The Economy

Earnings May Shrivel Along With the Corn Stalks

In SEC filings this month, companies are warning of the wide financial impact of the drought in the U.S. farm belt.
Vincent RyanAugust 10, 2012

The worst drought to hit the U.S. farm belt since 1956 has companies of many stripes forecasting the potential ripple effects in Securities and Exchange Commission filings. Companies linked to agriculture are preparing for lower revenues, tighter margins, and even higher leverage ratios for the rest of this year and possibly into 2013.

At the end of June, about 33% of the contiguous United States was in severe to extreme drought, according to the Palmer Drought Index, a measure used by the National Oceanic and Atmospheric Administration. So far, the weather in the Midwest and the Great Plains states has caused corn prices to jump. Corn-crop yields may be at their lowest in five years. Since corn and other affected crops like soybeans are used widely in animal feed and biofuel production, among other products, the tighter supplies and higher costs could dent the performance of many industries, from energy utilities and banks to restaurants and insurers.

CKE Restaurants, the food chain that includes the Carl’s Jr. and Hardee’s brands, pulled the plug on its planned initial public offering Friday, citing poor conditions in the stock markets. But in an amended S-1 filing this week, the company also said the extended drought could hurt its operating results.

In the filing, CKE explained that beef costs may rise as much as 5% next year because the expense of feeding cattle will rise. That increase is on top of a 10% to 15% increase during the past year, the result of a reduction in U.S. cattle supplies. Beef is CKE’s largest commodity expenditure, accounting for more than 20% of the company’s total food and packaging costs. “Material increases in the prices of the ingredients most critical to our menu, particularly beef, could adversely affect our operating results or cause us to consider changes to our product delivery strategy and adjustments to our menu pricing,” CKE said in the filing.

Other companies are also worried about having their margins squeezed by higher input costs. An SEC filing from egg producer Cal-Maine Foods this month projected that feed costs, which make up two-thirds of the cost of farm-egg production, would be high and volatile in the year ahead, and if they “are not accompanied by increases in the selling price of eggs [it could] have a material adverse effect on our operations.”

Further upstream on the commodity supply chain, Bunge Ltd., whose agribusiness unit purchases, stores, transports, and processes farm commodities, says the drought is exacerbating an already-tight global supply-and-demand balance, and that the price environment continues to increase the company’s “working capital funding requirements, and consequently [its] debt levels have risen as well.”

“The higher crop prices we are seeing will cause demand to slow down,” said Bunge CFO Andrew Burke during the company’s second-quarter earnings call. Still, he said, “the world’s grain needs will have to be served by nontraditional trade flows, and our asset base and logistic network are well positioned. Our strong balance sheet and risk-management capabilities are essential in the current high-price, volatile environment.”

Lower sales volumes will also hit agricultural processor Archer Daniels Midland, whose credit-rating outlook was revised to negative by Standard & Poor’s this week. S&P said the company’s “earnings and credit measures could weaken given the current drought” and pointed to potentially lower volumes for ADM’s grain-handling business and ethanol facilities.

Up to 40% of the United States’ corn crop goes to make ethanol, thanks to the Renewable Fuel Standard, which requires that billions of gallons of corn starch–derived biofuel be produced yearly. Ethanol producers are already being squeezed, and some have idled manufacturing facilities.

In its second-quarter 10-Q this week, Cardinal Ethanol said higher corn prices have not yet resulted in higher ethanol prices. So the company said it may have to reduce production at its plant if it cannot be “profitably operated.”

Vendors of companies like ADM, Bunge, and Cardinal Ethanol say they will also feel the pinch from a poor grain harvest. A filing this week from Interstate Power and Light, an Iowa electricity producer, indicated it could see reduced demand for electricity but that it was unable to forecast the potential impact on its financial conditions or operating results. The company added, however, that the effects could be material.

Meanwhile, banks that finance much of the nation’s farm belt are preparing for problems in their loan portfolios. Madison County Financial, a Nebraska bank, said this week that farmers with nonirrigated farms will lose a substantial portion of their 2012 crop from the drought, and that it could cause them to default on their borrowings. The farm loans the bank originates are used to fund crop production and are collateralized by the sale proceeds of the crop to be harvested, it said.

Industrywide, while some agricultural business loans are covered by crop insurance, coverage is often not required. In an SEC filing this month, insurer Partner Re said that while it is monitoring its exposure to U.S. drought conditions on a state-by-state basis, it didn’t have enough information yet to arrive at a “reasonable estimate” for its future incurred losses.

Munich Re, a larger reinsurer in the agricultural markets, said on Wednesday that it expects approximately $200 million in losses related to crop failures.

Economists say the income of U.S. farmers is taking a double hit this year, as the strengthening of the U.S. dollar is raising the prices of farm exports in foreign countries.