Pop Goes The Corn Market



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BY BRAD KELLY

INVESTOR'S BUSINESS DAILY

Posted 12/7/2007

The U.S. Corn Belt stretches from Ohio to Nebraska and Kansas. Think of it as one giant solar collector.

The energy conversion transforms carbon dioxide and nutrients into a starch, which can be processed into ethanol. This biofuel has become big business, boosting even seemingly unrelated agricultural business in the U.S.

Corn has become a religion of sorts to the agricultural operations industry. The key row crop can be used for producing food, livestock feed or ethanol.

In 2007, more corn was planted to support the large expansion of ethanol. The push has driven corn prices to historic highs and tightened supplies of other key crops such as soybeans.

Farmers planted more than 93 million acres of corn this year, up 24% from 2006. To accommodate more corn acreage, farmers cut about 12 million acres of soybeans.

The result is higher prices, says Paul Westcott, an agricultural economist with the U.S. Department of Agriculture's Economic Research Service.

"The run-up in corn prices triggered an increase (of) corn acreage, tightening supplies of other crops, essentially increasing crop prices across the board," Westcott said.

While the price hikes have benefited many companies within the agricultural industry, seed giant Monsanto (MON) has been particularly fortunate. It saw sales in its corn seed and traits unit surge 72% to $364 million in the fourth quarter.

1. Business

IBD's Agricultural Operations group has risen along with the price of many of its crops. The segment rose to No. 24 of 197 groups, up from No. 125 six months ago.

It's a diverse group, with only 23 publicly traded companies in the segment and dozens of small, independent seed producers and grain processors. Also in the mix are the units of giants such as BASF, DuPont (DD) and Archer Daniels Midland. (ADM)

The industry includes seed supply, agricultural biotechnology, ag-chemicals, fertilizers, farm machinery, food production, grain processing as well as wholesale and distribution.

The one thing these companies have in common is that they revolve around the farm.

Some firms supply the "inputs," the seeds, fertilizers and pesticides that help crops grow. On the other end, companies buy, process and sell goods after the harvest.

Crop protection chemicals, including herbicides, pesticides, insecticides and fungicides, protect the farmer's crops from unwanted plants, insects and fungi.

But in farming, it all starts with the seeds. Seed companies work to meet demand by selling farmers seeds with improved genetics that create a higher crop yield, or a more productive harvest.

"Our research works to support the growing food, feed and fuel demands of farmers' customers such as processors and consumers," said Carl Casale, Monsanto's executive vice president of strategy and operations. "Our research focuses on greater efficiency and benefits for animal feed processors, ethanol and biodiesel plants, as well as nutritional improvements in oil and dietary components."

After the harvest, companies such as Bunge, (BG) which also makes fertilizers, Agricore United (5AU) and Saskatchewan Wheat Pool (5VT) buy the crops and process them to sell as either food, animal feed or biodiesel.

Dry and wet milling are the two most common ways to process harvested crops. Processors buy grains and oilseeds from farmers and store, blend and sell them to commodity customers.

These companies can handle soybeans, rapeseed, sun seed, canola, wheat, sorghum, corn and other products. Many of these grains are main ingredients in food products, livestock feed or renewable fuels.

Name Of The Game: In agriculture, the common theme in any crop is boosting yield per acre, or doing more with less. Once harvested, crops are processed to meet the rising demands for food, livestock feed and ethanol.

2. Market

The largest of the group's 23 companies in market capital are Monsanto, Syngenta (SYT) and Bunge, which have a combined market capitalization of $94 billion.

Companies that make seeds and traits, fertilizers and crop protection chemicals have one customer: the farmer.

Companies that process the grains serve food producers and brewers as well as livestock handlers. Over the last few years, ethanol producers have become part of the customer mix.

The seeds business is crucial to the agricultural industry.

Mark Gulley, a specialty chemical analyst with Soleil Securities, said the corn seed business is roughly $7 billion worldwide, while soybean seeds generate around $3 billion to $4 billion globally.

"What drives the seeds and traits business is improved yields," Gulley said. "Farmers will pay their suppliers good money for higher quality inputs. A farmer is always focused on maximizing yield so he can maximize gross profit."

3. Climate

Ethanol is a major industry force. Demand for the biofuel has prompted farmers to grow more corn and reduce other crops.

Tighter supplies spur higher prices, which trickle down to consumers at the supermarket.

"The ethanol push did create some ag-flation," Gulley said. "The extra 15 million acres or so allotted to corn had a domino effect on other crops, from soy to wheat."

One potential driver of corn outside of ethanol, is the growing demand for protein in emerging economies of India and China. In 2020, China's population is projected to hit 1.6 billion.

Over time, these nations will consume less carbohydrates and more protein — in other words, less rice and more meat. And grains produce the feed for animals.

"To meet the protein demands of this growing population, China will look outside of their agricultural sector for protein resources, and these could include supplies of corn and soybeans," Casale said. "We believe the U.S. farmer can play an important role in supporting China's growing demand."

Also, Brazil could emerge as the low-cost producer of soybeans as prices continue to rise for the crop in the U.S. The South American country could effectively handle the major export demand for commodity beans, Casale said.

This creates an opportunity for U.S. soy to define a new high-value market focused on low-linolenic soybeans that reduce trans fats and omega-3 soybeans with heart healthy oils, he said.

The upside is the opportunities for companies, which have made research investments before these trends matured and are now poised to deliver technology to meet the demand.

4. Technology

Over the last decade, innovation for ag-operational companies has focused more on the input side and how a farmer can get more benefits through seeds, Casale said.

"The shift has transformed investment in agriculture by both seed and chemical companies," he said.

Monsanto spends about 10% of its total sales, which are expected to hit $10 billion next year, on research and development. Syngenta and other major seed producers also have robust research and development budgets and a pipeline of seed and chemical products to show for it.

A majority of the spending focuses on genetically modifying seeds in order to produce a higher yield, said analyst Bill Selesky of Argus Research.

For example, Monsanto and DuPont are using genetic engineering to produce drought-resistant crops that grow on far less water than regular strains.

"If one result of global climate change could be increased drought, then drought-resistant corn and other crops would certainly help mitigate this stress," Selesky said.

Seeds also are being genetically modified to withstand pesticides, resulting in better crop yields.

"Today, farmers are getting more bang for their buck," Selesky said.

5. Outlook

One of the biggest risks facing the industry is how to manage natural resources, such as fresh water.

The U.N. Environment Program estimates that 70% of the world's fresh water used annually goes to agriculture, but many nations are facing severe water shortages.

"The opportunity is where we can support and maximize the inherent harvestable yield of corn and other crops," Casale said. "In the future we plan to offer corn traits like drought-tolerance and nitrogen-utilization that can support the needs of our world."

Gulley said he is generally upbeat about the future for the industry. But his biggest concern is a backlash against ethanol, which would make the increases in 2007 just an aberration. But he called that a minor concern and very unlikely.

High corn prices will cut U.S. exports, Westcott said. The U.S. is the largest corn exporter in the world, accounting for as much as 70% of the world's corn. That share could shrink to 55% to 60% due to soaring prices.

"The market will adjust over the next several years as ethanol is factored into the crop equation," Westcott said. "The price increases will peak and plateau and pressures affecting parts of the industry will lessen."

Upside: Increasing demand for ethanol, food and animal feed will drive business for agricultural operations companies for the foreseeable future. The demand is also fueling more biotech research to improve crop yields.

Risks: At any time, water shortages and unpredictable weather can disrupt harvests and crush business. A major economic recession also could hurt.

Copyright 2000-2007 Investor's Business Daily, Inc.


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