These 2 Stocks Will Likely Benefit from our Nation’s Drought

Have you ever heard of the Palmer Z Index? Me neither.

But it’s something we’ll be hearing a lot about in coming weeks and months. This measure, compiled by the National Climatic Data Center, is a measure of soil moisture. And by the looks of things, dozens of counties in the U.S. have very dry soil. You have to go back to the 1950’s to fund such parched conditions on a national scale. As the nightly news tells us, crops are withering on the vine, which is bad news for both consumers and the folks that make a living on farms.
The expanding drought will likely affect your portfolio in myriad ways. For example:

Packaged foods makers like Kellogg (NYSE: K) and General Mills (NYSE: GIS) are faced with the unpleasant task if raising prices to cash-strapped consumers.
Ethanol producers will likely be hard-pressed to sell into the gasoline market at a competitive price.
Heavy equipment makers like Deere (NYSE: DE) and Caterpillar (NYSE: CAT) will see reduced demand for new equipment as farmers conserve cash.
Cattle producers are culling their herds as they run out of feed, setting the stage for a near-term glut that will (temporarily) reduce beef prices.

Yet not all companies are suffering. I’ve come across a pair of companies that actually stand to benefit from the drought. Each firm focuses on a different commodity, and each is on the right side of the pricing trends. Here’s a closer look:

1. Bunge (NYSE: BG)
This company, which was founded 194 years ago, has its hands in many areas of agriculture from commodities storage and trading to sugar-based ethanol processing to the production of cooking oils. Notably, 80% of its raw commodity exposure is outside the United States. In places like Brazil, growing conditions are better so crop price action has been fairly benign. This gives Bunge a crucial edge when competing against U.S.-leveraged producers.

As an example, Bunge is the leading processor of soybeans in South America. Analysts speak of “crush margins,” which notes the profit spread for finished soy products compared to input prices. For Bunge, those margins are good, and likely to get even better.

Bunge is expected to deliver second-quarter results on Thursday, July 24. Analysts had been throttling back their profit forecast for the quarter, from $1.43 a share in April to $1.34 in June. But few of those forecasts appear to reflect the impact of better “crush margins” that appeared starting in early June. Analysts at Citigroup have taken a fresh look at Bunge’s likely second-quarter profits, and see earnings per share (EPS) in the $1.55 to $1.60 range. These analysts also think Bunge will top current third-quarter EPS forecasts of $2.19 by roughly 10%, based on current trends.

Taking a longer view. Citi says Bunge’s profits will keep expanding on the heels of strong demand and solid margins, expecting EPS to hit $8.40 by 2014 (which is roughly 5% above the consensus).

The analysts see Bunge’s shares rising to $95 from a recent $63 in July — a 50% increase — based on a 12 times multiple of those 2014 profit forecasts. This logic may be too specific for most investors. Instead, many are likely to simply take note that the company is in the midst of a solid multi-year run of profit growth, and shares, at roughly 80% of book value, will likely change from a deep-value play into an earnings momentum play.

#-ad_banner-#2. Ingredion (NYSE: INGR)
At first blush, this producer of corn sweeteners should be suffering as much as its peers. After all, corn prices — the company’s biggest expense — are rising quickly. Yet Ingredion (formerly known as Corn Products International) was wise enough to lock in all of its 2012 corn needs at 2011 prices. Considering that rivals will likely be compelled to raise prices, Ingredion has room to maintain prices (boosting demand) or raise prices (boosting margins). It’s a nice problem to have.

But those gains are more likely to be seen in 2013, when Ingredion’s input prices remain hedged but selling prices are no longer hedged (at least as of today).
Yet as is the case with many stocks, Ingredion has been on a downward slide since the end of the first quarter, falling to a recent $47 from $58. That comes at a time when earnings forecasts have remained steady, thanks to those locked-in input prices.

Analysts at D.A. Davidson say Ingredion is poised for sustained profit growth thanks to those industry pricing dynamics. They see EPS rising from around $4.70 in 2011 to $5.25 this year and $5.80 in 2013. They say shares have 50% upside to their $70 price target. Ingredion will deliver second-quarter results on July 31, at which time management is likely to focus on the coming gains that accrue from fixed corn input costs.

Risks to Consider: Though these farm stocks stand to fare better than their peers, it may take several quarters for investors to fully trust that the profit gains are sustainable.

Action to Take –>
Both of these stocks offer a nice combination of value and growth. Each trades for less than 10 times projected profits, yet each appears poised for solid profit growth.