Material Matters: Soft Commodities Higher, Stronger Oz Dollar Impacting On Oil Sector

This story features INCITEC PIVOT LIMITED, and other companies. For more info SHARE ANALYSIS: IPL

By Chris Shaw

There has been movement in soft commodity markets after the US Department of Agriculture (USDA) made significant cuts to its estimates for US corn yields in 2010-11. Yields are now forecast to be 155.8 bushels per acre, down from a September forecast of 162.5 bushels.

In the view of Barclays Capital, any cut in forecast yields below 159 bushels per acre would give upside impetus to the market and this is what has happened. Chicago Board of Trade prices for corn, wheat and soybeans all closed "limit up" following the USDA release.

Even after the yield cut is factored in, US corn production is estimated to be at its third highest level on record but as Barclays notes strong consumption and export demand means US corn stocks of 22.9 million tonnes are at their lowest level in 14 years.

Given the US is a major supplier to the global corn market, this low level of stocks is generating concerns of a shortage. This is especially the case given China's imports have surged in recent months. As well, there is a proposal in the US to increase the ethanol blend rate which would further limit the amount of corn available for export.

The price spillover to other grains reflects more than just the news on the US corn market outlook, Barclays noting the wheat market is is already tighter than was expected earlier in the year thanks to production issues in Russia, Canada and Pakistan that is bringing down estimates of stockpiles.

Such supply issues bode well for the grains generally in the view of Barclays, with corn likely to outperform the sector. New highs in coming weeks are expected, Barclays forecasting an average corn price of US$5.24 per bushel in the final quarter of this year and US$5.40 per bushel in the first quarter of 2011.

There are other implications from the USDA report, Credit Suisse noting fertiliser prices jumped 7% on the news of revised inventory forecasts. The broker sees this as a positive for Incitec Pivot ((IPL)), as rising soft commodity prices support the planting intentions of farmers.

At present Credit Suisse is around 9% above consensus forecasts for Incitec Pivot in FY10 and 22% in FY11, though it expects this gap will narrow in coming weeks as market upgrades appear inevitable given rising prices.

While it remains above the market with respect to earnings forecasts, Credit Suisse retains its Neutral rating on Incitec Pivot on valuation grounds as the stock is trading within range of its valuation-based price target of $4.10.

The FNArena database shows Incitec Pivot is rated as Buy and Hold three times each and Sell once, with an average price target of $3.69.

Turning to energy markets, Commonwealth Bank notes total US rig counts rose last week to 1,671 from 1,659, with oil plays being favoured over gas plays at present. As well, the bank notes growth in rigs at present is concentrated in horizontal rather than vertical drilling reflecting changes in technology thanks to the US shale gas boom.

In terms of prices, Commonwealth Bank notes the recent tick-up in the oil price has been more than offset by a weaker US dollar, meaning oil product prices in Australian dollars have actually fallen. To reflect this JP Morgan has revised earnings estimates for the energy stocks it covers, the changes following updates to both the broker's oil price and foreign exchange estimates.

JP Morgan now expects a fourth quarter oil price of US$81 per barrel, down from US$85 previously, while in 2011 the broker's average price forecast has been revised to US$82.50 from US$90 previously. For the Aussie dollar against the US currency the broker now expects an average of US91c in 2010, up from US88c previously, and to US98c in 2011 and US95c in 2012 compared to prior estimates of US90c in both years.

Factoring in the changes sees JP Morgan cut its 2011 net profit forecasts for stocks in the sector by 16-25%. The changes also mean adjustments to price targets, the broker's target for Santos ((STO)) falling to $16.10 from $17.20 and for Roc Oil ((ROC)) to $0.40 from $0.44. Woodside Petroleum's ((WPL)) target actually rises to $48.00 from $46.50.

There are no changes to JP Morgan's ratings, meaning Santos and Oil Search ((OSH)) remain as Overweight recommendations. Neutral ratings continue to be applied to Woodside, Australian Worldwide Exploration ((AWE)) and Beach Energy ((BPT)), while JP Morgan continues to rate Roc Oil as Underweight.

By way of comparison, Sentiment Indicator readings for each stock according to the FNArena database stand at 1.0 for Oil Search, 0.9 for AWE, 0.8 for Santos, 0.5 for Woodside, 0.4 for Roc Oil and 0.3 for Beach Energy.

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