How to profit from rising food prices

By Jim Jubak

Bread will cost a lot more bread in 2008. So will cornflakes, soy milk, lentil soup -- anything made out of grain or legumes. And that includes the meat of the chickens, cows and pigs that fatten up on corn and soybeans.

Over the three months ending in October, the price of food went up at a 5% annual rate, almost three times faster than overall inflation, according to the Consumer Price Index calculated by the U.S. Department of Labor. It's likely that food prices will climb that fast or faster in 2008, even if the U.S. economy slips toward recession.

Food, in fact, is starting to behave a lot like oil.

Prices may fluctuate in the short term, but the long-term trend seems to be inexorably upward, as global supplies -- of food and oil -- struggle to keep up with rising demand from consumers in developing economies. In neither case does a big increase in supply seem to be in the cards. In fact, in both cases, it's going to take trillions of dollars in new investment just to stay even.

Food as a growth stock

That means investors should start thinking about agriculture and food-commodity stocks in the same way they now think about oil and other energy stocks. The latest round of big gains in oil stocks has come as the stock market gradually stopped pricing these stocks as if oil prices were going to collapse tomorrow.

The market has traditionally valued agriculture and food-commodity stocks as cyclical, too. That has kept price-earnings multiples down, because no one wanted to pay as much for growth that would end in three or four years as they did for a true growth stock. But if the "food cycle" is now so long that it's hard to see its end, why shouldn't these stocks trade at true growth-stock multiples?

Look at it this way: If farm-equipment maker Deere (DE, news, msgs) really will grow earnings by 15.4% annually over the next five years -- and the food cycle isn't anywhere near a turn for the worse -- then why should this stock trade at 18 times projected 2007 earnings per share when Intel (INTC, news, msgs), with an estimated annual earnings growth rate of 13.4% over the next five years, trades at 23 times projected 2007 earnings per share? Just because Intel is a growth stock and Deere is a cyclical? I don't think so.

Looking at supply and demand

Let me explain why I think it's time to change our thinking about how to invest in this sector.

In the agricultural year that ends with harvest season in 2008, the world will again consume more grain than it harvests. That will be the third year in a row and the seventh year out of the past eight when consumption has outstripped production.

World stocks of all types of grains will finish October 2008 at 319 million metric tons, the U.S. Department of Agriculture projects, down from 389 million metric tons in October 2006 -- a drop of 18% in just three years. And though 319 million metric tons seems like a lot of grain, it's only enough to feed the world for 56 days.

As of Dec. 1, world wheat prices were 50% to 65% higher than they were a year ago, soybean prices 60% to 70% higher, milk prices 100% higher and chicken prices at a 10-year high, according to the U.N. Food and Agricultural Organization. The U.N. agency's food price index, up 9% in 2006, had already climbed 37% in 2007 as of Sept. 30.

Who or what is to blame?

Not the world's farmers, that's for sure. They've done an amazing job at increasing global grain production over the past 10 years. Average global grain production -- actual and projected -- for the 2005-08 harvest seasons will be 2.03 billion metric tons, an increase of 12% versus a similar period 10 years ago. Adding more fertilizer, improving seed and putting new land into cultivation added more than 200 million tons a year to the average grain harvest.

But it hasn't been enough because grain consumption grew even faster.

Global grain consumption is expected to show an increase to an average of 2.06 billion metric tons a year for 2005-08, leading to a supply deficit of 28 million metric tons, or 1.4% of global grain production, despite the production increase.

The world has filled that gap by drawing down on global grain stockpiles. But that can't go on forever.

A growing appetite for protein

Farmers would face a big enough problem meeting demand if all they had to do was keep up with global population growth.

In 1950, the Earth supported just 2.5 billion human beings. By 2010, that number will reach 7 billion. That's an additional 4.5 billion people who need to eat.

But it's not just the increasing number of hungry people that strains global food production. It's what these folks want to eat. As incomes go up in the developing world, people there want more protein: eggs, dairy products and meat. Especially meat. For example, China's relatively wealthier urban population consumes three times more meat per capita than the country's rural population. The country's urban population is growing by about 15 million to 20 million mouths a year.

Continued: Ethanol shares some of the blame

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