In the second quarter of 2010 there were 33 announced deals worth million or more, which is more than double the 14 deals announced in the first quarter. And, deal value totaled .5 billion, more than triple the .3 billion in value announced in the first quarter.
Agricultural Sector – Last month several analysts and firms noted that sugar prices were skyrocketing. Cattle prices on the futures exchanges also moved upward to levels not seen in a couple years. Demand helped ‘trigger stampede in cattle prices’ according to one article. In Chicago the contract for pork bellies also set record.
Wheat prices have jumped 45% so far this year after Russia suffered a major crop failure and banned exports. And last month Russia announced they were extending the ban on wheat exports for 12 more months, which kept grain prices firm. Concern over the lack of soil moisture has the Russian government concerned over the viability of the winter wheat crop to be harvested next spring. (Charts courtesy Financial Times and Wall Street Journal)
Cotton prices are nearing the highest price level they have seen since 1995 as rising demand in emerging markets continues. Inventories are the tightest in 13 years. The U.S. is the largest exporter of cotton, and shipments this year are off to their fastest start since 1993 as apparel demand in China, the biggest consumer, increased 24 percent. Cotton may advance further before new supplies are harvested in October.
The United Nations called a special meeting to address the increase in food prices late last month after the first food riots since 2008 broke out in Mozambique. The share of income spend on food is much higher in most countries than in the U.S. (see chart), and food price increases can impact political and social stability. China also adopted policies last month to moderate food inflation and increase food production.
Farm incomes across the U.S. and Canada will jump substantially this year. Last month the U.S.D.A. revised their farm income estimates for 2010. Net U.S. farm income will increase to $771 billion in 2010, up 24% from 2009 and $12.3 billion above the 10 year average. Cash receipts are expected to increase 6.5%, due mainly to higher livestock receipts. Higher grain prices are also driving income gains, as well as moderate energy and fertilizer prices.
Investment implications – The merger trend is moving in a direction we think will support stock prices, especially for small and economically viable firms that are undervalued and growing.
Market strategist Donald Coxe noted in a conference call last month that “agriculture in the U.S. is in dramatically better shape than a few months ago.” The recent weather driven developments are ‘wonderful news’ for investors in the agricultural sector, especially the agricultural equipment manufacturing and sales sector. Weather may continue to be the subject of bad news into the fall according to Coxe, which may focus investor interest on companies in the sector.
If Coxe is on point on this analysis, and we think he is, this is positive news for the agricultural sector holdings.
