Dear Reader,
The global food situation is teetering on the edge of disaster as yields weaken, weather patterns shift, and geopolitical tensions escalate. There are many ways to look at stress points for how a crop’s yield will be, and it shouldn’t be surprising that many of them focus on what ultimately determines the quality of a crop – weather. Let’s review this aspect in this month’s issue.
The Importance of Bumper Crops
A food crisis doesn’t build overnight. Instead, it compounds over time as limited volume becomes available for the world.
Every country has grain silos and other storage facilities to help bridge gaps, But the world also needs “bumper crops” to help refill the coffers for the lean years. The problem is the lean years have become more pervasive while the “bumper” years are fewer and far between. Droughts in pivotal growing regions have become more frequent, which is made worse by overfarming, soil degradation, overuse of fertilizers, poor crop rotation, and other limiting factors.
Here are two charts looking at current drought conditions when evaluating potential yields. It’s important to track multiple versions of crop monitors because there can be some variation in methodology as well as timely data collection.
On a global basis, we have seen some improvement lately out of India and Western Europe, while there has been further degradation in North America and Argentina. Brazil started off weak, but with recent rainfall, there has been a bit of a recovery. Central Asia and Africa continue to struggle, which is a huge problem when you consider it’s where the most stressed farmers and local populace reside.
The availability of products is putting more stress on these sensitive locations that are struggling to source the shortfalls. There are several different growing seasons, and it’s important to track the progress of them as we go from one to the next.
U.S. winter wheat was one of the worst harvests in our history, and so far, spring wheat isn’t fairing much better. Spring wheat was 12% planted as of this past Sunday, the third slowest up to that date behind 1997 & 2011. Last year started a bit faster, but overly wet spring weather led to a record-slow planting pace by late May 2022. Spring wheat acres are forecast at 51-year lows in 2023.
The top spring wheat grower, North Dakota, is 6% planted, behind the average of 13% but ahead of last year’s 5%. North Dakota had gotten off to a slow start in a handful of other years but avoiding the 2022 progression will be key.
Global Wheat Crop Production Is Dire
Farmers are going to plant what they believe will unlock the most value when it fits into their crop rotation. Each crop requires a different amount of nutrients and is either a net negative or positive for what it removes from the soil.
For example, corn is essentially a weed that removes a lot of nitrogen from the soil while alfalfa is a net positive that replenishes nutrients in the soil. As corn acreage grows, it will require more nitrogen to be placed on the soil to ensure a successful crop and underlying yield.
Wheat is a neutral crop, but there are global issues when we look at food flows for the global population. It is a pivotal crop for global consumption, but we are seeing problems with the wheat crop in the U.S. as well as other areas in Africa as well as Russia/Ukraine. The deal that is front and center is the Black Sea Grain Initiative.
This deal allows Ukraine to export millions of tonnes of grain through the Black Sea despite the ongoing conflict with Russia. Ukraine is alleging that Russia is blocking ship inspections.
Farhan Haq, a spokesperson for the UN secretary-general said this week, “The Joint Coordination Centre didn’t reach an agreement Friday to authorize new vessels to participate in the Black Sea Grain Initiative. Traffic through the corridor has suffered repeated disruptions recently. While several outbound grain-laden vessels were cleared on May 6 and 7, no inspections are taking place on Monday, according to Ukraine.”
Also, Russia is claiming that two Ukrainian UAVs attempted to assassinate Putin in Moscow. This can be used as a means to not renew the current grain deal that is set to expire this month.
These pressure points are limiting wheat and corn flows out of the region, which has already taken down expected yields. Russia pegs its 2023 wheat harvest at 78 million tonnes, down from more than 100 tonnes last year. The estimate takes into account Ukrainian territories claimed by Russia.
The pressure keeps growing as Ukraine has been unable to receive the necessary personnel, equipment, fertilizer, and seeds to launch a successful planting campaign. This doesn’t even include the farmland that has been mined and is the location of current battles and fortifications. Flows from the region – whether Russian or Ukraine – will be falling significantly. This will push countries to get their products from other regions.
When we look at the UN Food and Agriculture Price Index, there has been some pullback in pricing. But even with the decrease, it still sits at historic levels. The Invesco Ag Fund factors in the future, which has started to shift higher and highlight that the pressure on the consumer is far from over.
Our Recommendation
There is a way to capitalize on these headwinds to global rotating crop production.
CF Industries Holdings, Inc. (NYSE: CF) is an American manufacturer and distributor of agricultural fertilizer that operates nine manufacturing complexes worldwide comprising 17 ammonia plants, the largest of which is in Donaldsonville, Louisiana.
The company is a member of the S&P 500 index, and its market cap is $13.20 billion. CF Industries’ chief competitors include Mosaic (MOS), Scotts Miracle-Gro (SMG), ICL Group (ICL), Bunge Ltd. (BG), and AngloGold Ashanti (AU).
The keys to the success of CF are its high asset utilization and productivity, an extensive multimode distribution network to lower logistics costs, maximizing margins by optimizing customer locations and product type, and a focus on cost management.
As wheat remains a problem, corn acreage has been accelerating, especially in the U.S. This opens up an opportunity to pick up a key company like CF Industries that provides nitrogen to the industry.
Prices for urea (a key fertilizer supplement) have been supported in New Orleans (NOLA) and we continue to see price appreciation given the advantaged feedstock in the U.S. There is continued strength in the U.S. as corn acreage grows and natural gas (main input for Urea) stays at a significant discount vs global cost.
Global nitrogen demand is coming back as natural gas prices have fallen back down and farmers look to buy excess to replenish grain stocks. We have already covered the different ways that the ability to cover shortages will be limited, but farmers will be incentivized to find ways to bump yield especially as costs fall.
From the CF earnings call:
“Forward price curves suggest that energy spreads between North America and high-cost producers in Europe and Asia will continue to be significantly wider than historical averages. As a result, we expect to continue to generate substantial free cash flow. This will enable us to both invest in growth and return capital to shareholders.
Pricing in North America started off sluggish as buyers were willing to buy discounted Russian flow, which reduced some demand for CF products.
We expect this to be an active fertilizer season, application season in 2023 with corn acres in the U.S. expected to be up about 5% and wheat acres up around 9% compared to 2022.”
The market is still facing global Urea constraints as China has limited exports of all fertilizers. As China remains on the sideline, we will have more product flow from the U.S. to meet the demand.
The flow from the U.S. is supported by the advantaged feedstock vs the rest of the world. India, Asia, and Latin America imports will remain elevated in 2023 supporting additional price appreciation on urea.
There are multiple suppliers that produce urea around the world, but the reasons we think CF is a formidable company is multi-faceted.
Well managed exposure to natural gas. Their geographical locations and hedging profiles open them up to more realized movements in urea.
Crop returns for corn are above the seven-year average. This will keep acreage levels robust and drive the additional need for nitrogen. There remains a low stock-to-use ratio which will keep elevated flows of fertilizer into the market.
Strong free cash flow. CF has very strong free cash flow metrics that support the view of undervalued equity as the market heats up into the planting season.
A pivot to clean alternatives. There is a big pivot to support “clean” farming, and the use of sustainable and renewable fertilizers. Some $3.1 billion — three times more than originally planned — would be spent on 141 pilot projects to offer incentives that encourage producers to adopt climate-mitigating practices on working lands.
The charts below give evidence of why CF is well-positioned to take advantage of a strong fertilizer season.
There are a significant number of grants that can be captured to deliver up to $100 credit per acre enrolled in the program. This is being supported by the pivot to using more “green ammonia.” By making this pivot, they can receive support from the Inflation Reduction Act as well as meet the needs of the future.
Conclusion
The pivot to green in a stable and efficient transitional manner is paramount. We don’t want to disrupt the normal flows of current products while the world works towards the energy transition. The transition can’t happen overnight but has to be managed over the long term to meet the needs of a changing environment.
The U.S. has one of the worst harvests on record with spring wheat not any better. Mixing this with Russia taking their “estimates” from 100M tons to 78 and now no longer allowing for Ukrainian inspections in accordance with the Black Sea Deal means the situation is dire.
Farmers and agricultural businesses are bracing for the impact of a winter wheat harvest devastated by prolonged drought across much of the United States, including central and western Oklahoma. More than half of the Sooner State’s wheat crop is in poor condition, and producers warn that consumers and local economies likely will face financial impacts.
The U.S. is seeing levels of drought that rival the “Dust Bowl” of the 1930s with more stress on yields. There is a global problem surrounding food that must be addressed head-on.
Remember… if we don’t address it, people will kill to eat. The favorable fundamentals of CF Industries are well positioned to provide the needs to attack the coming global food shortage.
Action to Take:
***BUY CF Industries Holdings Inc. (NYSE: CF) up to $68 per share***
Good Hunting,
Freedom Financial News
