Jeremy Glaser: For Morningstar, I am Jeremy Glaser. I am here today with Adam Fleck. He is the associate director of industrial research at Morningstar. We're going to look at whether high agricultural prices are here to stay and what the investment implications are.
Adam, thanks for talking with me today.
Adam Fleck: Thanks for having me, Jeremy.
Glaser: So, certainly over the last couple of years we've seen pretty significant increases in lot of agricultural inputs. Is this something you think is going to persist or is this just kind of a short-term blip?
Fleck: Yeah, if you look into very long term, our opinion is that the long-term secular trend for agricultural prices is probably up, probably positive. However, it's important to remember that much of the high crop prices we have now are due to weather. We had a horrible drought this year, obviously. So, we think that the cyclicality will likely remain, and in any given year weather is most likely to drive high or low crop prices, but certainly the secular trend is positive.
Glaser: Looking out over the future, then, we see those higher prices kind of inching our way there. What are some of the drivers of this? What do you expect to be moving those prices up?
Fleck: On the supply side some of the biggest drivers we found are the inputs; fertilizers, water, of course, and soil availability.
On the fertilizer side, one of the biggest concerns we have is for phosphate. This is a rock that is mined; it is necessary for growing crops. If you look out many, many years, several decades really, the country of Morocco controls the vast majority of phosphate reserves in the world. If they monopolize that in any way or even are unable to produce the necessary amount of phosphate, that could drive prices up pretty well.
On the soil side, this doesn't get a lot of mainstream press, but we're probably eroding soil 10-40 times faster than we're forming it for new soil. This is an issue that can largely be solved we think by no-till farming, so not plowing over the field every year. That's going to help alleviate, of course, some of the fertilizer requirements, but many developing markets are still well behind the U.S. on no-till farming, and that's something that will probably be a long-term issue that's talked about quite a bit.
Glaser: Certainly we hear about fresh water, too, as being a big concern. Is that something you see being alleviated anytime soon?
Fleck: Well, we have enough water. I don't think we're about to run out of water. Humanity uses about 4,000 cubic kilometers of fresh water annually. River run-off alone is probably in the neighborhood of 40,000 cubic kilometers. You've also got glaciers. You've also got some ground and surface water reserves. Those are not renewable, but, nonetheless, we have enough water. Accessibility is the biggest problem.
There is a study that came out in the late 1990s that suggests that of water that we need, we are accessing about 50% that's already currently accessible. And in many times it's in the wrong places. You think about the Amazon River versus where it's needed in the Middle East; that can be a big problem. Solutions could include things like more storage, perhaps even desalination, something that's very expensive right now. But down the road, if that becomes necessary, that's, again, just going to continue to push up the marginal cost of farming given that fresh water usage is consumed primarily by agriculture, about two thirds of it.
Glaser: We see those headwinds on the supply side. How about the demand, though? Certainly, we have an emerging middle class that's consuming more meats and consuming more agricultural products. Is that going to put even more pressure on prices?
Fleck: The demand side of the story is something that is talked about quite a bit. I think a lot of it has already played out, however. China is the real country that people point to and say a rising middle class in that country will consume more meat, will need more crops. Of course, if you consume more meat, that has a multiplicative factor on the amount of corn and soybeans that's needed. However, China right now already consumes more calories per person than Japan and already consumes more protein from meat per person than South Korea. Of course, they are well behind the United States, but I think there is probably a pretty large cultural difference. A lot of that growth has already happened.
Look at Brazil, for instance. That's a country that consumes more calories per capita than South Africa, than the Netherlands, than Sweden, than any other neighboring South American country.
The big wild card here, I think, is what happens to India. India, of course, has a massive population but is still well behind on caloric intake and protein intake, not only versus developed economies, but emerging countries, as well. I think we're not ready to say yet that it's about to turn the corner on that. If you look since 1990, India has increased its per capita caloric intake about 3% in aggregate; that's compared with a very high growth rate than China and Brazil in the mid-teens and even a 7% growth rate in the U.S. So, we're just not ready yet to say that India is about to suddenly develop its economy and its food consumption at a greater level.
Glaser: What are the investment implications here? What companies are going to be able to succeed in this environment, and which ones are going to struggle?
Fleck: Well, I think, if you look out again thinking of a positive secular growth story, however, maybe not quite as straight up as some people would think with annual cycles based on the weather, we really like companies generally with economic moats, sustainable competitive advantages and good balance sheets. These are the companies that are going to be able to survive to the long term. You think about a company like John Deere producing equipment that's going to help growers improve their yields; that has a narrow economic moat. Even a company like Potash Corp., helping to produce fertilizers; that has a wide economic moat. So, these are the types of companies we think are going to be long-term winners.
Glaser: Are there any specific names that you think look attractive right now?
Fleck: We think Potash Corp. is attractive on a valuation basis. Given the cyclicality in the industry, you don't want to be buying these things right at the top of the cycle. It's a long time to wait before you get back to the top of the next cycle potentially. You've seen the stocks of equipment manufacturers like Deere run up, that's trading right around our fair value estimate right now, whereas Potash Corp. is trading at a relatively good discount, given some of the short-term concerns of potash purchasing by countries like China and India given slowing economic activity.
Glaser: Well, Adam, thanks so much for your thoughts today.
Fleck: Of course. Thanks for having me.
Glaser: For Morningstar, I'm Jeremy Glaser.