While U.S. crops of corn and soybeans wilt in the worst U.S. drought in a half century, winners and losers are emerging in the agriculture sector of the Toronto Stock Exchange (TSX), even if investors are playing it cautious so far.
The drought in the key Midwest growing region has severely curtailed crop yields and harvest projections, pumping up new-crop Chicago corn futures more than 50 per cent since June 1 and driving other grain prices higher too.
But picking stock-market winners and losers from a weather disaster is complex, given the many factors at play.
"From an investor standpoint, what you like to invest in is something which is contributing to dealing with a shortage," said Don Coxe, advisor to the Coxe Global Agribusiness Income Fund. "And the agribusiness stocks are the ones that give the farmers the inputs they need to produce.
Those companies include TSX-listed Potash Corporation of Saskatchewan and Agrium Inc., which are both among the holdings of the Coxe fund, whose own units are up nearly 16 per cent year to date on the TSX, despite a drop in price in the last 13 weeks.
Shares of Agrium and Potash are up 21 per cent and eight per cent since June 1, lagging far behind the spike in corn.
High grain prices typically prompt farmers to apply more fertilizer to maximize the next crop, but the blow to U.S. farmers’ incomes may be so severe that some will forego autumn potash applications and put off machinery buys, Coxe said.
He sees Agrium, a leader in nitrogen production, as a more likely winner than PotashCorp, whose core product is potassium chloride, because of timing differences in applying the nutrients.
But Chris Damas of BCMI Research, an independent equity researcher based in Ontario, said Potash could see sales gains in South America, where farmers appear more willing and able to plant fertilizer-intensive crops like corn and soybeans.
"PotashCorp is more internationally diversified than some of the domestic names, so you might see some benefits," he said.
The drought is more worrisome for Agrium — widely exposed to the U.S. market as its biggest farm retail supplier, he said.
Politics add another layer of uncertainty. U.S. legislators are under pressure to waive the mandate to blend corn-based ethanol in fuel, a step that could weaken corn prices.
That scenario and other factors leave fertilizer shares with greater downside risk than upside, said Charles Neivert, an analyst with Dahlman Rose, who cut Potash and Agrium last week to "hold" ratings from "buy."
Yet most analysts remain bullish on both stocks, with nearly two-thirds of analysts rating both Potash Corp and Agrium a "buy" or "strong buy" according to Thomson Reuters I/B/E/S.
Three analysts have changed their rating on PotashCorp in August, all with downgrades. Four of six analysts who adjusted their Agrium ratings lowered them.
Handlers gain, packers lose
The drought is potentially devastating to meat producers because farmers pay more for feed grain and may reduce their herds, which boosts costs for packers.
Maple Leaf Foods CEO Michael McCain warned last week that the U.S. drought could boost food prices over several years, and the Canadian pork and poultry processor and baker would try to pass on cost increases to consumers.
Maple Leaf’s stock had dropped steadily since spring, but better than expected second-quarter earnings last week have helped it recover some of its value.
Analysts are divided on the stock, with half of its ratings calling it a "buy" or "strong buy" and the other half recommending "hold." But on average the street expects bigger year-over-year earnings per share in the second half as the company takes steps to become more efficient.
By contrast, high prices boost the bottom lines of grain handlers, potentially helping stock prices of Alliance Grain Traders and Legumex Walker, who buy and sell legume crops such as lentils.
Both stocks are up strongly since June.
Sellers of farm machinery or equipment, like Ag Growth International and Hemisphere GPS, are likely to find their products a harder sell in the key Midwest market, even if Canadian farming is a good-news story this year.
Yet agriculture remains the ultimate cyclical play.
In 2008, corn prices spiked to a record high, before crashing months later, taking fertilizer and grain stocks along for the stomach-churning ride.
Coxe says things may be different this time.
"This is the third time in five years that we’ve had soaring grain prices," Coxe said. "What’s sinking in is the notion that maybe we are closer to the edge globally than we thought."
– Rod Nickel writes for Reuters from Winnipeg.