VEGI - VEGI: Agriculture Producers Capturing Several Macro Tailwinds

2023-07-20 17:55:13 ET

Summary

• VEGI tracks a basket of agriculture industry stocks.
• A rebound in commodity prices has helped the fund rally from a 52-week low.
• We are bullish on the fund and expect improving global growth conditions to send shares higher going forward.

The iShares MSCI Agriculture Producers ETF (VEGI) invests in global companies that produce fertilizer and agricultural chemicals, farm equipment, along with related packaged food manufacturers. Indeed, this unique approach to the broader agriculture industry highlights the attraction of the fund that goes beyond simply tracking trends in commodity prices.

We like VEGI as a good option for investors to gain exposure to the high-level themes in agriculture amid what we see as a positive long-term outlook for the underlying stocks. Following a period of extreme volatility over the past year, several emerging macro trends are driving a new wave of momentum into the fund. We are bullish on VEGI and see more upside going forward.

What is the VEGI ETF?

VEGI technically tracks the "MSCI ACWI Select Agriculture Producers Investable Market Index" through a passively managed approach.

According to the index and fund methodology , investable companies across both developed and emerging markets are eligible for inclusion through a semi-annual review process classified within the Agricultural & Farm Machinery industry, Fertilizers & Agricultural Chemicals names, along with direct producers of agricultural products are included.

Furthermore, companies in the Packaged Foods & Meats industry are considered only if the majority of their revenues are derived from the production of those related commodities. This means that the food companies within the consumer staples sector need to have a vertically integrated supply chain compared to just packaging the end product.

From there, the fund features a free float-adjusted market capitalization weighting subject to a semi-annual review process.

The result is an extensive portfolio of 159 stocks that are broken down by sector approximately one-third in Consumer Defensives, one-third classified as Industrials, and the final third as Basic Materials.

Looking through the top holdings, Deere & Co ( DE ) represents the largest position of the fund at 22% of holdings, followed by agricultural trader Archer-Daniels-Midland Co ( ADM ) at 8% of the fund, and fertilizer giant Corteva Inc ( CTVA ) with a 7% weighting.

VEGI is Overweight Deere & Co

It's important to note that VEGI is "top-heavy" with the largest position in Deere & Co representing nearly a quarter of the fund's allocation.

While this level of weighting can often be seen as defeating the purpose of an exchange-traded fund for investors focusing on diversification, we believe the strategy here works given Deere's importance to agriculture globally.

Indeed, as the world's largest supplier of farming equipment, it's understood that the company's operating and financial trends should capture the major market trends in the segment. Simply put, higher commodity prices for gains and livestock incentivize customer demand for new capital investments to expand output benefiting Deere & Co.

We view DE as an agriculture producer bellwether that adds a layer of quality to the VEGI fund through strong fundamentals and a positive long-term outlook. At the same time, VEGI shareholders still access plenty of exposure to the broader segment considering the entire portfolio, including other large-cap market leaders and emerging high-growth small-caps.

VEGI Performance

With a fund inception date back in 2012, VEGI has returned more than 100% over the period including the impact of a regular semi-annual dividend that has been in place for the past 10 years. On this point, VEGI currently yields 2% with the payout variable depending on the underlying income of the portfolio holdings.

The bulk of the gains over the last decade have occurred more recently, going back to the skewed pandemic dynamics that added a wave of inflationary price pressures amid global supply chain disruptions toward agriculture. For its part, Deere & Co has been a big winner with shares capturing a wave of earnings strength with the company consolidating its market lead while also creating value by launching new services and high-tech features.

In hindsight, investing directly in DE would have been the optimal allocation in recent years, but the uncertainty of forward trends with the added diversification of VEGI adds to its allure.

Notably, the fund has managed to outperform what we would consider benchmarks including the Invesco DB Agriculture ETF ( DBA ), which tracks a basket of agricultural commodities over the last five years, highlighting the appeal of an equities strategy.

VEGI also squeezed out a few points above high-profile funds like the Materials Select Sector SPDR ETF ( XLB ) and the Industrial Select Sector SPDR ETF ( XLI ) which tracks the sector representatives within the S&P 500 Index ( SP500 ) over the same period.

The takeaway here is that the fund has performed as intended and paves a roadmap for continued gains over the next decade.

What's Next for VEGI?

When looking at commodities and agriculture, the white elephant in the room remains the situation in Eastern Europe with the Russia-Ukraine conflict still volatile. The initial uncertainty from the initial invasion last year helped push commodity prices to record highs, which have since been pressured by various factors between global growth concerns, higher interest rates, and easing supply shortages.

At the same time, recent headlines suggesting Russia has backed out of its Black Sea grain deal that allowed for the safe passage of transportation vessels has already led to a spike in the price of wheat, lifting VEGI over 6% in the past month.

There are other factors at play here. First, a major market theme has been the resiliency of both the U.S. and the global economy. Stronger demand and improved trade conditions, compared to the weaker outlook in 2022 can support higher agricultural prices.

We're also looking at the ongoing weakness in the U.S. Dollar, driven by an expectation that declining inflation opens the door for the Fed to end its rate-hiking trajectory. Our take is that conditions are ripe for stronger macro growth going forward. This backdrop should be positive for the operating and earnings environment of underlying VEGI portfolio companies as a catalyst to push shares higher.

Final Thoughts

Overall, VEGI is a solid ETF that can work in the context of a more diversified portfolio for tactical or strategic exposure to agriculture equities.

From the price chart, we see shares have broken above a long-running downtrend and are now more than 15% from their cycle lows. We see room for this momentum to continue through the end of the year.

In terms of risks, a scenario where global macro conditions deteriorate would undermine any forecast on the demand side for commodities and likely drive a new round of volatility. Given the weighting of Deere & Co within the portfolio, the company's quarterly earnings and management guidance are key monitoring points. Weaker-than-expected financial trends could pressure the fund and open the door for more downside.

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