Since 2020 the world has had to live with rising input costs of soft commodities.
The field crops of corn, soya bean and wheat have all soared in value, pushing up food price inflation and eating into food producers’ margins and the pockets of consumers.
Basic foodstuffs — made of flour, mealie meal and soya oil — are about to become a lot more expensive.
For years, the main driver of soft commodity price volatility was Mother Nature.
Droughts, floods, heat and pestilence, especially in the major field crop-producing nations of the US, Canada, Brazil, Argentina and the Black Sea region, directed the market.
Over the past two years the key determinant to rising prices has been weather related, with severe drought in parts of Latin America where vast quantities of soya and corn are grown for export.
Localised issues regarding either hard frosts or excessive heat also hit North America’s corn and wheat supply. And a record 2021 hurricane season closed many export ports for soft commodities in the Gulf of Mexico.
Climate change over the past years has had a profound effect on supplies.
And demand continues to rise, especially from China as its population matures towards greater consumption of meats, grains and dairy products. That demand has been met by an insatiable import demand for key raw materials.
Soft commodity prices started to run in early 2020. After some years of relative price stability, some key drivers saw softs soar with increased volatility.
On the international exchanges, corn, soya and wheat, the most ubiquitous food staples, have risen by 105%, 78% and 89% respectively since the start of 2020.
Some of these moves, as mentioned, were weather related, resulting in a reduction in supplies from leading global producers.
What has also been crucial is that for some years global demand has exceeded global production, leading to drawdown in global stocks. This has tightened the market.
This declining "buffer" of stocks was thus vulnerable to price movements on any sudden extraneous shocks such as poor weather or, latterly, an unanticipated war between Russia and Ukraine. More on this factor later, as the event has had a profound effect on wheat prices.
Geopolitics also played a key part of this softs elevation trend.
A hangover of the former Trump administration in the US was an agricultural trade agreement that meant China was obliged to buy vast quantities of American soft commodities, like soya, as an offset to the huge trade imbalance.
Soya is a product found in many common foods in mostly oil format.
The pulse is also widely used as an animal feed, especially for chickens (it makes up about 20% of feed production cost) as well as in the pork-rearing industry.
Between 2018 and 2020, global prices of soya were flat, trading between $8 and $9 a bushel. This was due to the giant Chinese pork-rearing sector having been decimated due to African swine flu (ASF), reducing import demand that ran to about 110Mt a year.
Pork is a key meat staple in China and it is estimated that a third of the swine herd was culled to contain ASF. This led to a dramatic reduction in Chinese demand for imported soya. In a simplistic perspective, China basically buys all the soya production output from the world’s largest producer, Brazil.
As swine herds have been rebuilding in China, there has been a surge in import demand for soya. Concurrent to this surge, a severe drought in Brazil led to production cuts and to firming soya prices.
That insatiable demand pull from China, alongside weather-related production issues, has been the key determinant in soft commodity price increases over the past two years.
Locally, on the Safex commodity market, prices have been mostly driven by global and geopolitical factors. This is in spite of bumper local harvests for the past two years in the key field crops, which ordinarily would have seen Safex prices decline on large domestic surpluses. They have not, and have instead been directed by global pricing.
Since the start of 2020, yellow and white maize have rallied 66% and 58% respectively, with soya increasing 49%, sunflower 106% and wheat 61%.
These are material cost pushes into a domestic economy battered by weak economic growth, the lingering effects of Covid as well as the July unrest.
We are in an economy with modest GDP growth, record unemployment and a wide swathe of the populace making ends meet from an extension of Covid relief social grants. So rising food inflation and the implications to food producers’ margins and volumes are palpable and will extend severely into the second half of the 2022 results season.
Warnings have been given from many listed food producers and in the animal-rearing sector, especially poultry, that the second half of 2022 may be a challenging time. Major broiler producers Astral Foods and RCL Foods have highlighted these elevated input cost issues in recent commentary.
So far, 2022 has not been a great year to be a food producer or consumer, though farmers have mostly been smiling, benefiting from higher prices despite higher year-on-year costs of production.
Higher chemicals, fuel and fertiliser prices have increased field production costs per hectare by, on average, 38%.
High soft commodity prices became even more elevated at the beginning of this year as tensions simmered between Russia and its former Soviet satellite Ukraine.
Russia invaded Ukraine on February 24, in a major escalation of the conflict that began in 2014. It is the largest military attack in Europe since World War 2.
As a result of that attack, the prices of soft commodities and oil spiked.
Over the week to March 11, wheat rose by 45% to $11.16 a bushel and corn by 28% to $7.59 a bushel. Brent oil has soared to a recent peak of $128 a barrel (+36%) before retreating to the present $112 a barrel, but well above its $94 a barrel level before the Russian aggression.
The Ukrainian issue has led to a surge in soft commodity prices. Russia and Ukraine are major exporters of soft commodities, mostly maize and wheat, accounting for about 25% of total global exports.
With Ukraine potentially unable to plant its 2022 field crops or export what may be produced, because its main Black Sea port, Odessa, has been captured, a disruption in global supply has seen buyers scramble to source crops, mostly from US producers. This has driven prices higher on the main Chicago Board of Trade futures market.
Sanctions on Russia by Western economies over the past weeks have also spooked buyers of Russian-produced soft commodity and fertiliser products. The same applies to Russia’s acolyte, Belarus, a major supplier of global fertiliser base product.
These products from conflict countries are, suddenly, globally taboo.
With supplies of maize, wheat, fertiliser and oil production potentially being removed from the global supply and payment platform, prices are reacting accordingly as countries scramble to find alternative supplies.
In such circumstances, given simple economics, with constrained supply aided by ongoing global supply chain logistics, shipping cost issues and high global demand, prices rise. In the past weeks they have soared.
I mention oil, despite this being a soft commodity-related feature, as crude is inextricably linked to corn.
A rising oil price usually leads to a higher corn price as demand increases.
In the US, corn-derived ethanol is used as a blend in gasoline. Producing ethanol becomes more profitable on a high oil price, so pushing up corn demand.
About 40% of US corn is used in ethanol production; again, constraining supply to meet a global market shortfall from the war in Ukraine.
With no early end to the war expected, food producers in the manufacturing sector have to quickly adjust to the new normal of elevated soft commodities.
With domestic administered costs such as wage demands and electricity prices rising, alongside a soaring domestic fuel price powered by global issues hitting distribution costs, JSE-listed food producers and related counters are in for a torrid FY2022/2023 reporting period.
In recent presentations, AVI, RCL Foods and Tiger Brands have highlighted the significant input cost challenges ahead.
Food prices will have to rise to try to recover input costs and preserve margins that, invariably in a weak economy, lead to some volume decline. It’s a delicate balancing act.
The same is true in the egg and poultry sector. Despite SA’s animal-rearing companies being highly efficient producers, you simply cannot pass on or recover a sudden surge in input costs, as recently experienced.
There will be some lagged margin compression before attempts are made to push through increased costs. This may be difficult as SA heads into winter, when demand for some foodstuffs usually slips as lower-income consumers reallocate money towards heating and clothing.
Predicting the current movement of soft commodities is near impossible as the instability in the Black Sea region is driving global soft commodity sentiment.
My stance for the past two years has been to be short on food producers and long on agricultural counters. That has been the correct relative move. I do not expect to change that stance for 2022.
The market has, in the past few weeks, cottoned on to the elevated impact of soft commodities on food producers. Year to date, shares in AVI and Tiger Brands have declined 14.8% and 16.1% and have recently dropped to 52-week trading lows.
Mid-cap food counters that produce a range of ready meals, value-added meal concepts and canned goods have also been hit, but not as hard, because their higher-end products are slightly more shielded by an ability to pass on higher costs to more affluent consumers. Libstar is down 13.1% and RFG Foods 12.1%.
Poultry counter Astral Foods, the country’s largest chicken producer, recently hit 52-week lows despite forecasting a stellar set of interim results to March.
Debt-free and having scale, Astral will have the ability to recover some costs. But with 60% of the costs of rearing a chicken being related to maize and soya, its second half will be materially weaker than the bumper first half due to the recent surge in maize and soya prices. Year to date the counter is down 10.5%.
I remain cautious.
Aside from Libstar, currently trading at 596c, where I have a buy as a special situation corporate play, I continue to avoid all mainstream JSE-listed food producers.
I have turned positive on the fishing counters Oceana and Sea Harvest as the long-term fishing rights, after a long delay, have been allocated.
Putting aside the recent corporate drama at Oceana, the counter will have a weak first half but a firmer second half. I’ve had buys on Sea Harvest since R12.99 and, latterly, on Oceana at R52, both having better prospects than the food producers sector.
The main winners in this rising input cost scenario are the agricultural and related stocks. Many are not that well known in the market but they have had bumper results as their agricultural client bases has benefited from rising prices.
Kaap Agri, TWK Investments and Senwes have all reported solid results and I continue to recommend these counters as buys, based on current fundamentals.
Ultimately, much remains unknown in the coming weeks and months. The agricultural markets are robust and offer far more capital protection than the strained consumer-related food producers sector.
My basket of preferred counters is made up of Kaap Agri, TWK, Libstar, Oceana and Sea Harvest. I’d avoid all the rest until some normality returns.
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