Should Your Portfolio Fear the Reaper?
Due to a strong bull market in corn over the past few years, farmers in the U.S. Corn Belt region have been feeling flush. Iowa has one of the highest personal income growth rates in the country, and farmers have used those profits to buy more fertilizer, better seeds, and newer tractors, leading to Iowa also having one of the lowest unemployment rates in the country as companies such as Deere (NYS: DE) and DuPont (NYS: DD) open new factories across the state to meet demand.
However, the bull market may be winding down. In its recent "World Agricultural Supply and Demand Estimates" report, the United States Department of Agriculture forecast a new record corn crop for the year, noting that it would result in a bountiful surplus that could bring corn prices down to as low as $4.20/bushel, down from a high of $6.88 last year. While that's still a relatively high price, historically, the papers in Iowa are already predicting an end to the good times and a downturn in sales for companies dependent on high crop prices. However, some companies could benefit from lower prices, and there's even reason to doubt the USDA's estimates.
Who stands to benefit
Not all farmers grow crops. Corn is a major input cost for livestock farmers, who are already benefiting from slightly lower feed costs over the past couple quarters. Pilgrim's Pride (NYS: PPC) recently reported its best first quarter since 2005, thanks in part to lower feed costs, and the company's stock popped 5% on the day of the USDA's report.
Similarly, food manufacturers that use corn as a primary ingredient will see margins improve and may even be able to lower consumer prices. Archer Daniels Midland (NYS: ADM) , one of the biggest producers of high fructose corn sugar, saw margins in its important sweeteners segment cut in half between the 2010 and 2011 fiscal years as the price of corn doubled in the latter year.
Meanwhile, ethanol producers will also benefit from cheaper corn, and it couldn't come at a better time -- last year, Congress let the $0.54 per gallon ethanol import tariff expire, opening the door for foreign ethanol producers such as Petrobras (NYS: PBR) . Last year, Petrobras announced plans to invest $1.9 billion by 2015 to increase ethanol production, and while the company mainly plans to increase its domestic presence, CFO Almir Barbassa told the Financial Times that the loss of the tariff would open a prime opportunity for Petrobras.
The increased supply from foreign sources could have a negative effect on ethanol prices in the U.S., and corn-based ethanol producers will need any cost advantage they can get. While your body may or may not know the difference between corn sugar and cane sugar, ethanol producers do. Corn-based ethanol only yields about 1.3 units of energy for every one unit of energy used to grow, collect, and process the corn. Sugar cane ethanol, like the kind Brazil uses, has an energy return on energy invested of about eight.
Why it might not even matter
The USDA, like anyone else, does not give perfect estimates. Over the past 10 years, the USDA's estimates on the low end of the price range for the year have been pretty accurate, and it's basically been a coin flip as to whether the actual 52-week low is higher or lower than what they estimated. But their estimates on the high end of the range tend to have a greater margin for error, and, more importantly, they tend to greatly under estimate the actual market high for the year.
In other words, we may see the $4.20 low the USDA is predicting during the 2012/2013 crop year, but there's a good chance we'll go even higher than the $6.88 high, keeping a strong wind in the sails of many companies that benefit from a high price. The weather this year certainly increases the chances, as the unusually warm and dry winter and spring allowed farmers to get their planting done earlier, but may progress into excessive heat and drought over the summer.
The Foolish bottom line
Every time the price of major crops such as corn starts to fall, investors start selling off industries such as fertilizer and farm equipment. But the crop markets are very complex and affect a wide array of businesses, hurting some and helping others. Predicting prices depends not only on how many acres get planted, but also political changes and even shifting weather patterns. It's better just to not fear the reaper, keep calm, and invest on.
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At the time this article was published