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