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Investment thesis
Outlook: the fight for acreage and wheat
The latest Prospective Plantings Report held some surprises for investors. Based on our
perspective, corn and soybeans will continue to fight for acreage and the attention of the
farmer via price. The USDA’s survey suggested that farmers were initially, going into the
2008 crop, favoring soybeans over corn. This led to an initial drop in soybean prices and rise
in corn prices, although some seed purchasing data in the aftermath, pointed to farmers
moving quickly back to corn. During this struggle between corn and soybeans, wheat has
come down from its peak (around $23/bushel on the relatively illiquid Minneapolis exchange).
Based on global plantings and farmer intentions, it appears wheat acreage will be up around
3% in 2008. Wheat is a truly global crop with significant acreage in the U.S., Canada,
Australia, India and Eastern Europe. Just as other crop prices are being lifted due to greater
demand from developing markets, low inventory levels, and government policies, so too has
wheat been impacted. But wheat has also suffered from particularly poor growing conditions
in recent years in the U.S., Europe and Australia. Assuming the weather is more
accommodative, we believe wheat is one commodity that could see some downside.
This bodes well for selected package food companies with high exposure to wheat such as
bakers like FLO, SLE and CPB as well as broader snack/cereal companies such as GIS, SJM,
K and KFT. These companies have raised prices significantly over the last 18-24 months as
an offset to the high input cost pressure including wheat. All of these companies hedge
exposure significantly as they are always “long” grain given demand is stable. Even though
the companies are hedged, basis risk and paying up for quality are other factors lifting cost.
Although a rollover in wheat cost in the next year or two would not immediately benefit
results due to the ongoing hedges, investors would likely bid up the shares very quickly in
anticipation of expanding margins. We aren’t yet ready to emphasize such a scenario, but
based on our view of the acreage wars, it appears companies with greater exposure to
wheat may be in a relatively better position.
Valuation & risks
To value commodity processors, we rely upon peak or normalized earnings expectations.
Using P/E as an example, we generally believe commodity processors should trade at 11-14x
normalized earnings. We use a 9% WACC to discount future projections. This 9% WACC is
derived via CAPM (0.8x beta, 4.5% risk free rate, 10% expected return). Commodity-oriented
stocks trade at significant discounts to more predictable, consumer-oriented stocks. When
appropriate we will use other valuation metrics to derive stock targets including traditional
tools (such as P/E, EV/EBIT and EV/EBITDA), our hybrid DCF/EVA model as well as our
proprietary IVCC valuation methodology, which values incremental economic profit.
Commodity processors should be viewed by investors as having substantial risk. Although
LT demand growth expectations are 3-4% and fairly predictable, the earnings cycle for more
commodity-oriented companies can create significant volatility with large swings in earnings
and cash flow. In general these commodity-oriented companies have lower profit margins
vs. packaged food companies and must deal with a litany of risks including: commodity price
swings, trade disputes, competition, currency, input cost pressure, substitution and weather.
Table of Contents
Investment thesis......................................................................................... 3
Corn: supply & use....................................................................................... 4
Corn ............................................................................................................... 5
Net corn costs .............................................................................................. 7
Corn oil.......................................................................................................... 9
Corn gluten meal........................................................................................ 11
Corn gluten feed......................................................................................... 13
High fructose corn syrup ........................................................................... 15
Ethanol ........................................................................................................ 16
Soybeans: supply & use ............................................................................ 17
Soybeans..................................................................................................... 18
Soybean meal: supply & use..................................................................... 20
Soybean meal ............................................................................................. 21
Soybean oil: supply & use......................................................................... 23
Soybean oil ................................................................................................. 24
Soybean crushing margins........................................................................ 26
Wheat: supply & use.................................................................................. 28
Wheat .......................................................................................................... 29
Poultry: broiler............................................................................................ 31
Poultry: skinless boneless breast ............................................................. 33
Poultry: leg quarters .................................................................................. 35
Poultry: turkey tom breast ........................................................................ 37
Hogs............................................................................................................. 39
Pork: cutout ................................................................................................ 41
Pork: packing margins ............................................................................... 43
Cattle ........................................................................................................... 45
Beef: packing margins ............................................................................... 46
Fluid milk .................................................................................................... 48
Cheese......................................................................................................... 50
Cocoa........................................................................................................... 52
Coffee .......................................................................................................... 54
Sugar ........................................................................................................... 56
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