Sow­ing the in­vest­ment seeds

As the long drought shows signs of lift­ing we have all, to some ex­tent, be­come farm­ers

Financial Mail - Investors Monthly - - Guest Column -

The drought has caused vast swathes of the maize belt to suf­fer be­low-av­er­age rain­fall for sev­eral years. The 2015-2016 drought brought al­ready-parched ar­eas of SA to their knees, es­pe­cially in the North West and Free State, adding to the woes of the farm­ing sec­tor.

With lower rain­fall, crop yields and pro­duc­tion of the key in­put sup­ply chain of maize and wheat fell in the har­vest sea­son. For a coun­try used to suf­fi­ciency in grains, a slump to 7.5 Mt of maize was a blow. Im­ports have made up the slack as SA needs 10 Mt/year to sus­tain it­self.

The im­pact to farm­ers, their em­ploy­ees and com­mu­ni­ties was crip­pling but the rip­ple ef­fect into ma­te­ri­ally higher prices of such grains on the Safex fu­tures mar­ket, along­side a volatile rand, saw maize and wheat prices soar.

This had a flow-through ef­fect into vir­tu­ally every as­pect of the food-man­u­fac­tur­ing chain.

Ris­ing food price in­fla­tion, not just in ba­sic grains, but in fresh pro­duce (also hit by the drought) led to surg­ing prices for food man­u­fac­tur­ers, an­i­mal rear­ers and con­sumers as prod­ucts such as mealie meal, bread, po­ta­toes and even toma­toes rose sharply.

Food in­fla­tion rose at dou­ble-digit lev­els in 2016, es­pe­cially in fresh-food cat­e­gories. Pro­tec­tion­ist tar­iffs to wheat farm­ers led to the wheat tar­iff nearly dou­bling , which, along­side large wheat im­ports, made all wheaten prod­ucts rise sharply to con­sumers on the shelves.

Farm­ers, un­able to keep live­stock due to surg­ing feed costs and lack of wa­ter, slaugh­tered herds. This caused red meat prices to plum­met (for a pe­riod). But as herds are re-es­tab­lished red meat costs will again rise as feed costs en­ter the equa­tion.

The big­gest im­pact of a lower maize crop and a near-dou­bling of prices was in poul­try. The likes of As­tral Foods, Rain­bow and Sov­er­eign, al­ready be­set by weak de­mand, were hit by im­ports. Some of these were brought about by free-trade deals with the US where prod­ucts were dumped on the lo­cal mar­ket to the detri­ment of pro­duc­tion and jobs.

With ris­ing costs, weak de­mand and a com­pet­i­tive land­scape, the poul­try sec­tor’s prof­its turned to ma­te­rial losses.

Mar­gins of man­u­fac­tur­ing busi­nesses with large sta­ple busi­nesses, such as Pi­o­neer Foods, tight­ened as con­sumers sim­ply ei­ther traded down or bought less.

Sec­tor com­pa­nies, wish­ing to pro­tect mar­ket share, of­ten had to ab­sorb some or all of these higher costs at the ex­pense of mar­gin and thus prof­itabil­ity.

Across the food chain, be it bak­ing busi­nesses, fast-food stocks or con­sumer-foods com­bines, all have suf­fered from the drought, push­ing up food price in­fla­tion.

But green shoots of re­cov­ery are now ev­i­dent and can be seen if early rain con­di­tions and the ex­pec­ta­tion of a har­vest re­bound to sec­tor norms in 2017.

In the cur­rent pe­riod, the soil con­di­tions for plant­ing ar­eas are en­cour­ag­ing. There’s been good rains, but the key pol­li­na­tion and ger­mi­na­tion win­dow is still ahead and rain­fall pat­terns need to be main­tained to pro­duce ac­cept­able hectare yields.

If in har­vest 2017 the maize crop bounces back as the fu­tures Safex mar­ket an­tic­i­pates higher sup­ply, in­put prices will fall. The re­cent strength of the rand from ex­tra­ne­ous rather than do­mes­tic is­sues, will also as­sist as all crops are priced glob­ally in US dol­lars, which SA tracks to an ex­tent.

As lower in­put costs start to be an­tic­i­pated, agri­cul­tural and food stocks will be­gin to lead this ex­pec­ta­tion. But, due to hedg­ing poli­cies, the real wind­falls of lower in­put costs to the sup­ply chain will prob­a­bly start to ma­te­ri­alise only in Q3 2017 and trickle into com­pa­nies’ prof­itabil­ity lines in Q4 2017 and H1 2018.

I’d be watch­ing As­tral Foods, Rain­bow and Pi­o­neer Foods. All have had a cathar­tic stock per­for­mance in 2016. If re­cov­ery prof­itabil­ity is ev­i­dent from lower in­put costs, these big three will be the main win­ners.

There will also be a rip­ple ef­fect through other food stocks such as Tiger Brands and AVI.

I’d have my bets with As­tral Foods and Pi­o­neer Foods. Both are well-cap­i­talised, well-run busi­nesses. As their in­put costs de­cline, they will trap some of that mar­gin in­ter­nally be­fore giv­ing much, but not all, of it back to a strapped con­sumer.

Ris­ing food price in­fla­tion led to surg­ing prices for man­u­fac­tur­ers, an­i­mal rear­ers and con­sumers

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