I’ve written about oil a few times this year, and the oil and gas producer Chesapeake Energy Corporation (NYSE:CHK) in particular. CHK stock has too many alternatives to be the safe pick it once was.
While I am interested in commodities, renewable energy and electric cars make me somewhat wary about investing in oil and gas. If Tesla Inc (NASDAQ:TSLA) gets it right, demand for oil and gas will decrease, and oil and gas reserves will lose much of their value.
Also, as I mentioned in my first article on Chesapeake Energy, oil and gas could be in for a long bear market, like in the 1980s.
But I see the bullish case for commodities. The ratio of the GSCI Commodity Index to the S&P 500 is now at its lowest level in 45 years. And commodities can be an excellent inflation hedge, protecting you from price increases and a decline in the dollar.
Inflation isn’t a big worry at the moment, but you want to prepare for events before they happen. By the time inflation hits the markets, much of the potential for gains will be gone.
I’ve ended my previous articles on Chesapeake Energy by suggesting alternatives to CHK stock, and in this article I will suggest yet another commodity stock: Fresh Del Monte Produce Inc (NYSE:FDP).
Fresh Del Monte markets a variety of fruits and vegetables, including bananas, melons, pineapples, grapes and apples. And according to its 2016 Annual Report, 45% of the produce Fresh Del Monte sold was produced on company-controlled farms.
Why is FDP a better play on commodities than Chesapeake Energy?
FDP Stock Is Better than CHK Stock in the Long Term
I discussed Chesapeake Energy’s finances in my last article. Although CHK earned $494 million in the most recent quarter, for the trailing twelve months both free cash flow and net income are negative. Also, Chesapeake’s book value is negative.
Chesapeake Energy owes $9.85 billion, more than its revenue for the trailing twelve months ($9.33 billion).
Fracked wells depreciate faster, and Chesapeake must spend a lot on maintenance. That doesn’t bode well for CHK stock.
Del Monte’s finances look much better. Over the past 12 months, FDP generated $236 million in operating cash flow and $85 million in free cash flow.
FDP owes $226.5 million in debt, giving it a low debt-to-equity ratio of 0.12.
Del Monte also spends a lot less on interest payments: $4.9 million for the trailing twelve months, versus $360 million for CHK.
High valuations and geopolitical turmoil mean a greater risk of a correction. More conservative investors should take this time to rotate into defensive, low-beta stocks that will hold up better in a crash.
Fresh Del Monte certainly qualifies as defensive, with a beta of only 0.44. This means that if the market as a whole fell 10%, Del Monte stock would only fall 4.4%.
Of course, this also means that if the market increases by 10%, Del Monte stock would lag, rising only 4.4%.
Chesapeake Energy, on the other hand, has a high beta, 2.05. This means that if the market fell 10%, CHK stock would fall 20.5%.
Fresh Del Monte’s low beta provides downside protection in the event of a correction.
Future Market Outlook
The oil and gas market faces a great deal of uncertainty. What will be our main sources of energy 20 years from now? Fossil fuels, such as oil, gas and coal? Or renewable energy, including solar and wind power?
Energy prices are falling due to low-priced renewable energy and natural gas.
I can’t really predict where our energy in 2037 will come from. I don’t know what will happen to our demand for oil and gas. Renewable energy could replace fossil fuels.
But I can’t think of anything that will replace food. I think people will still need to eat, even in the year 2037.
With population growth, rising incomes and urbanization in the developing world, demand for fresh produce will probably continue to increase. Demand for avocados is growing among China’s health-conscious middle class, and countries like Mexico, Colombia, Australia and New Zealand hope to supply this fast-growing market.
Also, arable land is a scarce commodity, and crop yields are growing too slowly to keep up with population growth. Unless this can be reversed, food prices will have to rise.
Conclusion: CHK Stock isn’t a great pick
Legendary investor Jim Rogers is very bullish on agriculture, going so far as to say that “Farmers will be driving Lamborghinis” because of increases in the price of food.
This might sound far fetched, but that’s often the case with investing. If you had sold your tech holdings in 2000 and bought gold and silver, people would have called you
Fresh Del Monte also trades at low valuations: 14.42 times earnings, 11.24 times forward earnings, 0.56 times sales, and 1.26 times book value. It is only 0.72% above its 52-week low, and yields 1.31%.
FDP low valuation and low beta makes it an excellent defensive stock.
I would pass on CHK stock. If you think commodities are the way to go, I would focus more on agriculture than the energy sector.
Energy prices soared in the 1970s, but so did food prices, to a lesser extent. In fact, according to the Bureau of Labor Statistics, food inflation surged to 20% at the end of 1973. And data from the St. Louis Fed shows that urban food prices increased 114.7% from 1970 to 1980, an annual increase of nearly 8%.
But while energy prices collapsed in the 1980s, prices for fruits and vegetables continued to climb.
The 1980s is remembered as a terrible decade for farmers; Willie Nelson and other singers had to organize benefit concerts to save family farms from bankruptcy. But this hit wheat and corn farmers in the Midwest more heavily than fruit and vegetable farmers in California.
Fruit and vegetable prices continued rising at a steady pace, in contrast to energy prices, which experience booms and busts. Also, fruit and vegetable prices rose faster than energy prices, food prices, and the overall CPI since 1980.
Even after adjusting for inflation, fruit and vegetable prices are up since 1978: fruits by 46% and vegetables by 41%.
These factors make FDP a better inflation hedge than CHK stock.
As of writing, Lucas Hahn did not hold a position in any of the aforementioned securities.