Will Hot, Dry Weather Shrivel These Sectors?

By Stephen D. Simpson, CFA | July 05, 2012 AAA

Much has been made of the near-record corn planting this year in the U.S., and this activity has certainly been a boon to Monsanto (NYSE:MON) and presumably DuPont's (NYSE:DD) Pioneer business as well. With this high level of planting activity, analysts had assumed a bumper crop and easing input cost pressures on the food sector. Unfortunately, planting is about the only part of the process that farmers can control and hot, dry weather is starting to sap the corn crop. Not only is this becoming a worrying scenario for farmers, but also for a host of companies and industries that need a healthy corn crop for their own prosperity.

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Agriculture is very much a local industry. Conditions in areas like Iowa, Nebraska and Minnesota aren't too bad, but states like Illinois, Missouri and Indiana are seeing pretty adverse weather. Overall, the USDA recently reported that 48% of the national crop was in "good" or "excellent" condition, an eight-point drop in just one week. Perhaps it's not surprising, then, that despite the high level of planting, corn prices (and the Teucrium Corn ETF (ARCA:CORN)) are quite high.

Ag Sector - The Good News Is Already in the Ground
Record plantings are good for the seed companies, and Monsanto and Syngenta (NYSE:SYT) (the pure plays) reflect that in their stocks. Unfortunately, that may be where the good news ends. Monsanto is conducting large-scale field tests of its drought-tolerant corn, and the weather is certainly helping that respect, but it will not be ready until next year at best.

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In the meantime, hot and dry weather won't do many favors for the rest of the ag sector. Fertilizer doesn't compensate for lack of water, and poor growing conditions could weaken demand for potash and nitrogen fertilizers from companies like Potash (NYSE:POT) and Agrium (NYSE:AGU). Elsewhere, a disappointing crop could ultimately reduce demand for new equipment from companies like Deere (NYSE:DE) as corn farmers may not see the revenue or profits they were expecting this year. A bad crop could also be a problem for major crop insurers like ACE Limited (NYSE:ACE), Everest Re (NYSE:RE) and Wells Fargo (NYSE:WFC).

Food - Will Cost Input Relief Vanish?
Companies like Kraft (Nasdaq:KFT), Kellogg (NYSE:K) and Tyson (NYSE:TSN) have been stuck in a difficult position for over a year now. The increased price of inputs such as corn, soybeans and wheat, has forced these companies to raise prices to protect margins, but these price increases are translating into substantial declines in product volumes sold.

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For the last quarter or two, sell side analysts had been getting a little optimistic that this year would represent the worst of that phenomenon, with cost inflation easing later this year and setting up for better comparisons next year. A disappointing corn crop could seriously threaten that hypothesis. Not only will higher corn prices hurt companies that use corn itself (whether as an ingredient or as animal feed), but companies like Archer Daniels Midland (NYSE:ADM) and Ingredion (NYSE:INGR) sell a range of corn-derived products like starches and sweeteners all across the processed food space.

Even Transports Could Feel the Heat
It's not just the food and agriculture sector that has something to lose with a bad corn crop. A large amount of the U.S. corn crop is carried by railroads like Union Pacific (NYSE:UNP) and CSX (NYSE:CSX), and while grain carload volume is erratic, it is still a meaningful contributor to many railroads' annual revenue.

Corn is also important as a fuel source in the United States. Ethanol already represents about 10% of vehicle fuel used in the U.S., and many gas stations sell gasoline blended with a small amount of ethanol. It is unlikely that a disappointing corn crop is going to translate into dramatically higher pump prices, but even just a 10 cents per gallon price increase is enough to get people's attention.

The Bottom Line
Predicting the fate of a crop is less of a science than alchemy or astrology, so there are no guarantees that the corn crop will be a failure or disappointment this year. That said, time is running short for major corn-growing regions to get the rain they need. While a bad crop may be good news for Monsanto if its drought-tolerant trait delivers the goods in large-scale testing, the potential impacts to the food sector and consumer are not going to be positive.

Stephen D. Simpson owns shares of Monsanto since April 2010.

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