Syngenta goes with the grain

Shares in the Swiss-headquartered group have risen 9 per cent since our 'buy' call of March 2011 - a decent enough return in today's equity markets. Now the rationale for buying the stock is more compelling.

High crop prices continue to drive demand for Syngenta's seed-care products. The latest update from the US Department of Agriculture confirms that unremitting drought, which is hitting large parts of the US grain belt, would reduce this year's corn harvest by 13 per cent compared with 2011, which was hardly a bumper year itself.

Corn prices have risen by 58 per cent since June, with December corn futures trading at an all-time high on the Chicago Board of Trade. A major shortfall in global soyabean production is also anticipated. These two crops are readily substitutable, so the food-processing industry can usually keep a lid on prices when one crop fails. When both crops are poor, it's another matter. Nor does it help that wheat prices are on the rise; a situation exacerbated by fears that once more Russia will ban grain exports.

Rising prices provide a strong incentive for farmers to sow additional acreage for the following harvest. For Syngenta, a global leader in crop protection and the world's third-largest seeds supplier, the desire of farmers to cash-in on high prices usually translates into bumper sales and cash flow.

Historically low levels of grain stocks will also encourage more plantings. That said, US farmers face the worst growing conditions in a generation. Drought has taken hold in two-thirds of farming districts and over half the rural counties in the US have been declared disaster zones. For the time being, it looks as if the steep rise in prices will more than offset the expected fall in yields. But it's possible that the current situation could deteriorate to the point where so many farmers are driven out of business that demand for Syngenta's seeds and crop enhancers dip alarmingly for a while.

Nevertheless, farming's vulnerability to increasingly erratic weather provides longer-term opportunities for Syngenta. Its research teams are developing plants that are more water-efficient, but produce higher yields.

Meanwhile, there is evidence to suggest that Syngenta is already starting to benefit from rising agricultural prices. Last month, the group delivered first-half sales that were in advance of analysts' estimates, driven primarily by double-digit percentage growth in North America. Net profits at $1.5bn (£955m) also came in ahead of expectations, despite some pressure on profits margins through rising raw-material costs and currency effects. The reported margin on cash profits was 27 per cent after a currency hit of $202m. Combine these factors with one-off capital spending and litigation costs, and first-half profit was held in check to the tune of $582m, according to broker Liberum Capital.

However, the good news is that these pressures should not be repeated in the second half. In July, Syngenta's chief executive, Mike Mack, was bullish as the immediate focus of business switched to Latin America, where record soyabean prices are likely to fuel demand. "Currency headwinds are likely to diminish," he added, "and we will realise further cost savings." These factors prompted Liberum to raise its earnings forecasts for 2012 and 2013 by 10 per cent and 6 per cent respectively (see table).