The Bureau of Meteorology has moved to an ‘El Niño watch’, which means the likelihood of it this year is around double the average at 50%. Our analysis of past El Niño events demonstrates Elders, Graincorp, Nufarm, and RuralCo are the most susceptible to share price underperformance, and that Websters and Huon are subject to production risk, particularly WBA in relation to cotton production and access to water.
There have been 14 El Niño events since 1965. While some data sets are limited in nature and there are distortions in the 1960-1980’s due to the general yield improvements through technology adoption in the sector, there are a number of observations we can make.
East coast grain production: The most susceptible commodity to an El Niño is the east coast grain crop. The east coast wheat yield is the longest historical data set and in our view serves as a reasonable proxy for overall winter cropping yield outcomes. In the past 14 events the average yields in El Niño years has been 22% below the long-term average (1961-2016). The most susceptible stock to a reduction in crop yield is GNC where ~45% of FY17e EBIT is reliant on the crop size. Second derivative exposure to the crop are those leveraged into supplying crop protection and fertiliser products and it is therefore no surprise that NUF, ELD, & RHL have been material underperformers (in share price terms) during past El Niño events. To an extent NUF should be the most insulated of the group, given its exposure to counter seasonal earnings in Brazil, though this is largely dependent on the timing of onset and fade of the event. It should be noted that a historical look at herbicide sales in El Nino years indicates a surprising on average 4% YOY uplift in sales values. Fertiliser sales also demonstrated a surprising average 1% YOY uplift in fertiliser sales in the total of Australia.
Cotton: On average hectares planted have been 4% higher YOY in El Niño years and yield 3% higher YOY. As a summer crop, the timing of El Niño onset and availability of carryover water is particularly important for the cotton crop development. We suspect a better indication of the impact is the 34% negative deviation in crop size relative to the rolling 10 year average in El Niño years. This suggests that the impact is potentially more dependent on rainfall activity entering the event rather than the event itself and is likely reflective of the large dependence on irrigation. We also note that it can take up to 12 months for the impact to be felt in crop acreage, suggesting again that water availability into the event is an equally as important indicator.
Milk production: There is a fairly limited history for the share price performances of dairy processors in El Niño events and it should be noted that in 2015-16 there was a material uplift in most dairy related exposures on optimism of infant formula sales into China which significantly distorts the performance of many stocks. While there is no clear YOY distortion in annual milk production since 1966, there is an average 6% YOY fall in East Australian milk production in the last four events. It is reasonable to suggest that lower access to water and hence pasture is a negative for annual milk production.
Sheep and cattle: Lower rainfall results in lower pasture growth and rising feed costs. As a consequence we observe an average 12% YOY decline in the sheep flock and an average 2% YOY decline in the cattle herd. This suggests rising slaughter rates which to a degree are reflected in weaker average prices (down on average 5% through each past event in cattle). Agency based businesses generate earnings in livestock from the value of turnover, as such weaker prices on rising supply can counteract one another in terms of commissions generated.
Wool: Wool volumes also take a noticeable 7% YOY decline in El Niño years. The majority of agency based revenues are volume based and as such softer volumes result in lower commissions.
In this report, ‘The Muster’, we look at this in more detail and round up all the recent corporate news and views in the Agriculture and FMCG space.
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