Look out for this sector in face of rising inflation

Additionally, food prices could extend their climb in 2022 as adverse weather – driven by La Nina, threatens to lower crop yield returns.

With this in mind, we revisit the VanEck Vectors Agribusiness ETF (NYSE:MOO), which delivered a strong return of 22.5% in 2021 (Figure 1).

Figure 1: MOO’s returns in 2021

We think that MOO is likely to continue to trend higher, as concerns of higher inflation, coupled with growing demand for food, would mean that agricultural commodities and the companies within this sector present an exciting opportunity for investors.

(Related article: Ride on the rapidly growing demand for food with this ETF)

Global food prices are set to soar even further  

The rate of inflation is now the highest it has been in more than 40 years, with the consumer price index (CPI) climbing 7.5% year-over-year (YoY) in January 2022, the largest 12-month gain since June 1982 (Figure 2).

Figure 2: US CPI YoY data 

High inflation has proven more stubborn and widespread than the central bank predicted, amidst the unrelenting demand for goods and services, and capacity constraints in the supply chain.

In fact, harvest setbacks, strong demand and supply chain disruptions have sent the UN Food and Agriculture world food price index, which tracks a basket of food commodities to a record high (Figure 3).

Figure 3: Food commodity prices have been rising 

The commodities sector as a whole tends to benefit from rising inflation. With agricultural commodity prices trending higher, companies that support production would benefit, as rising prices lead to increased production. Consequently, higher production translates to an increase spending on seeds, fertilisers and farm machinery, benefiting companies higher up the agribusiness supply chain (Figure 4).

Figure 4: The agribusiness supply chain

Moreover, agricultural prices could extend their climb in 2022 as adverse weather, driven by La Niña, threatens to lower crop yield returns. La Niña can make some places cooler and wetter than normal, and other places drier and warmer than normal, changing the weather from what is normally expected.

There is a risk of a severe upcoming episode, as the last event in between September 2020 and April 2021 was relatively short and average in strength, and there has not been a strong La Niña event for nearly 10 years. Weather disruptions resulting from this phenomenon could cause a decline in crop yield and provide a price boost for several agricultural commodities, including wheat, corn and soy.

In the past, the UN Food and Agriculture world food price index’s 2011 peak was driven by the strongest La Niña in a decade. 

Going forward, the Bureau of Meteorology Australia pegs the probability of a La Niña event at 70% in the coming months. Sea surface temperature in the Pacific Ocean Nino 3.4 region has already started to cool, consistent with La Niña behaviour. With supply shortages, agriculture commodities tend to outperform broad commodities during La Niña weather episodes, and in an inflationary environment, the agribusiness sector serves as a useful hedge against inflation.

Broader secular growth trends to further drive the sector’s growth

Looking beyond rising agricultural prices, we note the secular trends which make the agribusiness industry one with incredibly promising long-term prospects.

One of the most compelling trends underpinning the industry’s growth is no doubt the rising global population. With the global population expected to reach 9.8 billion by 2050 (Figure 5), there is a pressing need to figure out how to increase our food supply.

Figure 5: Global population expected to reach 9.8 billion by 2050

Another secular trend driving the demand for food is that of income growth. Entering the middle-class typically correlates with higher consumption of animal-based foods, which are more resource-intensive to produce. In order to feed this larger, richer, and more urban population, food production must increase by 70%.

In fact, it will take more than USD 1.5 trillion of investment to keep up with Asia’s burgeoning food demand by the start of next decade as consumers buy more and increase spending on premium products. Hence, these two secular trends will underpin the industry’s long-term prospects.

Ride on the growth in agribusiness

The agribusiness industry presents an area of opportunity. Agricultural prices are likely to extend their climb as we enter 2022, with higher inflation and adverse weather – driven by La Niña as a backdrop. Furthermore, the long-term prospects for agribusiness look promising, with secular trends such as population and income growth as a strong driver.

Not to mention, the current Russia-Ukraine crisis has the potential to exacerbate food-price inflation, by disrupting wheat exports. Russia is the world’s largest exporter of wheat, while Ukraine is also a major exporter. Combined together, the two countries are responsible for 29% of the global wheat trade. A prolonged military conflict which disrupts trade could make much of this wheat unavailable to the export market, causing food prices to rise even further.

Investors can gain exposure to the agribusiness sector via the VanEck Agribusiness ETF (NYSE: MOO). MOO is a diversified agribusiness play that provides exposure to companies in the farm equipment, seed and fertiliser, animal health, and food transport and processing industries, and member firms derive at least half their sales from agribusiness pursuits. MOO has an expense ratio of 0.56%.

Figure 6: Geographical allocation of MOO 

We maintain our 2023 target price of USD 115. This offers investors an upside potential of about 25%, based on the closing price of USD 92.15 on 23 February 2022.

Table 1: Top 10 holdings of MOO

Table 2: Earnings growth for the global agribusiness sector

Figure 7: In the long run, stronger earnings should lead to better share price performance

Declaration:

For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) and the analyst who produced this report hold a NIL position in the abovementioned securities.