By G.C. Mays
Producer prices rose 0.3 percent in August, suggesting continued demand and at least some economic momentum. The prices producers receive for their goods have narrowly averted annual declines in each of the last 2 years as growth in the U.S. crawls along at about a 2 percent rate (Figure 1).
The Federal Reserve prefers to exclude food and energy from its inflation estimates due to the volatile price action of these commodities. Consumers wish they could be like the Fed and exclude these costs from their budgets as well. Excluding these essential items producer prices were actually flat in August. So does that mean consumers will get a break in the coming months? Well, if the declines last long enough they just might see a lower grocery bill down the road.
In 2013 prices of the major cash crops tumbled after the drought of 2012 sent prices soaring to all-time highs. As I wrote back in March falling crop prices do help companies downstream in the value chain. In its fiscal 2012, which ends in September, Tyson Foods (TSN) reported that corn (CORN) costs were roughly 69 percent of the cost of raising a chicken to maturity and that they expected those costs to rise by $600 million in their fiscal 2013. Through the first 3 quarters of the company's 2013 fiscal year, they have realized roughly $440 million of those costs.
Despite the large decline in corn prices since the August 2012 highs, the average farm price of $6.90 per bushel was 13 percent higher than the previous year. The company managed to keep the operating margins of their chicken segment at the low-end of their initial 5 to 7 percent forecast. With average corn prices projected to tumble by 30 percent during the 2013/14 marketing year I expect Tyson Foods chicken segment to feast on strong operating profitability.
Archer Daniels Midland (ADM) expects corn prices to fall sharply and expressed concern on their 2nd quarter conference call about having higher cost inventory on hand that they must sell at lower market prices. The lower prices should make substitutes like high fructose corn syrup more competitive with sugar in 2014. While COO Juan Luciano would not be specific, he felt that it was probable that $5 corn would be competitive with sugar. The company is also optimistic about ethanol demand in 2014 and 2015 and plan to fill their bins with the lower cost corn.
Falling crop prices are influencing fertilizer demand and by extension, fertilizer prices. According to producer price data, prices for fertilizer have fallen across the board in 2013.
As figure 3 illustrates, through August ammonia prices have fallen 18 percent. However, prices actually rose through May before plunging nearly 40 percent over the next 3 months. For CF Industries (CF), sales of nitrogen-based fertilizers have accounted for more than 80% of firm revenues since 2010. Company sales will not show the price declines in ammonia until the company's reports its 3rd quarter results.
Potash pricing has been the most stable, down only 3 percent year-to-date. In my opinion, potash prices would have fallen more this year if the large North American Potash producers Mosaic (MOS), Potash Corp. (POT), and Agrium (AGU) were not working so diligently to keep prices from falling sharply. One of the ways they have done this is with a consignment program. The companies store potash in proximity to dealers, allowing them to sell product without taking on sizable price risk as they did in 2008, burning them badly. Phosphate prices have fallen steadily throughout the year, negatively affecting Mosaic's results as roughly 70% of company revenues come from peddling phosphate.
Since I wrote "Corn And Soybean Prices Have Opposite Effect On Fertilizer, Food Company Stocks", on March 18 the stocks of Tyson Foods and Archer Daniels Midland have risen 23.4 and 9.8 percent, respectively while fertilizer stocks Potash Corp., Mosaic, Agrium, and CF Industries are down 20.5, 26.6, 12.9, and 4.9 percent, respectively.
Accelerating and amplifying the gradual decline in the fertilizer stocks was the recent breakup of a joint venture between OAO Uralkali (OTC:URALL) and Belaruskali in late July. Recent statements by Vladimir Putin and rumors that Investor Suleiman Kerimov has sold his 22 percent Uralkali stake to investor Vladimir Kogan for $3.7 billion have caused fertilizer shares to rebound, as investors believe the sale would repair the relationship between the two companies. This thinking ignores the relationship between crop and fertilizer prices.
In my opinion, once the short-term speculation ends and investor focus returns to the business of producing and selling fertilizer this trading volatility will ease and those stocks will likely decline again. The short-to-intermediate term prospects for both Tyson Foods and Archer Daniels Midland look bright while the fertilizer companies will have to wait for crop prices to find a bottom before the resulting farm economics play their role in helping fertilizer prices find the right level.