Corn: Near-Term Weakness Affecting U.S. Farm Incomes

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Includes: ADM, BG, CORN, DE, MON
by: LD Investments

Summary

Corn is America’s most valuable crop.

Domestic demand has been driven by ethanol production. With current ethanol oversupply, it is unclear whether this would continue. A stronger dollar is likely to limit U.S. corn exports.

U.S. and world corn ending stocks are at multi-year highs.

U.S. farmers intend to plant more corn despite low prices and high inventories.

China’s decision to end its corn inventory program at a time of plentiful corn supplies and high inventories could put downward pressure on near-term corn prices.

Please take note this is only one aspect in weighing the attractiveness or non-attractiveness of the companies mentioned in the article as an investment and should not be used independent of other factors. This piece only examines one business segment of the companies mentioned and other factors such as valuation are not addressed.

The United States is the world's largest corn producer and corn is America's most valuable crop.

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Source: ageconomists.com

Slumping grain prices which includes corn have hit incomes for farmers in Iowa and across the Corn Belt, contributing to the current agricultural downturn thereby impacting agricultural businesses such as Deere and Co. (NYSE:DE) and Monsanto (NYSE:MON). Agriculture traders such as Cargill, Archer Daniels Midland (NYSE:ADM) and Bunge (NYSE:BG) are also facing difficulties as a result of limited demand for U.S. corn (due to a stronger dollar) amid an oversupplied world market.

Domestic corn demand lacks significant demand drivers

The United States is the world's largest ethanol producer and almost all of U.S. ethanol produced is based on corn as a feedstock.

Historically, the bulk of U.S. corn demand was for feed and residual use. From modest beginnings in 1980, corn use for ethanol increased rapidly, and over the past decade, much of domestic corn demand was driven by increasing ethanol production. In 1996, over 70% of U.S. corn demand was for feed and residual use while less than 8% was used for ethanol. By 2015, over 30% of U.S. corn was used for ethanol production.

Source: U.S. Department of Agriculture

Corn demand for ethanol has been improving recently though it has not offset declines in corn demand for feed and residual use. Considering the current oversupply of U.S. ethanol, it remains to be seen whether corn demand for ethanol is a sustainable demand driver going forward.

Corn-based ethanol production is expected to decline over the longer term. USDA projections show that corn demand for ethanol production is expected to decline over the next decade, partially due to declining overall gasoline consumption in the United States (which is mostly a 10% ethanol blend, E10), infrastructural and other constraints on growth for E15 (15% ethanol blend), and the small size of the market for E85 (85% ethanol blend), with less-than-offsetting increases in U.S. ethanol exports.

Source: U.S. Department of Agriculture

Export demand for U.S. corn impacted by strengthening dollar

The United States is the world's largest corn exporter. Exports make up less than 20% of demand for U.S. corn.

Source: World of Corn

The two biggest U.S. competitors for soybean sales on the world market, Brazil and Argentina, have been making inroads in the world corn market as well.

Source: U.S. Department of Agriculture

Corn exporters in Brazil and Argentina have been helped by depreciating currencies, which make their corn exports more price competitive. Since January 2015, the Brazilian Real depreciated over 20% against the U.S. Dollar, while the Argentine Peso has depreciated 40% against the U.S. Dollar.

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Source: Google Finance

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Source: Google Finance

The two countries are expected to limit America's share of the world's corn export market to 32% this marketing year, a 5% drop from last year. U.S. corn exports of 42 million tons would be the smallest since the 2012 drought, although still the largest in the world. By contrast, Brazil is headed for record exports of 36.5 million tons, a 66% increase in one year. Argentina will record its second-largest export total, 19.5 million tons, up 1 million tons from last year.

The EU is the world's largest corn importer and is the world's third-largest corn consumer after the U.S. and China.

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Source: IndexMundi

Cheap corn has partially contributed to surging corn imports from the EU - the 28-nation EU is expected to import a record 16 million tons of corn during the year ending June, up 83% from the previous year.

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Source: Bloomberg

However, surging EU corn imports are unlikely to have a significant impact on U.S. corn exports considering Ukraine and Brazil are the EU's largest corn suppliers, again helped by depreciating currencies.

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Source: Bloomberg

Since January 2015, the Euro has depreciated about 7% against the U.S. dollar while the Euro has appreciated against the Ukrainian hryvnia by over 40%.

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Source: Google Finance

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Source: Google Finance

Brazil has temporarily lifted a tax on corn imports for a maximum quantity of 1 million tons, amid tight domestic supplies. Brazil is expected to import between 500,000 and 700,000 tons of corn in the coming months to June. However, most of that imported corn would come from Argentina and Paraguay. U.S. corn would have to compete with Argentine corn (U.S. corn could be competitive in Northeast Brazil), and it remains to be seen how much U.S. corn would actually be imported.

Barring any weather disruptions, near-term supply pressures are increasing

The United States, China and Brazil are the world's three largest corn producing nations.

Source: World of Corn

The price for corn has slumped 50% since reaching record highs in 2012.

Source: NASDAQ

Despite the slump in corn prices and record high global inventories, US farmers in 2016 have indicated plans to plant the third most corn on record despite low prices. The US Department of Agriculture survey of American farmers signaled they would plant 94 million acres of corn this spring, up 6% from last year and the highest amount since 2013.

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Source: World of Corn

China, the world's second largest corn producer, will produce about 2% less corn during the 2015-16 growing season than previously anticipated, according to the United Nations' Food and Agricultural Organization. The FAO now expects the country to produce 221 million tons of corn instead of the forecasted 226 million tons.

At first glance, this may seem to offer some relief to domestic supply pressures. However the relief is expected to be minimal considering China's domestic corn consumption also is expected to fall. In fact, the FAO expects China's corn inventories to rise 5% at the end of the crop year.

Brazil's corn production for 2015-2016 is estimated at 85 million tons according to the USDA. Strong exports, which are being boosted by a weaker currency and high domestic corn prices lend support for corn plantings in Brazil. Brazil's corn production for 2016-2017 is forecasted at 86 million tons - which if realized would be a record.

Overall, corn harvests around the world will exceed demand for the fifth straight year according to the USDA.

Record high inventories

U.S. corn ending stocks are the largest in a decade.

Source: World of Corn

A continued U.S. corn supply/demand mismatch has seen the USDA peg 2015-2016 corn ending stocks at 1.862 billion bushels (about 47.2 million tons), up 25 million bushels from its March outlook. Analysts, on average, had forecast corn ending stocks of 1.845 billion bushels.

The USDA raised its outlook for global corn ending stocks to 208.91 million tons - a record high. The average of analysts' forecasts was 207.35 million tons for global corn ending stocks.

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Source: advantagefutures.com

Over half of those stocks are held in China.

China's planned ending of its corn inventory program could exacerbate near-term excess supply

This year, China, the world's second largest corn producer, will end its corn-inventory program, replacing the program with other farm subsidies. Years of preferential policies contributed to high domestic corn prices, which caused a rapid expansion in the corn industry and excessive corn supply. Domestic corn prices are about 25%-40% higher than import prices.

Source: U.S. Department of Agriculture

This led to excess amounts of corn stockpiled in China, ultimately giving rise to the "surplus crisis" the country is currently experiencing.

It estimated that China holds more than half (about 60%) of the world's corn stocks, amounting to more than 150 million tons, three times the amount of U.S. corn stocks, which are the largest in a decade.

China's decision to allow the market to determine domestic corn prices is likely to add further pressure on corn prices going forward. China may release some of the stocks to the world markets, and corn imports from China - the world's second largest corn consumer - are expected to slump 54% to 2.5 million tons in 2015-2016 from 5.516 million tons in 2014-2015. While imports slump, exports are expected to increase. Chinese corn exports are expected to be 50,000 tons in 2015-2016, a 400% jump from 2014-2015. China was a net exporter of corn until 2010.

Conclusion:

A major demand driver for U.S. domestic corn consumption has been ethanol production. However, while corn demand for ethanol production will continue to be strong, growth may not keep pace with increasing domestic supply. Despite low corn prices and U.S. corn inventories at highest levels in a decade, U.S. farmers have signaled intent to plant more corn, indicating excess supply conditions are likely to persist barring any supply disruptions such as unfavorable weather.

A stronger dollar is likely to limit U.S. corn exports indicating a continued domestic supply/demand mismatch, which should further raise U.S. corn stocks and put pressure on U.S. farm incomes. The EU, the biggest corn importer, has seen surging corn imports but the impact on U.S. farm incomes is likely to be limited considering corn from Ukraine and Brazil are more price competitive thanks to their currencies which have depreciated against the euro.

Globally, a supply/demand mismatch in previous years has contributed to record high global corn inventories. Over half of those inventories are held in China. Going forward, China's decision to reduce its corn inventories could see increasing corn exports while imports fall. China is not a major importer of corn (it is not among the top 10 largest corn importing nations). However, the decision to liberalize its corn market at a time when the global corn market is faced with ample corn supplies and record high inventories could put downward pressure on corn prices.

Barring any supply disruptions due to weather, these factors suggest corn weakness is likely to continue in the near term, affecting U.S. farm incomes. Since hitting a record high in 2012, the USDA forecasts corn receipts to fall 36% through 2016, primarily due to lower prices. While production is expected to increase slightly in 2016, continued weakening in corn prices - America's most valuable crop - is expected to more than offset production gains, leading corn cash receipts to fall by $0.8 billion in 2016.

Source: USDA

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.