Abstract

The upstream, midstream, and downstream of the agriculture-food industry chain exhibit distinct industry characteristics. The upstream is represented by highly concentrated and high-gross-profit agricultural input, fertilizer, and seed companies. The downstream includes a multitude of food and beverage producers and distributors, also with considerable gross profits. The midstream, consisting of agricultural product trade and processing companies, generally adopts a strategy of low gross profit and high market share, with a few major grain merchants connecting hundreds of millions of farmers upstream with numerous consumers downstream.

The traditional four major grain trading companies, Archer Daniels Midland (ADM), Bunge, Cargill, and Louis Dreyfus (referred to as ABCD), play a decisive role in the global grain supply chain with a 70%-90% market share. Their advantage mainly lies in their strong control over the grain sources of the main producing countries in Europe and America. Emerging grain merchants are committed to developing the Asia-Pacific consumer market, benefiting from increased consumption in China, India, and Southeast Asia, and have a significant advantage on the import side of the trade chain.

Investment Timing in Grain Merchants

Generally, the stock performance of grain merchants is highly correlated with the changes in agricultural product prices. However, it should be noted that since grain merchants are in the midstream of the industry chain, fluctuations in agricultural product prices affect both company revenue and costs. Therefore, the impact of agricultural product price changes on company performance may not be linear. We review the market conditions since 2000 and divide the cycles into four stages: rapid rise, strong fluctuation, weak fluctuation, and rapid decline.

► Rapid Rise Period: Agricultural raw material prices are high, but downstream demand is strong. For example, from 2020 to 2022, the COVID-19 pandemic combined with the Russia-Ukraine conflict led to a rapid increase in global soybean and grain prices. However, China's strong procurement demand also supported soybean export trade. Against the backdrop of rising quantity and price, the stock prices of ADM and Bunge companies rose significantly, and the company's investment return on investment (ROI) increased for three consecutive years.

► Strong Fluctuation Period: Agricultural raw material prices are high, and downstream demand is somewhat reduced due to high prices. For example, during 2003-2004, 2007-2008, and 2012-2015, soybean and grain price indices were at cyclical highs, and downstream demand was suppressed by high prices. However, due to the successful transmission of cost increases to downstream finished products, the increase in profit per unit of processing exceeded the contraction of downstream consumption volume. As a result, the net profit of ADM and Bunge companies increased, and the stock price trend was strong and fluctuating.

► Weak Fluctuation Period: Agricultural raw material prices are declining, and downstream consumption recovery is not enough to offset the low industry prosperity. From 2016 to 2020 and from 2023 to 2Q24, soybean and grain price indices were at cyclical lows. The pressure on the company's cost side was reduced, but the prices of agricultural finished products were also at low levels. The decline in processing profits led to weak net profit performance for ADM and Bunge companies, and the stock price trend was weak and fluctuating.

► Rapid Decline Period: Agricultural raw material prices fall while consumption weakens. Global grain and oil prices fell rapidly in the second half of 2008 and after 2012, but downstream consumption did not improve. In 2008/09 and 2012/13, global soybean meal consumption demand turned negative year-on-year, leading to a contraction in the net profit of ADM and Bunge companies, causing stock prices to decline rapidly.

Current Cycle Judgment: The Bottom Has Appeared, Waiting for a ReboundWe believe that the bearish factors for the agricultural product sector in the 2024/25 new season have essentially been priced in by the market, with the main agricultural product prices having bottomed out. According to the investment cycle, grain merchants are currently transitioning from a period of fluctuating decline to a period of demand recovery and price bottoming out, leading to a fluctuating upward trend.

Corn: Inventory peaks, with prices expected to start fluctuating upwards. After two years, the global corn restocking process is essentially complete, which may signal the end of the downward trend. In the 2024/25 season, against the backdrop of a new season supply-demand balance and inventory accumulation peaking, the price of global corn is likely to begin to bottom out and rise.

Soybeans: Short-term prices are expected to maintain a low-level fluctuation, waiting for bullish factors to emerge. The current period is the growth season in the Northern Hemisphere, and the new season production activities in the main soybean-producing countries of the Southern Hemisphere have not yet started. The current low price is based on the market's relatively uniform expectation of a new season bountiful harvest, but there are many uncertainties during the growth period, and the room for adjustment in yield and area is quite large. If there is a difference in expectations, it may drive a low-level price rebound.

The configuration value of grain merchants is becoming apparent.

Valuation multiples rebounding may be the main theme for the future. There are signs of overselling in the current valuation multiples of grain merchant companies. Based on the judgment that the cycle has bottomed out, we believe that on the one hand, the valuation multiples of grain merchants will gradually rebound along with the industry's prosperity. On the other hand, the recovery of investor confidence after the stabilization of agricultural product prices is expected to lead to a rebound in valuation multiples.

Defensive characteristics are obvious, and the configuration cost is relatively low. Compared with traditional defensive industries, we see that grain merchants perform no worse than the MSCI Defensive Sector Index in terms of returns and risk diversification effects. In addition, the current low industry valuation of grain merchants also helps to reduce their configuration costs.

Risks

Demand growth is lower than expected, and geopolitical conflicts disrupt the supply chain.

Main Text

Agricultural Product Trade and Processing IndustryGrain and Oil Traders: The Link Between Agriculture and the Food Industry Chain

The upstream of the agriculture-food industry chain begins with agricultural inputs, fertilizers, and seed industry, goes through the midstream processing stage, and finally reaches the terminal food and beverage distributors. With the increase in population, the improvement of per capita GDP, and the optimization of dietary structure, the global agricultural product industry chain value has risen from $3 trillion in 2013 to $3.8 trillion in 2022[1], with a CAGR of 2.7%. Agricultural product trade and processing connect upstream farmers with downstream consumers, playing a significant role in ensuring global food security and also reflecting the prosperity of the agricultural industry chain.

Looking at the characteristics of each link in the industry chain, the main business of upstream agricultural input companies includes seeds, fertilizers, agricultural machinery, etc., with a relatively high concentration. As of the statistics in November 2023, the market share of the leading agricultural machinery company Deere & Company is 25.3%[2], and the top three agricultural chemical companies have a market share of about 40%-50%[3], with a median industry gross profit of 28.7% in 2023; there are many companies involved in the downstream food and beverage and distributors, with a relatively dispersed market pattern, and a median industry gross profit of 24.7% in 2023.

Compared with the upstream and downstream, the median industry gross profit of the midstream trade and processing industry in 2023 is only 8%. Low gross profit means that companies need a higher market share to ensure operations, so the agricultural product trade and processing industry presents a highly concentrated pattern, with a few grain merchant companies connecting hundreds of millions of farmers upstream with numerous consumers downstream.

Under the background of low gross profit, grain merchants rely on high market share to go through cycles

At present, the world's four major grain trading companies Archer Daniels Midland (ADM), Bunge, Cargill, and Louis Dreyfus (referred to as ABCD) play a decisive role in the international grain supply chain with their large company scale and 70%-90% global market share. Although the four companies of ABCD are not the same in business focus and key business coverage areas, from their business model, through horizontal and vertical resource integration, ABCD has built a comprehensive industry chain that integrates processing, storage logistics, order agriculture, agricultural finance, and sales, thus achieving business penetration in all links from farmers to consumers.

In addition to traditional grain merchants in Europe and America, the Asia-Pacific region, as the main import and consumption area of global grain and oil, has a broad market space. Under the high degree of external dependence, relying solely on a single import source may lead to the risk of domestic food price fluctuations, so we have seen that the market share of new trading companies in the Asia-Pacific region has been expanding in recent years, such as China's COFCO International, Singapore's Wilmar International, and Japan's Marubeni Corporation.

Due to the low technical barriers in agricultural product trade and processing, and the absence of brand premium, we see that compared with the upstream and downstream, the gross profit margin of grain merchant companies is relatively low, about 6%-9%. We believe that low gross profit and high market share are the main business strategies of grain merchant companies.

Traditional grain merchants are committed to firmly establishing a foundation in the main producing countries of Europe and America. For grain merchants, controlling high-quality and sufficient grain sources is an important starting point for their agricultural business activities. Although most of the purchasers of grains and beans are governments, grain traders, or storage institutions, these grains and oilseed raw materials all flow to large grain merchants after being purchased by small enterprises. According to US Census data, in the traditional processing business of the four major grain merchants, the industry of soybean and other oilseed processing and wet corn processing, the number of large enterprises with more than 10,000 employees has been continuously decreasing over the past 40 years, showing a clear trend of concentration, with an industry CR4 of about 80% as of 2021.

Looking at the distribution of infrastructure, in terms of soybean oil processing, as of July 10, according to Reuters data, there are 38 soybean oil processing plants in the United States, among which ADM has 9, Cargill has 8, Bunge has 3, and Louis Dreyfus has 1; their production capacity accounts for 27.6%, 12.3%, 15.5%, and 2.11% of the total soybean oil processing capacity in the United States, respectively; in terms of soybean meal processing, there are 63 soybean meal processing plants in the United States, among which ADM has 18, Cargill has 12, Bunge has 9, and Louis Dreyfus has 1.Emerging grain merchants are committed to developing the Asia-Pacific consumer market. Although their penetration into the main production areas of Europe and America is relatively limited, these merchants benefit from increased consumption in China, India, and Southeast Asia, giving them a significant advantage on the import side of the trade chain.

Investment Timing in Grain Merchants

Generally speaking, the stock performance of grain merchants is closely related to the fluctuations in agricultural product prices. However, it is important to note that since grain merchants are in the middle of the industry chain, price volatility affects both company revenue and costs. Therefore, the impact of agricultural product price changes on company performance may not be linear. Considering the strong cyclicality of agricultural product prices and the many uncertainties they face, such as weather, production, and trade chain issues, we believe that controlling the investment cycle for grain merchants is crucial.

By reviewing the stock price trends, company performance, and the fundamentals and price performance of agricultural products since 2000, we attempt to analyze the different cycle performances of grain merchant companies under the fluctuation of agricultural product prices to grasp the timing of investment. Looking back at the stock prices of ADM and Bunge since 2000, we divide the price performance intervals into four stages: rapid rise, fluctuation with a strong bias, fluctuation with a weak bias, and rapid decline.

► Rapid Rise Period: Agricultural raw material prices are high, but downstream demand is strong. Between 2020 and 2022, under the disturbance of the COVID-19 pandemic and the Russia-Ukraine conflict, agricultural production activities and the trade chain were disrupted, leading to a rapid increase in global soybean and grain prices. However, from the perspective of downstream consumption, China's strong purchasing demand also supported the export trade of soybeans. According to USDA data, global soybean meal consumption volume continued to increase year-over-year for three consecutive years from 2020 to 2022. Against the backdrop of rising quantities and prices, the stock prices of ADM and Bunge rose significantly from 2020 to 2022, and the companies' investment return rates increased for three consecutive years.

► Fluctuation with a Strong Bias Period: Agricultural raw material prices are high, and downstream demand decreases due to high prices. In 2003-2004, 2007-2008, and 2012-2015, the soybean and grain price indices were at cyclical highs, and downstream demand was suppressed by high prices, with consumption once turning negative year-over-year. However, the cost increase of soybeans and grains was successfully passed on to soybean meal, soybean oil, and starch, flour, etc., leading to a high industry prosperity. The increase in profit per unit of processing was higher than the contraction of downstream consumption volume, and the net profit of ADM and Bunge companies continued to rise, with stock prices fluctuating with a strong bias.

► Fluctuation with a Weak Bias Period: Agricultural raw material prices are declining, and downstream consumption is stable but cannot offset the low industry prosperity. Between 2016 and 2020, and from 2023 to 2Q24, the fundamentals of soybeans and grains were relatively loose, with price indices at cyclical lows. The pressure on the cost side of companies was reduced, but the prices of agricultural products were also at low levels, and the industry prosperity was low. The decline in processing profits led to weak net profit performance for ADM and Bunge companies, with stock prices fluctuating with a weak bias.

► Rapid Decline Period: Agricultural product prices fall while consumption weakens. After experiencing two food crises in 2007-2008 and 2010-2011, global grain and oil prices fell rapidly in the second half of 2008 and after 2012. However, downstream consumption did not improve, with global soybean meal consumption demand turning negative year-over-year in 2008/09 and 2012/13. The contraction of net profits for ADM and Bunge companies led to a rapid decline in stock prices, and the investment return rate also decreased.

In addition, it is worth mentioning the impact of market sentiment on stock prices. During periods of significant fluctuations in agricultural product prices or when global food security supply concerns intensify, the increased market attention will also drive the EV/EBITDA valuation multiples of grain merchants to rise, with elasticity that can float above the mean by two standard deviations, which should not be ignored for its impact on stock prices. As agricultural product prices fall, even if the company's performance decline is moderate, the lack of market confidence may also lead to significantly low valuation multiples.

In summary, we believe that the investment value of grain merchants is most prominent when global agricultural product prices are rising, and downstream consumption is relatively resilient. Market confidence, combined with the increase in company net profits, supports stock prices and investment return rates. However, during the downward cycle of agricultural product prices, although the company's cost pressure is reduced, the decline in industry prosperity and the lack of market confidence will likely put pressure on stock prices to fall.Cycle Judgment: Bottom Has Appeared, Awaiting Rebound

After two years of high prices, the agricultural product sector has been under pressure and has been declining since 2023. The decline in prices is not only due to the dissipation of market concerns and premium, but more importantly, the fundamentals are becoming more relaxed. Although consumption is gradually recovering year-on-year, the rapid increase in supply has led to a significant accumulation of inventory, causing the price center to shift downward.

Looking forward, we believe that the bearish factors for the new agricultural product sector in 2024/25 have been fully priced in, and the prices of major agricultural products have bottomed out. Positive factors are continuously gathering, and the probability of future upward movement may be greater than the downward space. According to the investment cycle, grain merchants are currently transitioning from a period of fluctuating decline to a period of demand recovery and price bottoming out, with prices rising in a fluctuating upward trend.

Corn: Inventory Peaks, Price Expected to Begin Fluctuating Upward

Looking back at the first half of 2024, the global corn price continued to decline under the pressure of consecutive bumper harvests in the 2023/24 season. Although the main producing countries in South America experienced production disturbances in the second quarter of 2024 due to adverse weather conditions, which temporarily increased the supply premium, it did not change the long-term downward trend in prices. Among the main producing countries, Argentina contributed the most to the increase in production. The USDA estimated that the corn production in the 2023/24 season would reach 52 million tons, a 44.4% increase compared to the previous year. As a result, the total production of the two South American countries (Brazil/Argentina) increased from 174 million tons in the previous year, and the total export volume of the two countries is expected to reach 87 million tons, an increase of more than 9.4% compared to the 2022/23 season. In terms of demand, although global corn consumption in the 2023/24 season has recovered year-on-year, the corn import volume of major importing countries/regions such as the EU, Japan, and Mexico is about 100 million tons, and demand has been relatively stable in recent three years. However, overall, the growth rate of demand is significantly less than the increase in supply.

Looking forward, the global inventory for the new season in 2024/25 has basically peaked, and the price is expected to fluctuate upward. After a year and a half of price declines, the CBOT corn price has almost returned to the historical average level. However, against the backdrop of high inflation in the United States, the prices of various agricultural resources such as labor, land rent, oil and gas, and fertilizers have continued to rise, increasing the cost of corn planting. The net profit of American corn in 2023 was only $13 per acre, and it has been declining year-on-year for three consecutive years. Therefore, in the planting area intention survey report released by the USDA at the end of June, we saw that the new season's American corn planting area has contracted year-on-year, from 86.5 million acres in the previous year to 83.4 million acres, leading to a decline in American corn production from 390 million tons in the previous year to 384 million tons. In addition, the expected corn production of major producing countries such as Argentina, Russia, and Ukraine has also decreased.

In terms of demand, the decline in prices has stimulated feed consumption. The USDA-ERS, based on the FARM model, expects that by 2050, the per capita meat consumption in China and India will still maintain a high growth rate. As an important additive in feed, the long-term support for corn feed consumption is relatively strong, especially after the Russia-Ukraine conflict, the global wheat inventory has continued to decline for three consecutive years, weakening the substitution effect on corn. The USDA estimates that the global corn consumption volume in the 2024/25 season will be 1,222 million tons, a year-on-year increase of 0.3%.

In summary, we believe that after two years, the global corn inventory process has basically been completed, which may become a sign of the end of the downward trend. In the context of the new season's supply and demand balance and the peak accumulation of inventory in the 2024/25 season, the price of global corn is likely to have bottomed out. According to the USDA's new season planting cost of $877.53 per hectare, assuming a yield of 181 bushels per hectare, we believe that the bottom price support is about $4.30 per bushel, which is about 5.6% higher than the closing price of $4.073 per bushel on August 5.

Soybeans: Short-term prices remain at low levels, waiting for positive factors to appear.Looking back at the first half of the year, under the supply pressure from the abundant harvest in South America, CBOT soybean futures prices once fell below the planting cost line. According to the USDA report, the global soybean production for the 2023/24 season is expected to reach 395.4 million tons, a year-on-year increase of about 4.5%. Among them, the United States, Brazil, and Argentina are expected to produce 113 million tons, 153 million tons, and 49.5 million tons, respectively. Although the United States and Brazil both experienced a slight decrease in production compared to the previous year, Argentina's production increase reached 98% year-on-year, offsetting the reduction impact of other major producing countries. Driven by the increase in production, the global soybean inventory increased by 10.6% year-on-year to 111 million tons, and the stock-to-use ratio increased to 29.08%, higher than the five-year average of 27.5%.

Looking forward, in the short term, the expectation of a new season's abundant harvest suppresses prices, waiting for the emergence of positive factors. The USDA's 2024/25 soybean supply and demand balance forecast guides the market's consistent expectations, which believe that global soybean inventories will continue to accumulate in the future. The soybean planting area in the United States may increase by 3% year-on-year to 86.1 million acres; the yield is expected to be 52 bushels per acre, higher than last year's 50.6 bushels per acre. Under the optimistic expectation, the USDA estimates that global soybean production will increase by 6.69% year-on-year to 422 million tons, driving the ending inventory to increase by 15% year-on-year to 128 million tons.

We believe that the current bearish factors have been basically digested by the market and continue to suppress prices. However, before the abundant harvest expectation is fully realized, prices do not have the momentum to continue breaking downward. Currently, it is the growing season in the Northern Hemisphere, and the new season's production activities in the main soybean-producing countries of the Southern Hemisphere have not yet started. The market's abundant harvest expectation is based on many optimistic assumptions, such as planting area, yield, and weather conditions. The USDA's July forecast for US soybean yield at 52 bushels per acre is at the highest level in 20 years, and the harvest area forecast of 86.1 million acres is also at a high level in 20 years.

Under such optimistic expectations, distant contracts are under pressure and falling, and the market expects a loose new season's fundamentals. However, there are many uncertain factors during the growing period, and under weather disturbances, there is a large room for the reduction of both yield and area. In addition, the production situation of Brazil and Argentina in the new season has significantly increased year-on-year, but the South American crop market year does not start until October 2024, so the current prediction has a large uncertainty. We believe that once the uncertain factors occur, they are mostly likely to have a positive impact on prices.

► Soybean meal: Feed demand supports soybean meal consumption

Against the background of the increasing meat consumption in developing countries, the increase in the demand for pork, chicken, and beef drives the increase in the number of poultry and livestock. In 2023, the global production of pork, chicken, and beef reached 116.2, 103.5, and 60.0 million tons, respectively, all reaching the highest level in the past 20 years.

The increase in meat consumption may boost the demand for soybean meal as a feed protein additive. According to the USDA forecast, in the 2024/25 season, global soybean meal consumption will reach 266 million tons, a year-on-year increase of 4.7% compared to 254 million tons in the 2023/24 season. In addition, soybean meal export volume is also expected to increase by 2.8% year-on-year to 74.5 million tons. At the same time, we believe that after a round of price decline, the cost-effectiveness of soybean meal as a protein additive is now prominent.

► Soybean oil: Policy benefits support the continuous increase in biofuel demand, boosting the fundamentals of soybean oil

In recent years, countries have introduced favorable policies to increase biofuel production. President Biden announced the allowance of year-round sales of E15 gasoline [4], breaking the long-standing blending limit (E10 Blending Wall). At the same time, in response to the high domestic inflation, a package of bills, the Inflation Reduction Act of 2022 (IRA), was introduced, which significantly increased support for the development of renewable energy [5]. In March 2023, the Brazilian National Energy Policy Council (CNPE) announced that the blending ratio of biodiesel would be increased from 10% to 12% and would continue to increase to 15% between 2024 and 2026 [6]. Indonesia plans to implement the B40 policy in the next few years [7]. The dense introduction of biofuel policies by various countries has made the promotion and application of biofuels more and more common globally.Looking forward, under the 2050 net-zero emissions plan, the demand for renewable diesel and sustainable aviation fuels (SAFs) in the United States may continue to increase, thereby boosting the demand for vegetable oils. The U.S. Energy Information Administration (EIA) estimates that by 2025, the production of renewable diesel, biodiesel, and other biofuels in the United States will reach 2.98 billion gallons, 1.59 billion gallons, and 0.6 billion gallons, respectively. Based on historical data, these biofuels will drive the demand for approximately 15.5 billion pounds of soybean oil, 2.3 billion pounds of canola oil, and 3.8 billion pounds of corn oil. By 2050, the production of renewable diesel in the United States is expected to reach 3.95 billion gallons, with the total production of biofuels still reaching 4.88 billion gallons, resulting in a demand for vegetable oils of about 22.8 billion pounds. However, the USDA points out that as of 2023, the domestic production of soybean, canola, and corn oil in the United States is not sufficient to meet the increased demand brought about by the growth in biofuel demand. The United States still relies on imports for about 29% of its vegetable oil consumption, and we believe that the continued increase in biofuel demand will lead to a persistent shortage of raw materials.

The value of grain merchants' allocation is becoming apparent.

A low valuation multiple rebound may be the main theme for the future.

Reviewing the situation, the current global soybean supply and demand fundamentals are similar to the bottom of the last cycle in 2018/19. The USDA estimates that the global soybean stock-to-use ratio for the 2024/25 season will be 31.8%, which is comparable to the ample supply of 33.3% in the 2018/19 season. In terms of soybean prices, as of 2Q24, the quarterly average price of CBOT soybeans was 1185.2 cents per bushel. After excluding the inflationary impact (2015=100), the 2Q24 soybean price was 897 cents per bushel, slightly higher than the average CBOT soybean price of 824 cents per bushel in the 2018/19 season.

Based on the judgment that the cycle has bottomed out, we believe that on the one hand, the valuation multiples of grain merchants will gradually rebound along with the industry's prosperity. On the other hand, after a round of price declines, agricultural product prices have gradually stabilized, and we believe that the recovery of investor confidence will also lead to a rebound in valuation multiples.

Defensive characteristics are obvious, and the cost of allocation is low.

Beta is less than 1, effectively diversifying the risk of the asset portfolio.

Due to the relatively rigid downstream consumption of agricultural products and the relatively independent supply and demand fundamentals of the industry, it is relatively insensitive to economic cycle fluctuations, thus possessing defensive advantages. We have seen that in the past two years, during the high market uncertainty of the COVID-19 pandemic and the Russia-Ukraine conflict, consumer confidence indices fell, but the performance of grain merchant stock prices was outstanding, effectively hedging the disturbances caused by unexpected events.

Compared with traditional defensive sectors, the return on investment in grain merchants is high and the cost is low.

By comparing grain merchants with traditional defensive industries, we see that in terms of both return and risk diversification effects, grain merchants perform no worse than the MSCI Defensive Sector Index (MSCI USA Defensive Sector). The Beta of grain merchant companies is close to the defensive index. Compared to the volatility of the index over 3, 5, and 10 years, the volatility of grain merchants is significantly less than that of the index, while their net return rate is significantly greater than that of the index.Additionally, the currently low industry valuation of grain merchants also helps to reduce the cost of allocation. In the MSCI Defensive Sector Index, there is an allocation of 50.29% to pharmaceutical companies, 24.34% to essential consumer goods companies, and 15.98% to energy companies. Comparing the current valuation of grain merchants with other defensive industries, we see that as of 2Q24, the P/E and EV/EBITDA multiples of grain merchant companies are both in relatively low positions. Under low valuation, the cost of allocating grain merchants as a defensive sector is relatively low.