Drought Drying Up Profits for Companies
Erin is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Plain and simple, American efforts to move to renewable energy sources (and to please the voters and politicians of early-caucus state Iowa) have made us too dependent on corn and at the mercy of rain.
The Renewable Fuel Standard, a federal mandate enacted in 2005, and expanded in 2007, requires that 13.2 billion gallons of corn starch-derived biofuel (ethanol) be produced in 2012. The drought blistering most of the United States, is wreaking havoc with producers' abilities to meet the mandates. The result? Rising fuel, feed, and food prices.
Companies like biofuel giant Archer Daniels Midland (NYSE: ADM), the largest producer of ethanol and processed corn are taking a major hit from the drought. The company reported last month that lowered ethanol results hurt its fiscal fourth quarter profit. Its bioproducts business, reported a $61 million operating loss, compared to a $111 million profit a year earlier. For the year, the business lost $74 million, down from $749 million the year earlier.
The drought has sent corn prices skyrocketing up 50% since June, and with it, the prices of all products derived or dependent on corn- including fuel, cereal, livestock feed, domestic pet food, meat and poultry, nearly all processed foods, and just corn itself. The USDA predicts increases of 3-5% in domestic prices of beef, dairy products and eggs.
The drought is bringing much needed attention to the negative effects of the federal mandate, and the country's unhealthy dependency on corn as a source of fuel. When corn yields cannot produce enough to reach the mandates the priority goes to fuel over food. As much as 40% of the U.S. corn crop is destined to go into automobiles and not onto tables. Only 36% of the corn crop goes to feed. Critics say ethanol also is a major reason the price of a bushel of corn going from an average $2.15 a bushel in the 1997-2006 period to more than $8 today.
More than just ethanol producers will be hurt by raising corn prices. Companies like Tyson Foods (NYSE: TSN) and Hillshire Brands (NYSE: HSH) that produce chicken, beef, and pork, which are all fed processed corn (and soybean) products, will also feel the pinch. In August, Tyson reported earnings of $76 million on revenue of $8.3 billion. The year previous the company reported profits of $196 million on revenue of $8.25 billion.
Donnie Smith, CEO of Tyson Foods, said, "Grain costs have been increasing significantly and rapidly, largely as a result of the on-going U.S. drought. While we ultimately expect to pass along rising input costs, these costs, coupled with continued soft demand, are likely to pressure earnings in 2013... We can’t make it rain, but we can execute against our strategy by producing high quality foods using innovative and cost effective processes. It’s tough right now, but I’m confident we will come out of this in even better shape than we are in today."
Hillshire Brands, which only recently broke off from parent company Sara Lee, sees a similar outlook- the drought will cause higher grain prices that will raise expenses that will get passed along to the consumer. But more specifically, the company points out that the impact of the drought will not be felt until late 2013 and into fiscal 2014.
"It really has to do with the cycle times associated with raising different livestock species," CEO Sean Connolly explained in the earnings call. "So we expect the grain prices to roll through the proteins later, not sooner."
CFO Maria Henry added, "The timing of exactly how the conditions will flow through the market and affect the basket of commodities we purchase will continue to evolve."
Currently fuel companies are required by the mandate to mix 9% of corn-based ethanol into gasoline. This has resulted in a boom of ethanol production plants over the past decade. As recently as March of 2012 there was an ethanol surplus in stores. However, due to the drought, companies including Valero Energy (NYSE: VLO) have been forced to temporarily stop production in its plants. According to Bloomberg, the company, which is the third-largest U.S. ethanol producer, is operating at about 50% of capacity. The company has idled or stopped production at four plants since June. Valero owns 10 ethanol plants and 16 petroleum refineries, and will reopen the plants when corn and ethanol prices allow them to regain profitability. Valero's ethanol business accounts for about 5 percent of its revenues, according to company spokesman Bill Day.
In the end, politics could prevent financial troubles for the food industry companies. Lawmakers could suspend or lift the mandate. However, it doesn't look likely. The National Corn Growers Association is against lifting the mandate, and in an election year, no politician will risk the wrath of crucial Midwest farming states. Until the rains fall and the drought is officially over, investors beware of rising corn prices and falling profits.
ErinAnnie has no positions in the stocks mentioned above. The Motley Fool owns shares of Archer Daniels Midland Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.