News Analysis date published New: 
Friday, June 29, 2012 - 14:30
New Date created: 
Friday, June 29, 2012 - 14:33
New Date last updated: 
Friday, June 29, 2012 - 14:30

2 Stocks for the "Hidden" Bull Market in Commodities Right Now

Friday, June 29, 2012 2:30 PM

While the stock market has been down a little in the past week, there is one market that has been on fire. Ever since temperatures across the country reached triple digits, traders have been buying contracts for corn futures and have seen prices rise more than 20%.

Problem is, the easy money is already behind us in corn futures and any revision in weather forecasts could send prices down. So why do I bring it up?

It's because sometimes the market for foreign exchange and commodities can give us a preview of things to come in the stock market. When foreign currencies drop relative to the dollar, for example, companies with large overseas operations will see losses when they translate earnings back to dollars. When commodity prices jump, companies tied to the market by commodity costs will feel the pain later on in the quarter.

On the other hand, there's a company that's perfectly positioned to profit from rising corn prices. But before I tell you about this stock, it's important to understand what's causing this price surge...

Worst conditions in more than two decades
The impetus behind the surge in corn prices and your clue to the next move in the stock market is the record-breaking heat and drought conditions across much of the nation. The University of Nebraska reports that 71% of the Midwest had conditions ranging form abnormally dry soil to extreme drought as of June 19. Crop conditions at that time were the worst since 1988, and the National Weather Service has said that dry conditions and above-normal temperatures will continue through July.

Further, global demand for corn and other grains has increased for 16 consecutive years, and world inventories at end of last year were lowest since 1974. Combine the possible plummet in supply with increasing demand and you get prices through the roof.

The heat and falling supply is good news for fertilizer companies. Historic food demand has already pushed revenues up. Now, farmers will need to increase the use of fertilizers to combat falling yields due to poor weather conditions.

Potash (NYSE: POT) is the world's largest diversified fertilizer company by capacity, with sales increasing 31% to $8.72 billion in 2011. A warm spring led to record corn and soybean acreage planted, pushing up demand for fertilizers. The staggering heat, especially now during the important pollination period, will further increase fertilizer demand if farmers want to maintain crop yields.

The company missed earnings expectations for the last three quarters, meaning a strong second-quarter report or forecast on July 26 could surprise the market and send the shares up sharply. Analysts are only expecting this year's earnings to increase by 13.6% to $3.45 per share, but even at 13 times trailing earnings, the shares are a good value compared to the industry average of 15.

The record heat and drought could also mean record revenue for irrigation equipment manufacturers like the Lindsay Corp. (NYSE: LNN). Sales in the irrigation division, accounting for 87% of business, increased by 18% in the last quarter to $149.6 million, and earnings per share jumped 22.5% over the same quarter last year to $1.47.

The Department of Natural Resources in Indiana is reporting the largest jump in new irrigation wells since the 1990s, and well-digging companies across the plains are booked solid. Where there are new irrigation wells, irrigation equipment will soon be needed.

Currently, only about 6% of the country's four major crops (corn, soybeans, cotton and wheat) are grown under irrigation equipment, leaving a great deal of room for growth. With tax incentives for equipment and the value of irrigated land outpacing non-irrigated land by more than 7% last year, the equipment manufacturers could see sales jump going forward.

Risks to Consider: Making weather-related bets can unwind quickly if forecasts change. Fortunately, the two companies I've mentioned also have strong long-term demand factors to support shares.

Action to Take --> Potash and Lindsay Corp. have beaten the broader market lately but have yet to recover year-to-date highs. While I am betting on short-term conditions to boost the stocks, there are also long term demand characteristics that make them good bets over the next few years.

Lindsay beat earnings by more than 7% last week, leading to a jump of about 16% in the stock price within a couple days. Obviously, we're not the only ones in on this trade, but shares are still more than 10% off of 52-week highs.

Potash is also up about 16% since the beginning of June, but still well off last year's highs. Valuations start getting a little high around $55 to $60 per share, about 30% above the current price, so you may want to take profits at those levels.

Joseph Hogue does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.