Wheat Price Run-Up Reminiscent of 2008 Corn Panic

Includes: AGU, CF, DE, MON, MOS, POT
by: Chris Damas
I have a small news clipping saved on my desk (from the AFP newswire) about the Russian drought. It’s dated July 11, 2010 and I plan to paste it to my forehead this weekend.
Because I didn’t pay enough attention to it.
The small clipping has became a big story over the past 2 days. Anyone trading fertilizer stocks off prescient news reports (The Globe and Mail also ran a story on bad Russian weather dated July 8), was destined to make serious money on Ag stocks.
My little note says drought had destroyed nine million hectares of crops in Russia and the Russians had declared a state of emergency in 14 regions. Russia has about 200 million acres of cultivated land, and the agriculture ministry revised its 2010 forecast for cereal crop yields down from 95 to 85 million metric tonnes.
On July 11, CME wheat prices were just breaking stride at $5.75/bushel on the December contract. Almost a month later, December wheat hit $8.68, but closed down 60 cents to $7.55.
The seeds of the Russian drought were evident to careful weather watchers as far back as April. But who was watching Russian weather when Greece was threatening to destroy the euro zone?
My feeling is the commodity rally will cool off for at least a week, as the market assesses the Russian wheat crop damage and decides it “can’t get any worse”. I.e. Sell!
The stocks of Agrium (NYSE:AGU), CF Industries (NYSE:CF), Mosaic Company (NYSE:MOS) and PotashCorp (NYSE:POT) all enjoyed a second stage rally in the latter half of July and early August, after coming off a year bottom in late June. Not to mention other ag stocks, such as John Deere (NYSE:DE), Monsanto (NYSE:MON) and Viterra up here in Canada.
Yesterday and today’s price spike was caused by Russian Premier Putin’s forbidding of any further Russian wheat exports until year end (Russia is the third largest global wheat supplier).
The fact wheat futures made a significant downward reversal today doesn’t surprise me.
The current Russian Wheat Panic spike is reminiscent of the effect of the US Midwest Floods of June 2008, when river overflows obliterated crops on several million acres of prime Iowa, Indiana, Illinois farmland.
In the case of the Floods, Corn was the main worry, and reached over $7.50 a bushel but all the upside coincided with reporting of the actual event. Then it was a slow, painful decline for not only corn, but most other cereal prices.
Global wheat stocks were in a large surplus position before the current drought and fires in Russia. The drought has also impacted Europe, Kazakhstan and the Ukraine.
A review of the potential wheat deficit from the former USSR countries (7.5 million tons) would indicate that by Fall, US and Australian, not to mention Russian wheat in the North, will cover the shortfall.
In fact, the huge run-up in wheat prices could have been fueled by frantic short covering by hedge funds, as being short looked like an easy moneymaker until July.
Therefore, I believe the run-up in crop prices should be watched with caution.When the wheat price turns farther down as it started today, it will take positive sentiment towards fertilizer stocks with it, at least in the short term.
A note on CF Industries (CF), which reported its Q2 ending June 30 on Friday:
CF Industries missed our $5.04 per share cash flow target, coming in at $4.01. We also were looking for revenue of about $1.5 billion and it came in slightly over $1.3 billin.
CF has many more moving parts now that they have Terra Industries after the lengthy battle to reel them in. The Q2 includes full results from both legacy companies.
Ironically, more revenue growth came from the Terra side (up $72.5 million over Q2 last year) than the CF side (down $209 million year over year).
The CF legacy nitrogen business sold 1.9 million tons, whereas the historically larger Terra nitrogen business, sold 2.0 million tons. CF’s phosphate business sold 459,000 tons, for a total tonnage of 4.36 million tons company wide.
The better Terra-side (for lack of a better term) results could be due to the more stable industrial nitrogen results from Terra’s IGAN product (used for explosives) and the ammonia imports from Terra’s JV with Koch Industries at Point Lisas in Trinidad and Tobago.
The Second Quarter, typically the most important for US domestic fertilizer, was lopsided, as in April and May, US farmers were hesitant to bid up agricultural nitrogen prices (the main product of the group), due to the credit crisis, the headlines out of Europe, and still depressed grain crop prices.
By June, things started to look better, but nitrogen prices and revenues for the group were weak on average for the quarter. Gross margin for the Nitrogen business came in at $367.5 million, 9% lower than the $403.2 million for Q2 of 2009.
Only one half (1.379 million) of the combined 2.8 million annual tonnage of ammonia the legacy companies have sold on average over the past few years, was laid down in the first half.
UAN sales at 1.56 million tons for Q2 were on track, but you couldn’t get very good prices for UAN during the early part of the quarter, as ammonia application was preferred during early Spring. (Due to its volatility, ammonia is preferred for application during cold Spring weather).
UAN prices may also have been depressed due to import competition from the MHT operation startup in Trinidad (owned by Helm AG).
Conversely, phosphate (DAP and MAP) demand has been strong in the USA, and prices have been high. Gross margin for the phosphate segment was $29.3 million, or 15.8% of sales.
Therefore, a solid 2010 second half refill and fall application season will be required for CF to mount even better results than Q2.
Prospects for CF Industries are good. But at the $85.80 closing price yesterday, CF is trading at 8.17 times our $10.50 estimated cash flow per share for the entire 2010.
Reaching that target will require CF company staff and its CEO Steven Wilson, to execute on the stated strategy of “selling products where they have the highest value” with an operation that is decidedly more complicated than the one they had before the Terra merger.

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