Money Grows Out of the Ground

DECATUR, Ill. ( TheStreet) -- Agriculture and fair competition have had a strained relationship.

Price-fixing scandals, such as the lysine conspiracy, have marred the industry. (Lysine is a vital component of livestock feed and the subject of the new movie "The Informant.")

Regardless, the industry is growing in appeal as the world's population expands, straining food production. More food is needed from less space as cities grow, claiming more farm land. Companies such as Archer Daniels Midland ( ADM) is a big source of food, and its shares will benefit as a result. Archer Daniels has risen 37% over the past year, compared with a decline for the benchmark S&P 500 Index. Archer Daniels' growth potential is all but guaranteed.

Still, not all food producers have risen quite like Archer Daniels. Bunge ( BG) and Corn Products International ( CPO) declined during the past year, while The Andersons ( ANDE) is little changed. Some of the biggest players in the industry, such as Cargill, are closely held.

Global population growth stands at 1.1% a year, which doesn't sound like much, but in reality means there will be 77 million more people every year, taxing an already stretched food supply and leaving a huge hole to fill by food producers. Food isn't a complex industry to understand: Everyone needs it, and it's all basically the same.

That last point gives the industry most of its character. Commodities, be they corn, grain or lysine, require hedging, which is a huge task. Archer Daniels, for example, has nearly $2 billion in derivative contracts to help guard against a decrease in price or other events that could affect profits, such as foreign-exchange risk.

Commodities lead naturally to price fixing. Fixing prices at the manufacturing level is almost impossible. Retail is the most likely venue, but it's also the easiest to catch. With agricultural products, which are sold by the ton all over the world, the red flags are more difficult to identify than, say, gas prices at filling stations in any given town.

Dealing with a commodity also makes product differentiation a moot point. Investors should focus mainly on companies' operating efficiencies and price-to-sales ratios, in addition to the sensible use of debt. While sales for a particular company may be growing faster than its competitors, the reason for this increase could stem from a higher debt load, levering the company to a larger production level -- one that may not be sustainable.

Agricultural production will be a hot topic in the coming years as emerging markets continue to grow and the earth's population nears the 7 billion mark. Companies such as Archer Daniels will be feeding the world.

-- Reported by David MacDougall in Boston.

Prior to joining TheStreet.com Ratings, David MacDougall was an analyst at Cambridge Associates, an investment consulting firm, where he worked with private equity and venture capital funds. He graduated cum laude from Northeastern University with a bachelor's degree in finance and is a Level III CFA candidate.

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