The United States Department of Agriculture (USDA) projects a decline in corn and soybean prices over the next year, which will impact more than just farmers. Crop commodity prices contribute to the overall sales and margins realized by agricultural technology companies, renewable fuel companies, and food producers. If USDA projections are accurate, which companies stand to benefit and which companies could be negatively affected?
The winners
Corn prices and cotton prices are projected to drop over 10% during the 2014-15 marketing year versus the previous 12 months. The projected decline in soybean prices is even greater over the same period, amounting to over 20%. The industries that could profit off of reduced crop commodity prices are those whose operations are dependent on the crops as feedstock or ingredients.
The nation's largest food producers like PepsiCo (PEP 3.62%) and Kraft Foods (KRFT.DL), which manufacture large amounts of corn- and soy-based products, may be paying less for ingredients, but consumers shouldn't expect a corresponding drop in food prices on the shelves. The savings have to be going somewhere, and that should make for moderately improving margins for these companies.
The majority of corn grown in the United States is used as either animal feed or is used in ethanol production. When feed prices drop, meat processors like Tyson Foods and milk producers like Dean Foods can cut operational costs without sacrificing volume or pricing. The more prolonged the drop is in crop commodity prices, the longer food, milk, and meat producers will stand to profit.
Last on the abbreviated list of winners are the ethanol producers. The success of Archer Daniels Midland Company (ADM -0.37%) is highly dependent on crop commodity prices as the company uses these commodities to generate animal feed and ethanol, among several other crop-derived chemicals. ADM's Corn Segment has already been able to benefit from lower corn costs realized in Q4 2013 ADM that cut costs in ethanol production and production of other corn-based products. ADM's Corn Segment should see continued profit gains if crop commodity prices follow the USDA's projections for 2014.
The losers
The losers when crop commodity prices drop are the companies that lose sales when farmers choose to plant less overall acreage or try to hold on to their tightening margins. Basically, the companies that service the farmers are the companies most likely to suffer when crop prices drop.
The anti-ethanol industry uses fundamental macroeconomics to argue that the rise in demand for corn for use in ethanol is the primary culprit behind the rise in corn prices witnessed over the past decade. The model becomes slightly more complex when volume is also considered. With a few recent exceptions due to drought conditions, alongside the rise in corn prices was also a rise in the overall acreage of corn planted, as well as a rise in the yield per acre. The main benefactors of the move toward more corn, besides the farmers, should have been the agricultural product companies like Monsanto (MON) and DuPont (DD) as well as fertilizer companies like Mosaic and Potash Corp.
Again, a lot goes into operating a successful company, but increased demand for high-yield corn seed made it easier for Monsanto and DuPont's agricultural technology division to expand over the past decade. By the same logic, when crop commodity prices drop, the demand for these companies' seed products and their weed control products may drop as well.
The takeaway
USDA projections and actually realized crop prices are two very different things. For example, the crisis in Ukraine has spurred a quick rise in most commodity prices, including crop commodities. Whether prices drop if/when the crisis is resolved is yet to be determined, and how the market will respond is unpredictable.
If crop prices drop, the companies that win are those that use the crops as primary ingredients in their products, and the benefits to these food, feed, and fuel producers should be directly measurable in their quarterly operational expenses. The effects on companies that lose when crop prices drop are less directly measurable, as these effects are secondary in the sense that crop commodity price drops could lead to declining incentive to plant these crops, which would in turn affect seed and fertilizer sales.
In the end, seasonal fluctuations and moderate increases and decreases to crop prices are nothing for investors to worry about when making long-term investments. Watching long-term pricing trends, however, will give investors one more valuable piece of information to use to identify what companies will be the enduring winners or losers in crop-dependent industries.
