Many believe the agricultural sector is slow and sleepy; this is not so.
The dynamics of soft commodities are as fast-paced as one can get.
I will try to encapsulate the forces at work, especially in an SA context, and how investors can play the cycles to their advantage.
I will use as my example the poultry and animal feeds stock Astral Foods, a stock whose earnings are closely correlated to the price of maize.
Life-sustaining soft commodities such as maize, soya and wheat, pushed by global issues and drivers as diverse as geopolitics, trade tensions, Middle East oil prices, floods, droughts and pestilence, can seem almost biblical in these scenarios. Predicting Mother Nature can also be problematic, but more often than not, the signs are fairly clear to read. Farmers have been doing it for generations.
As an analyst in the sector for about 15 years, I have covered and commented on the levers and drivers that, if used effectively in what is a cyclical environment, can lead to profitable investments in stocks that are directly influenced by volatility in soft commodities.
Stocks such as poultry counter Astral Foods, egg and animal feeds business Quantum Foods, grain and agri giant Senwes and large integrated food producers such as RCL Foods and formerly listed Pioneer Foods can have their earnings directly affected by volatility in basic commodities.
Get the basic input cost scenario right and the cyclical nature of these counters will lead to great timing opportunities to buy and sell the counters to investors’ benefit, often months in advance of actual earnings events.
The two biggest global soft commodities are wheat and maize — or corn, as our American cousins call it.
The annual global production volumes are staggering: 760Mt of wheat and 1.1-billion tons of maize.
In an SA context, we produce on average, 1.5Mt and 12Mt respectively.
There is sufficient grain produced in the world to meet demand.
The problem is that localised factors in the biggest producers (the US for maize and wheat and Brazil for soya) drive the global price direction, or localised factors that benefit or hit major users.
I can provide two recent examples.
The world’s biggest producer of corn/maize is the US.
It plants more than 90-million acres a year and produces on average 355Mt a year.
SA produces about 3% of what the US can grow.
Where the US price of corn/ maize goes, the world has to follow. In May 2019, severe flooding in the eastern corn belt in the US led to fears of a lower, smaller harvest as planting season was under way.
In a month, the futures price of US corn rose 30%. That dramatic move rippled into global prices.
In SA, on Safex in May 2019, maize rose 16% in a month. Within a couple of months, the US price had normalised and the spike receded as expectations were tempered that the US crop would not be as badly hit as initially feared.
Tracking the early harvest expectations, planting and growing trends can be beneficial in extrapolating maize tonnage production levels.
Why is this vital in the case of a poultry stock? Because 65% of the cost of rearing a bird for the table is allied to input feed costs, and 55% of the feed cost is maize.
Thus, the volatility in maize and extrapolating out the volumes that companies purchase can be a lead indicator to the direction of profits and headline earnings per share (HEPS).
Imagine if you’re Astral Foods, which buys 800,000t of maize a year, or Pioneer Foods, which buys 950,000t a year, to suddenly see a sharp rise in input costs.
Yes, all companies hedge, but extended volatility is no help for companies which constantly procure and hedge to try to average out input costs.
Domestic maize volatility has had a dramatic impact on earnings. The severe drought in SA in 2016 led to maize prices surging more than 70% as the harvest crashed to less than 8Mt.
SA generally needs 11Mt a year for domestic needs. With such a swift rise in input costs it is virtually impossible for companies to recover the full extent of sudden rising costs, especially in a weak consumer environment. Corporate margins are hit and profits weaken in such scenarios.
Poultry stocks in the 2016/2017 reporting period all suffered big slumps in earnings.
This was eminently predictable up to nine months before the event, if one tracked the planting season and early maize production patterns.
A rebound in the maize harvest in 2017 resulted in 17Mt being produced as weather patterns improved and yields recovered domestically. The maize price crashed from R4,000 a ton in 2016 to R1,800 a ton in 2017.
The golden window for Astral Foods is a maize price between R2,000 and R2,200 a ton; then they print money.
In the FY2017 reporting period aided by materially lower maize prices — again this was predictable — Astral Foods’s restated HEPS surged 98% to R19.14 a share with a 115% rise in total dividend to R10.55 a share.
In FY2018, still benefiting from the lagged effects of low input costs and a brilliant one-year fixed hedging strategy, Astral’s earnings ran another 94% to a record HEPS high of R37.12 with a R20.50 a share dividend paid. Astral’s share price in the period ran from R150 a share to a high of R320, a gain of about 115%, mostly from lower input costs aiding earnings. It’s certainly worth tracking these costs.
Results for the year ended September 2018 was Astral’s earnings zenith.
It became evident that the 2019 harvest would be lower than the 13.2Mt in 2018 (which was 22% lower than 2017’s record harvest). The commercial maize harvest in 2019 ended 15% lower at 11.275Mt. On this production decline the Safex maize price strengthened from a 2018 low of R1,800 a ton to a high of R2,900 a ton in 2019. Astral’s glory days were clearly over for the time being.
That sort of sudden gain in a key input cost, allied to price and rand volatility in a weak consumer environment, resulted in Astral reporting a 55% decline in HEPS to R16.74 a share and a 56% cut in dividend to 900c a share. Again, a look at the early maize indicators would have foretold this slump was on the cards, aside from the dire economic conditions and rising poultry imports.
From a share price high of R320 in 2018, as the market belatedly started to factor in lower earnings for the 2019 financial year, Astral’s share price fell to R145 at the start of 2019 and the counter trended sideways for much of that year.
Due to the timing of the maize harvest and the timing of corporate financial results, I look for the early indicators regarding expectation to plant at the start of the maize season. This starts by me gauging anecdotal opinions in August as to the condition of the soil at the end of the harvest season, moisture levels and long-term weather forecasts.
More factual insights are gained usually by late September into October on planting expectations. It was in this window in late September 2019, with Astral Foods at R151 a share, that I issued my first buy recommendation, followed up in late October 2019 with a feature in this magazine when Astral was R161.25; again, I reiterated my buy on the stock.
Why was I so confident, given Astral was trading at its lowest share price for 2019?
Again, the answer was insight into expectation for the 2020 maize harvest, which early intelligence led me to estimate a 28% rise in maize for the coming season from the 11.275Mt of commercial maize produced in 2019 to my estimate of 14.5Mt for 2020.
That belief of a larger harvest was despite doom-mongers worrying about late planting and weather issues. Early on, the farm intelligence had indicated to me (1) good soil moisture levels coming out of winter, meaning ideal planting conditions; (2) higher Safex prices would encourage larger hectarage to be planted; and (3) weather patterns for rain looked encouraging, aiding seed germination, plant population (yield) and crop development.
That ideal scenario, if confirmed, would be a larger than expected harvest and, if my forecast was correct, a material carryover of stock into 2021, given that SA consumes only 11Mt a year. Factoring in benign US maize prices gave me confidence that Safex maize prices would start to decline materially as the news, if confirmed, flowed into the wider equity market.
My narrative began to be confirmed in late October 2019 as the crop estimates committee detailed their first intention to plant report, which suggested a 9.5% increase in year-on-year hectares planted to 2,519-million hectares with a 10.3% uplift in white maize and 8.5% in yellow maize. That first official report saw the Safex maize price fall by an average 10% over the coming two months.
A market 15% spike in prices in December 2019 was on concerns over late planting and weather. I looked through this, convinced that "farmers knew better than the market".
The January 2020 crop estimates committee report on preliminary hectares was again bullish, with a modest upgrade to 2,525-million hectares but a notable swing in 16.7% more white maize planted and a revision in yellow maize to 1.8%; white maize was a far more profitable crop for farmers so they just planted more.
The February crop estimate committee report on first production continued the bullish trend. Hectares were raised again by 2.5% to 2,599-million, with a forecast 29% rise in year-on-year total commercial maize to 14.6Mt (remember, I had forecast 14.5Mt back in September 2019) and a 49% increase in white maize tonnage and 9.5% in yellow.
Thus, my early call on Astral Foods in September/October 2019 as a buy based on a materially higher maize harvest leading to a dramatic fall in its key input cost had been vindicated.
In that period Astral had run to R220 a share in mid-December 2019, giving a return of 30% on my early call.
Thus, it pays to track soft commodities very early.
This predictive scenario has worked for me for years and plays out on many stocks where maize is a key input.
The flip side is panning out again for the FY2021 earnings window. After a lower harvest in 2019 of 11.275Mt, an early forecast of a bumper harvest in 2020, now confirmed by the crop estimate committee, has seen a sharp fall in the Safex maize price.
Only recent rand weakness — due to weak SA GDP prospects, then the recent global stock market sell-off — has slightly upset the pricing expectation.
A bumper white maize harvest in 2020 has led to many input users switching from using yellow maize for feed into cheaper white maize; the current saving at the time of writing is R141 a ton, though that is offset by a cost of R40 a ton because of the need to add colourant additives into feed.
Like-on-like, Astral Foods is still more than R400 a ton in savings on feed costs. That, apart from lower poultry imports due to the weak rand and the expectation of long-due increased tariffs on Brazilian product, will see a material rebound in mainly H1 2021 and FY2021 earnings. Remember, Astral is a September year-end.
H1 2020 HEPS will not look pretty. Festive trading was weak and maize prices were only starting to come off their highs. The lower maize price will only start to benefit Astral and the big-sector input users in Q4 or July to September 2020, with the full benefit of lower like-on-like costs coming into their new financial period. Thus, FY2020 will be better than HEPS of R16.74 reported for 2019, but not dramatically better.
At the time of writing, Astral Foods is trading at R206.09. Despite the global stock market crash in mid-March, the counter has risen 7% during the turmoil; one of the few that has stayed in the green.
I re-issued my buy call on Astral at R190 at the start of March.
Based on my expectation for maize prices and Astral’s earnings recovery, I can see an earnings target of between R25 and R30 in 2021.
To date, my forecasts on maize and Astral Foods have played out. Unless there is an act of God and the domestic maize harvest is slashed, which is unlikely, as current forecasts are as high as 15Mt to 15.5Mt, I see further weakness in domestic maize prices due to the expected surplus.
I am, however watching the rand versus the US dollar closely as that is a tempering factor to domestic maize.
The easy money was made in my September/October 2019 recommendation. However, I remain positive on Astral Foods. It’s my main maize play in the sector. I have a target valuation of R300 for the counter into 2021; an upside of 39% from current levels.
A secondary, if less liquid, sector play is ZAR-X listed grains titan Senwes. Its earnings lag the maize harvest because it’s mainly a grain logistics and storage play. Its bump in earnings from higher maize tonnage comes six to nine months after the end of the harvest season.
At R13, Senwes won’t have great FY2020 earnings due to the low harvest of 2019. But its FY2021 earnings will be a nice rebound. Senwes reported HEPS of R17.75 a share in its April 2019 year-end and interim results to October 2019 declined 11%.
There’s talk of corporate activity at Senwes, with further sector consolidation under way and the stake sale of Grindrod’s 20% holding in Senwes.
The share has been steady in the current market volatility and has been a solid if pedestrian performer, but it’s been one of the better pure agri-sector plays.
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