Darling International (NYSE: DAR): The Easiest Way to Play the Worst Drought in 50 years

by Jason Jenkins

Is this drought of Biblical proportions?

Well, I doubt they’ll still be talking about this for the next two millennia – but it may get some discussion for a few decades.

Drought is referred to as the "creeping disaster." It doesn’t hit you hard and in the face like a tornado or hurricane. It wears you down, slowly but surely, over time. However, what we’re experiencing now is more hare-like than tortoise-esque…

From mid-June to mid-July, the amount of farmland lost to drought has been astounding. Over this period, the percentage of land under the category of severe drought increased from 17% to 39%. The reason? We’ve hit a perfect storm of nasty crop weather. There’s been little rain, and 2012 is scheduled to go on as the hottest year ever recorded.

Reports from the U.S. government state that this is the largest drought since 1956. More than half the country is experiencing somewhere between moderate to extreme drought. Before long we should all expect to see this drought hit the economy, raising the prices of everything from food to gas.

Since many investors aren’t comfortable with trading commodities or futures contracts, I’ve identified a great stock play on this below. But first, let me discuss how this drought is affecting commodity prices.

How Has This Hit Commodity Prices?

Expect commodities to enter a bull market, with grain futures leading the way. The Standard & Poor’s GSCI gauge of 24 raw materials was up last week about 1.2% to 677.29 – that’s the highest since the spring. It’s skyrocketed 21% from this year’s lowest close back on June 21.

In August alone soybeans reached a new all-time high of $17.1275 a bushel, while corn set a record at $8.49 a bushel. In June, the Department of Agriculture decreased its corn harvest forecast by 27%. It also went on to say that it estimates almost 40% of the U.S. corn crop is in bad shape.

Sudakshina Unnikrishnan, a London-based analyst at Barclays Plc stated, “The grains have been the strongest performing subsector in commodities the past few months, and that has purely been driven by supply-side considerations and the U.S. drought in particular.”

Goldman Sachs Thinks Rally Will Continue

In the middle of June, Goldman Sachs Group Inc. moved to a “near-term overweight” recommendation in commodities. Earlier this month they held steadfast on forecasts for a rally where corn would reach $9 a bushel, soybeans could reach $20 a bushel and wheat could see $9.80 a bushel by November.

Goldman analyst Damien Courvalin wrote, “We expect soybean prices to outperform to ration resilient export demand in the face of critically low U.S. supplies, corn prices to rally to secure sufficient ethanol demand destruction and wheat prices to underperform corn prices on relatively higher supplies.”

According to the USDA, U.S. corn production may drop to 10.78 billion bushels, a six-year low, while the soybean harvest at 2.69 billion bushels would be the smallest since 2007. Crops are in the worst condition since 1988, a year when the corn harvest tumbled by 31% because of drought.

An Easy Way to Play It…

A lot of times when people talk about the commodities market, they talk about how they’re going to play commodity futures. All you may know about the commodities markets is what you remember from the movie Trading Places, where Dan Aykroyd and Eddie Murphy put the Dukes out of business by means of a false orange juice “crop report.”

Almost 30 years later, most people who’ve seen the movie still don’t know how they got rich and were able to hang out on the tropical island with a young Jamie Lee Curtis. So I’m going to give you a less complicated play on the matter…

The one company you want to take a long hard look at is Darling International (NYSE: DAR). This 130-year-old company is in the rendering business.

Never heard of the rendering business? A lot of people haven’t. Rendering means you render down animals into oils and proteins used by agricultural, leather and chemical firms. It also recycles cooking oils and baking waste used by commercial businesses into high-energy animal feed parts and commercial oils. It’s the largest and the only publicly traded rendering company. It’s up around 25% year-to-date.

Darling has put itself in this position through the rollercoaster ride known as animal feed prices. The agricultural world uses its tallow, yellow grease, and meat and bone meal products as alternatives to corn and soybeans. So now you get it...

They stand to make a killing with the prices of corn and soybean going crazy the next few months.

Diversifying Outside of Animal Feed

The company has also found itself in a strong position in the bio-fuel industry as an alternative to vegetable oils.

Darling, when it first entered the fray in the biodiesel business, had to deal with a two-edged sword. On the technology side, they faced a temperature problem. In the beginning, biodiesel made from animal fat worked as long as the temperature was above 50 degrees. Anything colder produced a block of rendered animal “stuff.”

The problem was solved by UOP - a division of Honeywell International Inc. (NYSE: HON) - which gave Darling a hydro-treating process to correct the problem.

As far as marketing and distribution were concerned, the problem was getting a foot in the door of an industry controlled by heavyweights. But to their good fortune, three years ago Valero contacted Darling and said it was interested in working with them to expand its alternative energy portfolio. The move into fuels doesn’t just expand their business opportunities – it also presents a hedge against its feed business.

When I first looked at the company, I saw it as a good play against this “blitzkrieg” drought we’ve faced this summer. However, now that I’ve done more research, it’s probably a solid long-term play.

Good Investing,

Jason

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