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Ag trading giants could be on the brink of better times

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Better times may lie ahead for agriculture’s trading giants, which are suffering their lowest profitability in three years, a leading sector analyst said, even as Louis Dreyfus embarked on a cost-cutting drive.

 

The agriculture market ructions caused by the China-US trade dispute and the Asian African swine fever outbreak which is having a “major impact on demand” have “weighed on the profits” of the large trading houses, said Simon Taurins, a managing director at Credit Suisse.

 

Furthermore, “excess supply and high stock levels” of major crops, such as wheat and sugar, “have not helped merchant opportunity,” he said.

 

“The opportunity for arbitrage has decreased.”

 

‘No reason to buy’

Combined operating profits of the so-called “ABCD” group of traders – Archer Daniels Midland, Bunge, Cargill and Louis Dreyfus – totalled $3.23bn in the first half of 2019, down some $480m year on year, and the weakest performance of any half-year since the first six months of 2016.

 

The share price of ADM is down some 7% over the past year, and that of Bunge down 6%, compared with a rise of more than 17% in Wall Street’s S&P 500 index.

 

“The stock market is saying there is no reason to buy into the sector,” he said.

 

The comments came even as, unlisted, Louis Dreyfus issued a memo to staff unveiling a review to achieve “cost and productivity gains”, and temporary "measures on travel and entertainment, hiring and salary restrictions”.

 

Expand, or quit

However, the market conditions will “probably create opportunities for large ag groups in the end,” Mr Taurins told the International Sugar Organization’s annual Seminar in London.

 

While the uncertainties created by “exogenous factors” had “made life very difficult”, they would ultimately favour wider-ranging groups.

 

The choice for operators “is to increase your global footprint, or exit the industry,” he said.

 

‘Move downstream’

Furthermore, the trading houses may start to reap more credit for their spread from pure agricultural trading, with Mr Taurins noting that “we have some increased diversification, particularly over the past five years.

 

“We have seen many of these companies move out of, for example, metals… and move downstream,” he said, highlight expansion by Cargill in proteins, Bunge in speciality oils, ADM in nutrition, while Louis Dreyfus has been “reinforcing downstream integration”.

 

For now this diversification was being largely overlooked as they represented a relatively small part of the companies.

 

“The market will not give them real credit until it becomes a more material part” of profitability.

 

‘Higher margin, more profitable’

However, this may change as the strategies bear fruit, and earnings from higher-rated downstream operations become more obvious, and easier for investors to identify.

 

Indeed, Mr Taurins saw as “particularly interesting” the ingredients sector into which some of the trading houses have expanded, seeing this as “higher margin, more profitable business”.

 

Taking as an example the shift away from sugar as a food ingredient, he said that “if we want to cut sugar content… we need innovative solutions”.

 

Nonetheless, even in the sugar sector itself, there were signs that “market sentiment is beginning to turn” with, for instance, analyst “buy” recommendations on German giant Suedzucker increasing, and “sell” calls disappearing, with tightening supplies of the sweetener boding well for industry profits.

 

There appears a spreading “view that there is reason to come back in the sector”.

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