CLSA oodles of noodles

As an analyst (Swati here), it is not easy to justify a big earnings downgrade/upgrade based on big volatile movement in input cost. She is not making any macro calls on global commodity prices. Best she can do is perhaps use current spot price (In Indofoods case, wheat and flour) in her forecast. Still she decided to be a little generous based (Wheat prices now already 30% higher than our forecasts) on the prospects of a strengthening Rupiah and that recent surge in soft commodity prices is only spike.

However, the uptrend here of commodities look more like a structural than cyclical issue. Not only global grain inventory is still very low in a historical context, rising prices is also a side effect of inflation. This is a structural issue. It is also true that I’d rather be a stock broker than a farmer. No one that I know wants to be a farmer. At the same time, Asians’ diets are quickly catching up to those of the developed country (very bullish for soft commodity prices). Not to mention water table is declining rapidly in the agricultural regions.

In the short to medium term, wheat price is the most at risk. Russia is experiencing its worst drought since record began (130 years ago). Farmers harvest yields were 2.22 tons per hectare, down from 2.78 tons last year. In the central federal district, wheat yields are averaging only 1.81 tons per hectare, down from 3.13 tons last year. Russia’s grain exports may fall as low as 11 million tons in the marketing year that began July 1, down from 21.5 million tons last year.

Drought and extremely hot weather have also negatively impacted wheat production in Ukraine, western Europe, and Kazakhstan. Below average rainfall last month in western Australia is also threatening wheat production in the region.

In Canada, world’s second largest wheat exporter, prospects for wheat production have also been diminished, due to excessive which is now expected to harvest 17% less than a year earlier.

Rising wheat price is negative for Indofood. Last time when wheat prices surged, their noodle business EBIT margin got compressed to only 1% (our assumption still at 13%)

I will be a seller of Indofood and buyer of London Sumatra and Gozco