Returns from large-scale agribusinesses like Bunge (US:BG) and Archer-Daniels-Midland Co (US:ADM) have easily outstripped inflation over the past six months – at least the official rate. The group’s share prices have more than doubled over the past three years, as global export demand for foodstuffs increased significantly in response to lockdown disruptions. Their growth rates are extraordinary given the scale of their operations and their entrenched market positions – they are not growth stocks by any measure, but you could be forgiven for thinking otherwise.
Investments in any primary industry carry an inherent degree of risk linked to the price of the underlying commodity, although circumstances dictate that the global agriculture bull market has some way to run.
It’s well appreciated that the war in Ukraine is leading to severe shortages and rising prices for grains and fertilisers. We are experiencing decades-high inflationary pressures in advanced economies, while political instability stalks emerging and frontier markets, where, typically, a greater proportion of household income is given over to food purchases.
Surging energy prices were already feeding into increased costs for fertilisers and other farm inputs prior to Russia’s war on Ukraine, exacerbating pandemic-linked impacts in the process. Adding to the woes, much of India and Pakistan have been subject to the early onset of high temperatures, a somewhat unexpected event given that they have occurred during a La Niña weather pattern – which generally has a cooling effect globally.
Aside from the dreadful toll on human health, the prolonged heatwave – the hottest March on record – has raised concerns over the viability of the wheat crop in northern India, as it remains largely unharvested and has therefore been subject to scorching temperatures. Although temperatures on the subcontinent eased in the first week of May, conditions are set to deteriorate again, with meteorologists forecasting a return to temperatures of up to 50 degrees Celsius.
According to the World Population Review 2022, India is the world’s second largest wheat producer, although virtually all its production is destined for domestic consumption. By implication, any major shortfall in a country of 1.3bn people would place an even greater strain on global export markets, with all the attendant price implications.
|Price||PCHG 6-mth (%)||PCHG 3-yr (%)||PER||DY||Market-cap (bn)|
|Archer Daniels Midland||$89.41||38.6||105||16.5||1.79||$50.3|
|J M Smucker||$137.6||9.4||11.4||26.1||2.88||$14.9|
|Lamb Weston Holdings||$63.43||10.0||-5.47||39.6||1.55||$9.21|
|McCormick & Co||$96.44||18.7||26.8||34.8||1.53||$24.1|
|Tyson Foods 'A'||$90.9||11.5||21.1||9.00||2.02||$26.5|
Any price volatility linked to the shortages will be uppermost in the minds of trading strategists at Archer-Daniels-Midland, Bunge and the market leader in this area, privately held Cargill Inc. Although these types of companies are certainly not immune to price pressures, their broader trading activities render them less susceptible on the inflation front compared with a processed food business such as Kellogg Co (US: K), where margins are intertwined with the ability to pass on price hikes to retail consumers.
The Michigan-based food manufacturing group beat analyst expectations last week after reporting first-quarter net income of $422mn (£325mn), although management warned that price sensitivity was increasing and will continue to do so. The good news for Kellogg shareholders is that demand for breakfast cereal is generally inelastic, mainly due to its relative inexpensiveness, although there are certainly lower-margin generics now available.
Beyond cereals, the world’s edible oil supply is also under severe pressure, not only from events in Ukraine, which hit exports of sunflower oil, but also due to a decision by Indonesia to curtail palm oil exports, with the ripple effects spreading from the food industry to producers of household consumer goods. It’s not only a problem for already cash-strapped households, but could also affect big end-users such as Unilever (ULVR) and Mondelez International (US:MDLZ), highlighting the importance of substitutability in oil markets.
The situation in Indonesia, which ships about a third of the world’s edible oil cargoes, has been brought about by the determination of Jakarta to shield domestic consumers from global market price hikes, at least temporarily. The Indonesian Vegetable Oil Industry Association believes the situation could change shortly.
In any event, prices will almost certainly remain elevated, along with those for substitutes, such as soybean and canola oils. For the foreseeable future, conditions will remain favourable for big edible oil traders such as Archer-Daniels-Midland and Bunge, so investors would be justified in asking whether it would be possible to capture any further share price gains. Consensus figures point to potential upside of 12 and 21 per cent, respectively, although we can’t gauge if these analyst figures take account of the palm oil situation.
For net income to grow, raw price increases need to more than offset increased operating costs. This appears to be playing out at Archer-Daniels-Midland, as its net profit margin is forecast to increase by 32 basis points to 3.72 per cent on an expected 13 per cent hike in sales. The net margin at Bunge is forecast to decline by 36 basis points to 2.97 per cent on a similar sales increase, although that level is respectable enough when combined with a 2 per cent forward dividend yield.