Fertilizer firms hitch fortunes to the elements
LONDON (MarketWatch) -- Earth, air, water and fire.
Analysts say the volatility of the four elements pose a significant threat to farmers' future harvests, but are also instrumental in boosting the growth outlook for players in the agrochemicals sector.
"Parts of the world are in the middle of a huge drought and grain crops are falling short of demand. Grain supply is tight, food prices are rising so farmers can afford to invest more," said Felicity Smith, senior research analyst at Bedlam Asset Management.
"At the same time, politicians are pushing [farmers] to increase yields, so farmers need fertilizers and crop protection to make sure those yields are rising," Smith added.
Farming conditions have been particularly rough this year across the globe, with the U.S. standing out as one of the hardest-hit places. Seventy-eight percent of the contiguous U.S. has experienced moderate-to-exceptional drought conditions, with July the hottest month on record, according to the National Drought Mitigation Center at the University of Nebraska-Lincoln.
The severe drought across the country's "bread basket" has sent prices for corn, soybeans and wheat soaring, and the U.S. Department of Agriculture forecasts that all food prices will climb 3% to 4% in 2013. See: USDA's 2012-2013 food-inflation outlook unchanged.
Meanwhile, harvest forecasts in Russia have been cut as drought has affected the nation's eastern regions, and in the U.K., heavy rainfall in some areas has hampered harvesting.
Parviz Koohafkan, director at the Land and Water division of the Food and Agriculture Organization of the United Nations, said that in the light of the climate-related threats to food production "obviously there will be a higher demand for fertilizers. Just the scenario of people starving will increase the call for higher food production."
"But it isn't going to solve the problem. We need to diversify and the type of fertilizer and usage will change," he added. "Modern agriculture is based on big farms and mono-cropping, which is much more fragile to climate change. If a disease breaks out within a crop, it will be very dramatic because of the extension of these systems."
Still, the need for agrochemicals to sustain farming is likely to increase steadily over the coming years. The FAO expects more severe weather conditions, which increase the frequency and severity of extreme events such as cyclones, floods, hailstorms and drought. All conditions that would bring further volatility in crop yields and local food supplies.
In a report, the International Fertilizer Industry Association, based in Paris, estimated that for 2012-2016 fertilizer demand will "steadily increas[e] in response to supportive agricultural market fundamentals", and specifically that demand will rise 2.8% in 2012 and 2.5% in 2013. About 60% of the demand growth forecast for the five-year period is forecast to come from South Asia. India and China are the largest consumers of fertilizers, with companies such as China's Sinochem International Corp. (600500) and India's
Within the European space, Bedlam's Smith highlighted companies like Swiss
Since the start of the year, the agrochemicals sector in the U.S. has outperformed the broader S&P 500 index (SPX) (SPX) In Europe, there is no specific agrochemicals subcomponent on the benchmark Stoxx Europe 600 index (SXXP) , but the broader chemicals sector, which includes companies such as Yara International, Bayer and Syngenta, has outpaced the wider regional stock market.
"Most companies in the agrochemicals sector, such as fertilizers and crop protection, as well as companies that produce seeds and agricultural equipment in general, would be a good investment," Smith said.
"If the harvest is better next year, food prices will correct themselves, but long term there is clearly a trend. We think that grain prices can fall a long way before farmers would have a disincentive to invest," she added.
Bill Herz, vice president of scientific programs at The Fertilizer Institute, a trade association based in Washington, D.C., said, "Farmers will be planning to have the best year they possibly can next year and we expect good prices for crop nutrients and crop protection."
In Europe, there is additional reason for optimism for the sector.
Jacob B. Hansen, director general at Fertilizers Europe, a trade organization based in Brussels, said that large parts of Eastern Europe weren't used for farming after the end of the Soviet regime in the early 1990s, as cash-strapped farmers had little money to invest. Consequently, the use of fertilizers dropped dramatically, but as the region's agricultural sector is growing again the demand for nutrients is rising.
"There is always a danger you overshoot production and it can be quite a volatile sector even if demand is growing steadily," Hansen said. "But in terms of basic demand we are in a very sound sector and will have increased demand in the future because the world needs more food."
However, Hansen also said that if too much fertilizer comes to the market prices would fall. "Globally everybody is trying to figure out how to" play this, he said.