Weekly Broker Wrap: Oz Equities And Scarce Global Grain

This story features QBE INSURANCE GROUP LIMITED. For more info SHARE ANALYSIS: QBE

By Andrew Nelson

Last week a few more Australian analysts switched their focus to the intensifying drought situation in the US and its impact on global grain crop supplies.  Global mining capex was also examined as well as domestic pharmaceutical distributors, with a few strategic ideas for an investor's portfolio.

The continuation of extreme drought conditions in America’s grain belt is beginning to devastate US agricultural production prospects, with crops now withering in the field. In response, global grain prices have soared by more than 50% since June as global supplies contract.

The situation has now seen the Commonwealth Bank sharply raise its global grain price forecasts, with the bank noting higher prices are needed in order to ration demand.  CBA Agri Commodities analyst Luke Mathews notes US corn prices have spiked 60% since June, posting record highs along with US oilseed prices late last week.

CBA notes production estimates for this year’s US corn crop have already been cut to 12.97bn bushels by the USDA, below the previous record low estimate of a 14.8bn bushel crop. Matthews believes yield estimates will be cut even further given the ongoing drought and expects US corn output of 12.22bn bushels, which is 6% below current USDA estimates.

Thus, the US corn crop has become a global issue, as the nation contributes 38% to world output, with the US also responsible for nearly half of global corn exports. As evidence, Matthews cites NSW wheat futures on the ASX, which have jumped $70/t to $310/t over the past month, with Matthews noting that soaring grain prices have begun to stir up some serious concerns about global food price inflation. Simply put, a US corn shortage means a global grain shortage.

Making matters worse are production issues in other parts of the world. CBA notes South American corn and soybean crop production has been cut due to poor conditions early this year , while global wheat  production for 2012/13 has fallen by 37 million tonnes year-on-year, mostly because of adverse growing conditions.

Because of the crop shortages, CBA reckons another 6.4 million tonnes of US corn is going to have to be rationed in the US livestock, ethanol and export markets. Matthews points out this is on top of the 26.6 million tonnes of rationing that the USDA has already forecast in its July report. Yet even with significant demand rationing, CBA expects US grain supplies will fall to record low levels in 2012/13. The run in corn prices has in turn pushed US wheat prices 50% higher over the same period.

As a result of all of this, CBA has raised its global grain price forecasts. ASX NSW wheat futures are now forecast to average $290/t in H1 2012 and $270/t in H2 2013, before falling below $250/t by December 2013 on an expected improvement in global grain supplies in H2 2013.

Analysts at UBS have taken a look at the US drought from another perspective, the impact it is having and will likely continue to have on crop insurers.  The broker notes that things are about as bad now as they were in 1988, when 50% of US corn was classified as poor.  Right now, only 38% of corn is classified in poor or very poor condition, but this is expected to get worse.

While UBS sees a pretty good chance for some very big crop losses in the US, given the structure of the US crop insurance program, which includes government reinsurance, it doesn’t expects to see the losses stemming from the drought as being significant for US crop insurers, of which Australia's QBE ((QBE)) is the third largest.

Under the broker’s worst case scenario, the ongoing US drought would reduce QBE’s FY12 EPS by up to 5% on a stand-alone basis. However, the broker believes the company possesses adequate headroom within its current large loss allowances to absorb this. Thus at this point, there is no impact on UBS’s forecasts.

That’s all on the US drought, for now.

Deutsche Bank sees some signs of a possible rebound rally for Australian equities building towards the end of 2012. The broker notes a few factors to support its view:

It believes economic surprise indices are close to a trough, meaning the possibility of less drag on risk assets; leading indicators for China and the US are turning more positive, which could support faster growth towards year end.

However, the broker also sees a few things that could stymie this late year upswing like the fact equities have held up fairly well so far given the circumstances mean they are vulnerable to negative data flow. European issues could also remain a drag, depressing markets that otherwise may have begun to reverse.

As far as industrial stocks go, the broker thinks EPS growth forecasts are probably still too high, although it still sees scope for modest earnings growth as the rate of writedowns slows. Deutsche notes cyclical stocks are around 14% cheaper than defensives, but with reporting season likely to disappoint and to see FY13 numbers trimmed, the broker predicts cyclicals may stay cheap a little while longer.

Falling commodity prices have kept a lid on the share prices of miners for the most part, but with China’s two most-forward looking lead indicators pointing to a solid pick-up in growth by year-end, the broker sees an improving chance of a substantial rally in resource stocks.  This is especially so given domestic investors are very overweight banks right now, which could see a run to cheaper resource stocks later in 2012.

The local equities outlook from Citi is similarly positive, with the current spate of policy easing underway in China likely to assist FY13 earnings growth in Australia, providing at least the potential for the ASX/200 to move up to Citi’s revised forecast of 4450 by end year. Citi’s previous forecast was at 4750, but the broker expects troubles in Europe to flare up again this year, so market volatility will probably continue.

Here’s the rub. If China doesn’t soon change course and the landing is much harder than expected, Citi thinks there’s a chance that we’ll see a major recession in Australia. The broker envisions a dominos scenario, where a falling China asks questions about some vulnerable areas like housing, the banking sector, etc.

Another issue facing Australian markets is that it is seen by many as being ex growth, given healthy employments levels and the benefits from high commodity prices. And while the broker agrees to some extent, it sees good chance for at least some moderate levels of growth.

Citi has also conducted a survey among global mining and construction firms and this has raised some red flags. The broker notes that around 25% of participants are considering lowering future capex budgets. Citi is now forecasting a 10% decline in mining capex in 2013, with construction capex to remain flat for the next 12 months.

Our last topic concerns Australian pharmaceutical distributors. In Goldman Sach’s view they could be in for a bit of trouble given the Pharmaceutical Benefits Scheme for statin drugs could be cut by up to 25% from December 2012. If it were to occur, the broker estimates PBS outlays could decline by about 2.5%, with the price cuts likely to reduce pharmacist profits.

For Australian Pharmaceutical Industries ((AP)) and Sigma Pharmaceuticals ((SIP)) a reduction in the value of Crestor and the generic alternatives to Lipitor would be negative, although cuts to Lipitor would have no impact given Pfizer distributes it directly to pharmacists. Small EPS cuts ensure for both stocks.

Deutsche also weighed in on the topic, agreeing a cut to Lipitor pricing will have limited impact on the wholesalers, while Crestor was already expected to face generic competition later in the year, thus a cut in some ways was already figured into the broker’s expectations. Yet while the broker sees limited direct impact on Sigma and API, it does note the pressure on other parts of the value chain will eventually feed through to more pressure on wholesalers.

 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

Click to view our Glossary of Financial Terms