Russia’s invasion of corn and wheat exporter Ukraine in February turbocharged the surge in global soft commodity prices that began with the outbreak of Covid in early 2020.
Covid did not constrain the production of soft commodities, but it did throttle the supply chain as global logistics systems were disrupted. As a point of reference for global food price inflation, from a March 2020 baseline the price of corn had risen 168% in April 2022, wheat had soared 348% by the end of February 2022 and soya had doubled by early June 2022.
Farmers may have gained extra revenues but the consumer paid the price as higher input costs in the production chain were passed on. That is the global inflationary push, alongside energy, we are experiencing.
Most soft commodities have corrected over the past two months as market concerns eased over the supply from sanction-hit Russia, a major soft commodity exporter, and the resumption of exports from Ukraine, an important supplier of grains and edible oils to many developing economies.
Enough grain is grown around the world to match demand, but it is extremely finely balanced. Any disruption, such as recent weather-related issues and market concerns over key production countries Brazil and the US, can send prices soaring again. The idea that rising inflation across the world, driven by oil and food costs, will subside soon is unrealistic.
A sharp fall in the July UN Food & Agricultural Organisation’s food price index, as soft commodities corrected on fund liquidations, drove key inputs back to pre-war levels, but there are doubts that the good news will last. Higher fertiliser and fuel costs, a bleak global macroeconomic outlook and volatile global currencies are a strain on global food production, geopolitics notwithstanding.
As the pandemic eased and global economies reopened, the demand for animal feed, food and biofuels surged as economies ramped up. But agriculture and Mother Nature are not like an industrial business where a switch can be turned on and production can resume, pumping out more product. Agriculture has a longer-term horizon.
In agriculture, factors such as the weather and the availability and price of fertiliser, diesel and field chemicals are far more critical. Climate change-induced weather patterns have resulted in protracted dry conditions in major producers such as Brazil, a leading supplier of soya. In the US, the 2022 planting season was delayed by extremely wet or cold weather that was preceded by hot and dry periods. None of these conditions is conducive to good crop yields.
This background must also be taken into account: for years globally we have consumed more than we have produced. Stock drawdowns have tightened carryover supplies. This, alongside natural production supply disruptions, has helped to push soft commodities higher. Recent geopolitical events have made things worse.
As China’s enormous economy reopens, its demand will suck in global soft commodities, supporting prices
Many investors seem to have irrational expectations, especially for soft commodities — they believe that as the market moves from hoarding to destocking and higher-priced inventory is worked through the system, softening economies will drive prices lower on weaker consumer demand. This is partly true but misses some key caveats.
China, the world’s largest softs importer, remains in semi-lockdown. As its enormous economy reopens, its demand will suck in soft commodities, supporting prices. Another support for softs will be the farmer. As softs fall and if input costs remain high, there is a trade-off — farmers will simply plant less or switch to more productive crops.
Agriculture is a business, not a charity. Input costs for farmers remain elevated and soaring prices for natural gas and oil have a knock-on effect for the fertiliser and chemicals chains. Prices of fertiliser, as an example, have slipped in 2022 after the northern hemisphere planting season but remain sharply above average early 2021 levels.
In SA the weather patterns have been favourable. After an unprecedented three successive good harvest periods we are heading into our fourth for the 2022/2023 season. However, while domestic production has risen in key softs, input costs are starting to bite. The golden period for domestic agriculture was 2020, when input costs were low and SA Futures Exchange (Safex) softs prices were trending higher after the 2018 lows.
Fuel, a main cost component, was about R13/l compared with R25/l today. Fertiliser and chemicals were still reasonably priced. Input costs started rising in 2021 (another great agricultural season), when the inflationary cost push for the farm sector was about 20%. Post-Covid prices for softs started to run higher but input costs ran harder.
In 2020 softs prices soared mainly on geopolitical factors before easing recently. But production costs have risen 50% year on year, paring farmers’ profits. Farmers are still making good returns but are well off the peaks of a few years ago.
Today, SA has additional challenges. Inefficient state-backed businesses are hampering domestic production and industry. Dysfunctional ports and logistics, disruption of electricity and water supplies and a stagnant economy are all impeding economic activity and boosting production costs. Recent rand weakness has aided exports but pushed up prices of imports such as fuel, field chemicals and capital equipment.
Soft commodity prices may fall further in the short term as northern hemisphere crops start coming off the field. However, this must be balanced with mixed news about the impact on harvests of abnormal weather patterns, the fragility of exports from Ukraine and any further sanctions on, or retaliation by, Russia.
Locally, the 2021/2022 agricultural season was good. Farmers faced higher input costs but enjoyed higher Safex prices, and this was reflected in hectares planted — the maize crop is estimated at 14.7Mt and soya production could reach a record 2.15Mt. The sector’s buoyant sentiment is reflected in robust demand for agricultural capital equipment — in June, tractor sales were the best in 40 years.
Farmers expect incomes to remain elevated into the 2022/2023 season as preplanting preparation gets under way. Early expectations for the season are that another 2.6-million hectares of maize will be planted, giving a harvest of 14Mt-15Mt. Ongoing global demand for soya and edible oils should also result in increased planting despite higher field production costs. The season looks likely to be another good agricultural year as the La Niña weather pattern continues to bring wetter conditions for an unprecedented fourth year.
Statistically, yet another La Niña year seems unlikely, which means maize harvests could drop from the 14Mt range back to the 11Mt bracket
However, the key concern is the 2023/2024 season. Statistically, yet another La Niña year seems unlikely, which means maize harvests could drop from the 14Mt range back to the 11Mt bracket. This would still be enough to meet domestic needs and there is good carryover, but exports would be curtailed and farm incomes squeezed.
This is the grave concern I have for the 2023/2024 season. Should this scenario unfold, I’d consider selling primary-related agricultural stocks such as Kaap Agri, Senwes and TWK in late 2023 as earnings growth could stall and even reverse, given the high base the sector currently enjoys.
JSE-listed food producers have had a punishing period year to date. Elevated soft commodity prices and higher input costs such as electricity and fuel have squeezed margins. Higher interest rates and a weak domestic economy have constrained consumer spending in the middle market, though the higher end has held up remarkably well. The low-end consumer segment has been propped up by ongoing state grants.
With sharply rising food prices now seeing the lagged effects of the surge in soft commodities, the ripple effect on finished consumer foods has been evident in the past three months. It is likely to abate only towards year-end and into 2023, should softs remain at current levels.
Since mid-June softs have declined materially on international markets. Wheat plunged 40% and is back to pre-Ukraine war levels on better prospects of exports from Ukraine. Corn declined 22% on fund liquidations, though soya remains robust due to cuts in Brazilian production and increasing Chinese demand.
Investors need to be careful. Softs may have retreated but there are many clouds on the horizon that could snap the sector back into elevated-price reality. Leading poultry producer Astral Foods has rallied 35% in the past three months to R207.50 as the market expects that a recent 16% slide in local maize prices, a key input for Astral, will improve margins and earnings growth into its new financial year. This will be the case if the trends hold, though Astral has to work through its expensive midyear procurement and could yet still see a weaker fourth quarter to its September 2022 year-end. I’d not be pushing this bird much higher after its recent flight.
On the consumer foods front, companies are battling for market share or modest consumer growth. Tiger Brands and AVI have shown muted revenue and earnings growth. This will not recover any time soon. Rhodes Food Group has its own challenges with margin growth and problems stemming from integration of past acquisitions. Its export business has encountered port and supply chain issues. Rhodes, down 17% year to date at R10.21, is not a stock I’d chose to buy.
RCL Foods at R10.65 is down 21% year to date. The diverse food stock has gone nowhere for 20 years. But moves are afoot to turn around Rainbow Chicken, and RCL’s core groceries business has held up well. Its mishmash of assets needs paring, but majority shareholder Remgro might at some stage take out the 20% minority. I’d not rush into RCL, but it has speculative interest.
My preferred pure mid-cap food sector play is Libstar. At 555c the stock has rebounded off its recent lows and a robust interim results trading update was very good. It shocked the market with revenue growth of 9.6% and headline earnings per share guidance higher at 11.5%-16.7%. The stock ran on the news but on a forecast p:e of six, Libstar, unloved and misunderstood, remains the standout buy in the sector. I have a target of 750c.
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