10.11.10 Ten Reasons to Buy Art

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Harvest Shocker: Ten Reasons to Buy Art's Way Manufacturing (ARTW)

October 11, 2010

Recent agricultural reports from the U.S.D.A. have been very positive for investors ? and we think represent a great long term investment theme. The Wall Street Journal called a recent U.S.D.A. report a "Harvest Shocker" and the Financial Times noted the "dramatic supply squeeze" may "bring a repeat of the global food crisis".

Compared to other sectors relatively few publicly traded agricultural oriented firms exist ? in our opinion a positive for those who find the long term trends attractive. Art's Way Manufacturing (ARTW) was our Dick Davis Digest `Best Investment Idea for 2010', and we have ten reasons to buy agricultural equipment manufacturer:

1. Creighton University prepares a monthly economic survey that includes data on trends in farm equipment sales and farmland prices. Both remain in expansion mode, with the September farm equipment sales index rising to 56.2, up from 52.7 the month before. Sales are expanding when the index is above 50. According to the report "the outlook for the farm sector has improved significantly, farmers have likewise expanded their purchases of capital equipment. I see this very positive trend continuing for the rest of 2010" said Dr. Goss, economist at Creighton and chief author of the survey

Art's Way is highly dependent on agricultural equipment sales levels, so we would expect the stock price to track the Creighton farm equipment index. We calculated the correlation coefficient, a measure of the strength of the linear relationship of two variables, between the Art's Way share price and the farm equipment sales index. The correlation coefficient can vary from 1.0 (perfect linear relationship) to ?1.0 (perfect inverse relationship). For Art's Way the 12 month correlation coefficient was 0.72. The data indicates that the share price of Art's Way closely follows the farm equipment sales index ? and the index is trending upward in a "very positive" manner.

2. In a report issued late last week the U.S.D.A. cut its estimate of the corn crop to 12.7 billion bushels this season, down 4 per cent from its September forecast. It was also 3 per cent lower than last year's record production of 13.1 billion bushels.

Most shocking the U.S.D.A. projected average yields per acre would decline to 155.8 bushels, down from the month earlier U.S.D.A. forecast of 162.5 bushels. It is very out of character for the U.S.D.A. to lower estimates that much in back-to-back reports. The decline was mainly due to weather related issues. Grain prices jumped upward, as did fertilizer and agricultural related stocks.

The report also noted grain demand was higher than expected and increasing due to exports and biofuels use, and the grains stocks to use ratio fell, two more bullish trends. Barge transport facilities are at system limits handling the massive amount of grain being shipped for export. These trends indicate that grain prices should remain elevated compared to year ago levels ? and may actually trend upward so as to ration supply.

This forecast confirms earlier assessments that farm incomes across the U.S. and Canada will jump substantially this year. Last month the U.S.D.A. revised their farm income estimates for 2010. Net U.S. farm income will increase to $771 billion in 2010, up 24% from 2009 and $12.3 billion above the 10 year average. Cash receipts are expected to increase 6.5%, due mainly to higher livestock receipts. Equipment sales correlate closely with farm income gains, a very positive trend.

3. Gradient Opinion upgraded Art's Way Manufacturing to a 'buy' as of July 16, 2010 - only 24% of the companies they follow are rated buys, 76% of their database are rated a 'hold' or 'sell'. The Company Research Report notes the Gradient Opinion report is 'very accurate' ? again very positive. No other analysts cover the firm so it tends to be overlooked. The sector has not been popular with investors until recently, so it is easy for the market to mis-value the company.

4. Louis Navellier's system grades Art's Way a "B" - buy. His system is a mix of fundamental and technical indicators based on historical data and correlations. This is the first time in several years that ARTW has been rated a buy in his system - it had been rated C (hold) to F (sell) after the market crash. Very positive.

5. Barchart, a technical analysis service that we utilize, has Art's Way as a "strong buy" - the first time we have seen ARTW as a strong buy in at least a year. The service has Art's Way as a short, medium, and long term buy ? with all the indicators in each period bullish. StoXline also has Art's Way rated as a buy on a technical basis:

Our rating system posted a BUY today, same as yesterday. The market seems to continue bullish move. If you bought, continue to hold stock until SELL signal. You are relatively safe to buy now, upward move is expected. [Oct. 9 report]

Very positive.

6. Barchart also rates the relative attractiveness of different sectors by measuring a statistic they refer to as `alpha' (excess returns). The Machinery - Farm sector is rated by Barchart at # 4 of around 250 sectors they track, which means the sector is attractive and outperforming. A rising tide floats all boats, at worst Art's Way should track the movement of the Machinery - Farm sector. Very positive.

7. A report recently issued by SmarTrend indicates that Art's Way has one of the lowest price to cash flows in the industry. They claim that companies with the lowest price to cash flow values "present the greatest value" to investors. Very positive.

8. Standard & Poor's Quantitative Stock Report notes that "Since August, 2010, the technical indicators for ARTW have been BULLISH". They also note that relative strength is `strong'. Historically market studies indicate relative strength has a positive correlation with future stock performance. Very positive.

9. Some analysts are starting to recognize the impressive potential of the agricultural sector and the company. An article on the agricultural equipment sector published last week by Aaron Levitt, an investment analyst, mentions Art's Way as a `possible acquisition target':

The world is facing a global food crunch. Recently, the United Nations' Food and Agriculture Organization held an emergency meeting to discuss the possibility of a near-term global food crisis. Rising bread prices have led to riots in Mozambique. Poor weather in Russia has lead to a wheat shortage.

The planet's population is expected to grow from 6.8 billion to 9.1 billion by 2050 and the U.N. estimates that, in order to keep up with this exponential demand, the world's food producers will have to increase food output by nearly 70%. This estimate doesn't even factor

in that a growing worldwide middle class is expected to create an increased demand for more varieties of food. Long term, feeding the growing world population represents a great investment theme. . . . .

Finally small cap, Art's-Way Manufacturing (Nasdaq:ARTW) produces equipment for the raising of livestock, including grain elevators, hay and forage gear, as well as mixers and mills. The company has market cap of less than $25 million, making it a possible acquisition target down the road.

Don Coxe, market strategist and manager of the Coxe Commodities Strategy Fund, noted in a recent conference call that "agriculture in the U.S. is in dramatically better shape than a few months ago." The recent weather driven developments he notes are "wonderful news" for investors in the agricultural sector, especially for companies in the agricultural equipment manufacturing and sales sector.

Note that Coxe generally invests in larger capitalization firms in the sector. Due to the amount of money he manages it is impossible for him to take a meaningful position in a small profitable company like Art's Way without essentially buying the firm, a common problem for institutional managers ? but a situation that creates investment opportunities.

Weather may continue to be the subject of bad news into the fall according to Coxe, which should help focus investor interest on companies in the agricultural area. Unlike other stock sectors he notes agricultural stocks tend to correlate with trends in global weather events and patterns, so even a bad economy stocks in this sector should outperform. In his latest report he states:

Within equity portfolios overweight commodity stocks. As a group, they have significantly less endogenous risks than the broad stock market . . .

The prices of corn, soybeans and wheat are the most important indicators of agricultural stock performance, and they are continuing strong in response to weather problems in Europe and Western Asia. . .

The severe Russian drought, floods in Pakistan, erratic weather in Columbia, and weather related cuts in sugar output from Brazil are all weather events pushing agricultural prices to multi-year highs. Wheat, corn, coffee, sugar, and cotton, to name a few, are all crops with robust weather driven upward price trends.

Agricultural export bans are increasing as governments increasingly are trying to control food costs ? and prevent food riots where shortages erupt. The Wall Street Journal had an article last month noting how sensitive grain prices were to any future weather related issues--and how governments might `panic' in such an event leading to a `very large' increase in prices:

Investors focused on global food supplies have been watching the U.S. Department of Agriculture's latest estimates on wheat and corn production. While the department said Friday that wheat supplies remained robust, it cut its forecast for corn, sending prices to their highest level since Oct. 1, 2008.

With Russia playing an increasing role in the international food chain, the health of the new winter wheat crop is being watched by traders, food companies and aid agencies around the globe, amid fears that the world could face a possible food shortage next year. "We have to watch their planting season very, very carefully here," said Mayo Schmidt, chief executive officer of Viterra Inc., a Canadian agricultural conglomerate. "Not only do they have to have moisture, but it has to be timely."

A drought decimated the nation's spring wheat crop, prompting the government to halt grain exports. Farmers now are trying to plant their winter crop, which typically is bigger than the spring yield, but with dry soil and little rain on the horizon, it is looking likely that this next season also may be sparse.

It isn't just Russia. In Australia, locusts threaten to curtail the wheat yield, and Argentina could fall into the grip of the La Ni?a dry-weather pattern. Friday, the U.S. government pared its corn forecast, but still expects a record harvest.

"We have set up the conditions where governments might begin to panic" if there's another shock to global food supplies beyond Russia's borders, said Scott Irwin, an agricultural economist at the University of Illinois at Urbana-Champaign. Prices for some crops, which already have risen sharply this year, could also see jumps in the face of further supply cuts.

"A small reduction in production prospects and stocks can lead to a very large price increase," Mr. Irwin said.

And last month Barron's discussed a new report issued by Nomura Securities that forecasts a multiyear increase in global food prices.

"There's going to be a multiyear increase in food prices that's highly likely to go beyond the peak prices of 2008," according to Nomura's chief Asia economist, Rob Subbaraman, the lead author of the report.

Note the long term upward trending chart of food prices at right (from the report).

Bloomberg summarized that "investors should buy producers of seed and fertilizer, farm machinery and companies involved in the shipping and storage of soft commodities as food prices go on a `multi-year' rally, according to Nomura Holdings Inc."

Matt Theal, an Editor at Minyanville Media, wrote an interesting article last month entitled "Investing in the Coming Boom in Farming" ? and he noted Art's Way was a `farming equipment play":

The new trend emerging among investment professionals is investing in farmland. Last week former hedge fund manager Michael Burry told Bloomberg he was investing in farmable land. To quote, ""I believe that agriculture land -- productive agricultural land with water on site -- will be very valuable in the future."

Well over a year ago, Jim Rodgers told Bloomberg that farming will be one of the greatest industries of the next 20 years. He sees farmers driving Lamborghini, not brokers on Wall Street. . .

For those looking for farming equipment plays consider Deere, AGCO, and small-cap Art's-Way Manufacturing (ARTW).

All very positive.

10. Last, we were asked a few months ago by the Dick Davis Digest to update our "Best Investment Idea" for 2010 ? or pick a new one. In the July 21, 2010 edition we summarized why we continue to like Art's Way:

Charles Munger, Co-Chairman of Berkshire Hathaway and long time investment partner of Warren Buffett, was asked the secrets of their investment success. He noted good investments do not grow on trees. They are rare. Lots of due diligence needs to be done. Many investment ideas turn out to have many serious problems that are not initially apparent. Most worthy ideas tend to be centered on small, illiquid, and underfollowed companies and markets. He claims a good business environment is as important as management in generating healthy returns. Growth potential, and a good market niche, is critical. After reviewing the thousands of investment ideas floating around, when an idea has merit and the risk/reward relationship is tilted heavily in your favor, Munger claims the secret is to invest heavily.

Wall Street Journal, October 9, 2010, Page B1: Financial Times, October 9, 2010, Front Page:

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