By Jörg Dehning, Food & Beverages Sector Analyst and Fund Manager of the DJE - Agrar & Ernährung
Upswing for agricultural shares
Rents and real estate prices have risen in the urban centers for years - we are used to this situation. Rising food prices, however, were not an issue for years. Well, that seems to change now. The consequences for the agricultural sector are analyzed by Jörg Dehning, fund manager of the DJE - Agrar & Ernährung.
We have undoubtedly become accustomed to further increases in rents and property prices in the metropolitan areas. Rising food prices, on the other hand, have not been a topic of public discussion for years. This seems to change. Although the current weaker demand for vegetables and meat from the catering industry continues to put pressure on prices in these segments, this could change quickly in the wake of a successful control of the Corona virus.
Import demand from China drives food prices
The price index of various food prices published by the Food and Agriculture Organisation (FAO) has already been trending clearly upwards in recent months. Particularly noticeable are the strongly increased prices for vegetable oils and cereals. Prices for maize and soybeans have also exploded since mid-2020.
The trigger? One major reason is certainly China's high import demand. The below-average Chinese harvests are one reason. In addition the increase of the pig breeding stock after the African swine fever has led to a higher demand for feed, which cannot be met by domestic stocks. In particular, the Chinese government's efforts to transfer pig breeding increasingly into the hands of professional breeding farms has not least promoted the admixture of maize. Therefore the higher demand in this sector may continue for some time, even though more efficient seed varieties will be used. The other reasons for the price rally are more a temporary phenomenon. Including weather-related crop failures, especially in South America and the Black Sea region.
Grain and oilseed markets: tight supply situation
On the other hand, the improved price environment will lead many US farmers to expand their cultivated areas this year significantly. Despite this at its annual forecasting conference at the end of February the US Department of Agriculture (USDA) expected a tight supply situation on the grain and oilseed markets for 2021/22. According to this US soybean stocks are expected to remain at almost the lowest level since 2013/14. Nevertheless, even this USDA forecast is not without risk. In particular, the assumption of a trend of average yields in the context of acreage expansion appears quite dangerous. Usually, area expansion takes place in regions with less good soils and less favorable climatic conditions. Further disappointments in harvest estimates are therefore almost inevitable later in the year. In addition, demand from both the feed industry (supported by the recent cold snap in the US) and ethanol producers could turn out to be greater than expected. The latter is especially true if the Corona-related mobility restrictions end. The announced export restrictions of individual supplier countries (e.g. Russia and Argentina) are also likely to increase the willingness of individual deficit countries to build up safety stocks as a precaution.
Expansion of acreage: Advantages for US fertilizer and seed suppliers
Accordingly, the price dynamics of agricultural commodity prices could gain further momentum in the coming months. This would also give a further boost to shares of the agricultural segment. Most shares from the fertilizer and seed sector benefit already from improved sales prices and volumes. The fertilizer, seed and crop protection suppliers established on the US market, will inevitably enjoy the biggest advantage from the planned expansion of US acreage. Their shares have recently shown the highest price increases. Anyway, a high South American sales exposure has often proved disadvantageous, if only because of the weakness of the Brazilian real.
The agricultural machinery sector is another beneficiary of the improved framework conditions. US farmers in particular are eager to renew finally their aging fleets. At the same time, inventories of the US agricultural machinery wholesale trade are extremely low compared to historical standards, so that manufacturers can largely avoid usual dealer discounts. Accordingly, it can be assumed that even the high price increases for steel can be passed on to the end final customer without any problems for the time being. The high order backlog also ensures a much more efficient utilization of production capacity, if the supply chains remain intact despite the Corona-related restrictions.
Robotics and artificial intelligence: more efficiency in the agricultural sector
From a company perspective, but also from an investor's perspective, the numerous new automatic control and robotics solutions are also interesting. They are often sold as an additional option. With new applications the turnover per agricultural machine therefore increases continuously. With higher prices for fertilizer and more stringent crop protection requirements the purchase of so-called "precision farming" offers often pays off for the farmer after about two to three years. Their use not only enables a reduction in working hours and the minimization of necessary operating materials such as diesel. With the help of increasingly better sensor and camera technologies, it is now possible to optimize the use of fertilizers and crop protection products. While fertilizers in the first wave and improved seed varieties in the second wave significantly increased the yield per hectare, the future improvement of crop yields is likely to depend largely on the use of digital robotics technologies. Even so-called "artificial intelligence" is making its way into agriculture. For example, computers are learning to distinguish weeds from the actual crops. More targeted control thus seems to be only a matter of time. In turn, large-scale herbicide treatments could become outdated. Consequently, the promotion of corresponding investments through subsidies also seems to make sense in terms of environmental protection.
Sustainable cultivation methods are becoming more important
In this context it should not be forgotten that US farmers received considerable aid under the old US administration. The extent to which these subsidies will continue remains unclear. Some cuts are to be expected. This also applies to European farmers, who will be confronted with lower direct payments from Brussels in the medium term. Therefore it is even more important to reward sustainable farming methods. First steps are being taken in North America. For example, Nutrien, one of the leading US agricultural commodity traders, wants to test CO2 certificates for particularly soil-conserving plantations for the first time from 2021 and sell them on to interested parties from the industry. This could be a promising way to generate finally a second source of income for farmers away from traditional subsidies. As a result the income cycle caused by the strongly fluctuating agricultural commodity prices would at least be eased somewhat. In the short term, however, many farmers can expect rising yields for the time being. Shares in this segment remain promising despite the price gains already achieved.
Note: All information published is for your information only and does not constitute investment advice or other recommendation. Long-term experience and awards do not guarantee investment success. Securities are subject to market-related price fluctuations which may not be compensated for by the active management of the asset manager or investment advisor. This information cannot replace a consultation. All information has been provided with care and to the best of our knowledge at the time of preparation. Despite all due care, the data may have changed in the meantime. Further information on opportunities and risks can be found on the website www.dje.de. The sales prospectus and further information are available free of charge in German from DJE Investment S.A. or at www.dje.de The fund management company is DJE Investment S.A. DJE Kapital AG is the distribution agent.