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Rising Commodity Prices Help Agriculture, Harm Chemicals

With commodity prices rising, agriculture companies benefit and chemical firms get squeezed.

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High agricultural commodity prices are fertile soil to the fortunes of crop input producers. However, rising raw material costs are pressuring chemical companies to raise prices in an effort to maintain profitability.

High Crop Prices Bode Well for Crop Input Sales.
Prices of most major field crops, including corn, soybeans, wheat, and cotton, have been on quite a bull run since mid-2010. Adverse weather conditions across the globe have limited crop supply, and driven by a growing population and rising incomes, demand for food shows no signs of abating. These factors have led to a tight supply-demand market for multiple crops. According to the latest estimates provided by the U.S. Department of Agriculture, or USDA, the stocks-to-use ratio (a measure of supply and demand that historically exhibits negative correlation with crop prices) for U.S. corn is 5.0%, its lowest level since the 1995-1996 growing season. For soybeans, the U.S. stocks-to-use ratio stands at 4.2%, the lowest figure on record. Low stocks and high crop prices send strong signals to farmers that agricultural inventories must be rebuilt. As a result, more acres should be planted in 2011. The USDA's chief economist expects 9.8 million additional acres, a 4% increase over the prior year, and the largest year-over-year increase in the U.S. since 1996. With more acres planted, we expect sales volumes for crop inputs, such as fertilizer, seed, and crop chemicals, will increase. High prices also motivate growers to increase yields through greater use of agricultural inputs. Additionally, higher crop prices improve farmer economics, giving crop input producers leeway to raise prices.

On the company level, we saw high crop prices (and expectations that high prices will persist) drive strong fourth-quarter results for crop-input producers and sellers, including  Potash Corporation of Saskatchewan (POT),  Agrium (AGU), and  Mosaic (MOS). Double-digit, year-over-year potash volume increases were the norm in the fourth quarter for the producers we cover. Also, potash prices are on the rise with Potash Corp and  Intrepid Potash (IPI) recently announcing price increases. The dynamics pushing up potash prices are also pumping up prices for nitrogen and phosphate fertilizer, the other two primary crop nutrients. As of the end of 2010, Agrium noted that total nitrogen inventories in North America were below the five-year average, supporting high prices. In phosphate, tight supply and demand conditions continued to support the market, as U.S. DAP/MAP inventories remained 32% below five-year average levels at the end of 2010. Moreover, the battle for acreage between crops, particularly corn and soybeans, is also a win for fertilizer producers, particularly companies selling nitrogen fertilizer. The USDA is predicting an additional 4 million acres of corn planted in the U.S. this year versus 2010, but only 0.6 million additional acres of soybeans. Corn requires much more nitrogen fertilizer than soybeans, because soybeans produce their own nitrogen. In addition to fertilizer producers, makers of crop chemicals and genetically-modified seeds, including  Monsanto (MON),  DuPont (DD), and  Syngenta (SYT), should also benefit this year from increased acreage and the desire to increase yields.

We think high crop prices will continue well into 2011 and perhaps beyond. In our opinion, even a bumper harvest around the world may not return agriculture stocks to more normal levels. Thus any further adverse weather could send crop prices even higher this year. Finally, a further rise in oil prices would likely boost ethanol demand, and thus corn prices, further improving the outlook for crop input producers.

Raw Material Cost Increases Force Chemical Companies to Raise Prices.
Similar to the third quarter of 2010, many chemical makers dealt with higher raw-material costs in the fourth quarter, and the rising price of oil means further increases in 2011 are likely for some producers. Backed by recovering demand in just about every end-market except for construction, chemical companies are raising sales prices to battle higher material costs. Even with capacity underutilization decreasing, some companies are having mixed results raising prices.

The chemical industry is rife with examples of materials cost inflation in the fourth quarter of 2010. Quarterly operating margin for  Eastman Chemical's (EMN) coatings and adhesives segment fell sharply despite higher year-over-year sales, as rising material and energy costs depressed profitability. Driven primarily by higher propylene prices,  Cytec Industries(CYT) coatings and resin raw materials costs rose during the fourth quarter. The company was unable to offset higher costs in this business, despite a 9% increase in year-over-year prices. In the paint and coatings industry,  AkzoNobel (AKZA) has been successful in pushing through price increases, and  PPG Industries (PPG) plans to implement 2011 price increases to fully offset rising raw materials costs. However, some pricing lag generally occurs in the coatings industry, especially through the retail distribution channel. As a result, paint companies could see lower profits if cost inflation accelerates. DuPont and  BASF (BASFY) have aggressively announced price increases in various commodity chemicals, including titanium dioxide (a main ingredient in paint), resins, and plastic additives, among others.

In our opinion, chemical companies should be relatively successful passing along cost increases as long as demand remains strong. That said, steady price increases could choke off the very demand that is allowing companies to pass along higher costs in the first place, a dynamic that could leave downstream specialty players without a chair when the music stops. Higher oil prices are creating a backdrop that is making price increases from commodity chemical producers more palatable. Downstream manufacturers, such as coatings companies PPG and AkzoNobel, could be squeezed if they are not ultimately able to pass further cost hikes down the value chain.

Jeffrey Stafford does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.