Investors did a double-take last week after news broke that Dow Chemical (DOW) and DuPont (DD) had agreed to merge into a $130 billion mega-company in one of the biggest deals of the year.
Once the dust settles 18 to 24 months down the line, the plan is to split again into three separate, publicly traded companies — one of which should trump Monsanto (MON) to become the world’s leading pure-play provider of genetically modified seeds and crop protection products.
Since the announcement, share prices for both companies have dipped considerably — but frankly, I’m more concerned about the current state of the agriculture market, which has been limping along for a while now.
The Science of DOW and DD Stock
Agricultural sciences make up roughly 15% of DOW and 25% of DD by revenue, so this is a big slice of the business. In theory, it’s also the sexy side because of the oft-mentioned “feed the world” narrative: a rising global population plus limited viable acreage should lead to demand for more efficient agriculture, not to mention all the ancillary products you need to keep livestock healthy.
Within that context, agriculture stocks should have enough tailwind to rise slowly and steadily. But we’re not seeing that scenario play out, at least not yet.
Just look at the collapsing crop prices: corn peaked at around $5 a bushel last summer, but has since plunged over 28% from its highs. It’s the same story for wheat and soy beans, down 34% and 40% respectively from last year. If farmers aren’t making any money, they certainly won’t shell out for new equipment, fertilizer or more expensive seeds.
That’s why I’m not surprised ag stocks have been crushed across the board, with heavy-hitters like Mosaic (MOS) and Potash (POT) down 34% and 48% year-to-date.
China and India, both densely populated, are where the rising demand for food is concentrated, but that’s also where agriculture was extremely inefficient. Simply applying factory farming techniques on the land has kept supply moving more or less in line with demand, which means there isn’t any incentive to pull crop prices up from their lows.
Agricultural business stocks have felt the pressure of a strong dollar as well — U.S. grain is quoted in dollars, so it becomes cheaper in local currency for importers around the world. Oil is also quoted in dollars, so it’s now much cheaper in local currency terms, which makes it cheaper to farm (tractors burn diesel) and fertilize (90% of nitrogen fertilizer input cost is natural gas).
In other words, it’s cheaper to both import your meal and to grow it, which combined eliminates any pricing power global agricultural commodities may have had due to rising demand.
On top of that, we’ve seen record harvests and a decline in the conversion of food into biofuel (i.e. corn into ethanol) because of the oil glut. It’s a utopian scenario if you want to keep the world fed, but not so great if you want to make money on a spike in demand for food and the tools required to grow it.
It will take a serious shock — a plunge in the U.S. dollar’s value or a massive oil price surge — to force the kind of food insecurity we saw in 2007 and 2008. No food riots in Cairo or Bangladesh means the time to make big money in agriculture is not yet upon us.
So that’s the agricultural landscape.
Bottom Line for DOW and DD Stock
As far as Dow and DuPont are concerned, theoretical cost savings in the combination are decent. After the companies split again, though, the synergies get a lot harder to add up.
Carving out the agricultural science side creates a more specialized entity with larger share in specific markets, which is good, but also makes that entity more vulnerable to the ebb and flow of that market.
Right now that market is on the ebb, so the timing isn’t great.
Hilary Kramer is the editor of GameChangers, Breakout Stocks Under $10, High Octane Trader, Absolute Capital Return and Value Authority. She is an accomplished investment specialist and market strategist with more than 25 years of experience in portfolio management, equity research, trading, and risk management. She has extensive expertise in global financial management, asset allocation, investment banking and private equity ventures, and is regularly sought after to provide her analysis on Bloomberg, CNBC, Fox Business Network and other media.
