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ETF Securities says agriculture may see regrowth


The weaker dollar and the impact of production expenses are having an impact on the agricultural sector, according to James Butterfill Executive Director – Head of Research & Investment Strategist at ETF Securities and Aneeka Gupta Associate –Equity & Commodities Strategist at ETF Securities.

Commenting on crop prices and the latest farm income outlook, James says: “A sustained period of high crop prices from 2008 to 2012 led to a bout of investment by agricultural producers, since then falling soft commodity prices have revealed high debt loads and narrowing margins. However the drop in input expenses coupled with a turnaround in sentiment is painting a more optimistic picture for agricultural producers heading into 2016.
“In the latest farm income outlook released by the United States Department of Agriculture (USDA), US net farm income, a key indicator of U.S. farm well-being, is forecast to decline by 3 per cent in 2016. While this will be the third consecutive year in decline, it is not as severe as the declines of -27 per cent and -38 per cent witnessed in the prior years 2014 and 2015 respectively.
“Global nitrogen fertilizer supply is poised to grow as cheap energy prices fuel production increases, providing a boost to their bottom line. Although it is worth noting that the recent squeeze on farmers margins does not eliminate the risk of farmers skipping application of fertiliser or shifting acreage from chemical intensive corn to other crops. We believe the fall in fertiliser costs is likely to benefit both fertiliser producers and farmers.
“Overall farm production expenses are forecast (USDA) to decline for the second consecutive year. Occurrences of multiyear reductions in farm production expenses are rare, the last time being 1984-86. This drop in expenses for inputs such as feed, livestock/ poultry purchases and fuel are forecast to outweigh the increase in interest expenses and hired labour costs thereby alleviating falling cash receipts. More importantly input costs (currently in second year of decline) tend to lag behind commodity price swings (that have been in decline for 4 years).
“Agricultural exports have been a major catalyst for the strong US farm income in prior years, accounting for more than 30 per cent of gross cash farm income. As majority of commodities are priced in US dollars, the appreciation of the dollar against the local currency of non-US growers has made the commodities more expensive for the foreign based buyer. Although it’s difficult to quantify just how much buyers have been sourcing lower cost soft commodities we have seen anecdotal evidence of this behaviour. For example, Brazil’s soya bean exports surpassing US soya bean exports in 2015 are likely due to the Brazilian Real’s depreciation.”
Despite pessimism engulfing the industry, Aneeka Gupta suggests there are signs of optimism.
“Agricultural producers are currently trading at 20x earnings and 3x book value, in line with their respective ten-year average. Profitability of these companies has been volatile given their exposure to the vagaries of the weather. We are currently in one of the most extreme El Niño events on record, dating back to 1950. According to the Australian Bureau of Meteorology, out of the past 26 El Niño events since 1900 approximately 40 per cent have been followed by a La Niña. If this came to pass, wheat, corn, soybeans, coffee and cocoa will benefit from favourable weather thereby negatively impacting prices while sugar prices will benefit on the upside.
“We believe agricultural producers are modestly valued, with profitability starting to turn the corner in-line with shifting positive sentiment. Despite the pessimism that permeates through the farming industry, farm income credit has not been curtailed. While net farm income is forecast to decline for the third consecutive year, the lag in declining expenses is expected to catch up and help alleviate the decline. 2016 has seen a positive turnaround for majority of commodities and is lending support for the price outlook of agricultural commodities.”

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