Biggest Trends in Food and Ag, From ESG to Inflation to the Supply Chain

Michael Torrance:

Welcome to sustainability leaders. I'm Michael Torrance, chief sustainability officer with BMO Financial Group. Sustainability Leaders features leading sustainability practitioners from the corporate, investor, academic and NGO communities, as they explore how this rapidly evolving field of sustainability is impacting global investment, business practices, and our world. This week, our global director of research, Bert Powell introduces a special episode from our 16th annual farm to market conference. In today's show, you'll hear BMO capital markets chief executive Dan Barkley, drill down with our leading analysts on how ESG has taken center stage for the agriculture industry with impacts across the food chain.

Speaker 2:

The views expressed here are those other participants and not those of Bank of Montreal, its affiliates, or subsidiaries.

Bert Powell:

I'm Bert Powell, global director of equity research for BMO capital markets. Our farm to market conference spans the global food and agricultural value chain. In 2021, we had the pleasure of hosting 90 public and private companies, presenting to more than 500 equity, debt, and private equity investors on the trends in the industry, ESG initiatives, technology, and the outlook for companies who fall within the farm to market value chain. Today on our podcast, we are pleased to be joined by BMO capital markets group head, Dan Barkley, who will moderate a discussion or the core takeaways from our farm to market conference between three of our equity research analysts. Joel Jackson, who covers fertilizers chemicals, Kelly [inaudible 00:01:45] , who covers food retailers, and Ken [inaudible 00:01:48] who covers food and agribusiness. Dan, welcome to the podcast.

Dan Barkley:

Thanks, Bert. It's great to be here today and talk about our 16th farm to market conference, and our second consecutively, in a virtual format. The common theme among attendees was acceleration and innovation. No matter what the vertical, they're all working towards a common goal, to drive solutions linked to sustainability, scalability, and improved cost efficiency, in order to combat inflation, labor reductions, and supply chain management. During last year's conference, we were in the midst of a global lockdown and pandemic. We had no idea how long it would last. Today, we're seeing vaccinations roll out around the world and the global recovery on the horizon. A very different backdrop for the conference. And we started to see the impacts of COVID-19 in the agriculture and food sector. So for our first question to each of you, what was your single biggest takeaway from the farm to market conference? I'll start with you, Joel.

Joel Jackson:

Thanks Dan. I think for me, it was how quickly we went from the sky is falling in agriculture, only 13 to 14 months ago. That was because of estimates of huge crop carry outs and inventory, closed ethanol plants, there were lower fertilizer prices and they were challenged seed markets. But now, suddenly, we have top of cycle expectations for growers and cropping [inaudible 00:03:10] profitability. That being said, at the conference, we did detect more cautious optimism than outright bullishness, as I think the proceeding challenging years of marginal profitability and the fact that farmers still haven't monetize these high crop prices yet. And the concern that ag cycles tend to be short-lived when they're keeping farmers and crop producers level-headed.

Dan Barkley:

Ken?

Ken:

Thanks, Dan. Echoing what Joel said, the level of confidence in which the company's crossed the food supply chain believe they are positioned to benefit from the current environment, was our biggest takeaway. Across our coverage universe, they all believe that years of hard work in less than ideal market conditions have laid the foundation for them to reap the benefits from the current favorable environment. Agribusiness companies, such as Bungie and EDM, are capitalizing on China demand and renewable diesel. The protein companies, like Sanderson Farms and Tyson, are benefiting from the chicken sandwich wars and the emergence from COVID. People sometimes forget about the packaged food companies, but they also can benefit from elevated demand, as well as their data analytics, which is making pricing easier to pass through.

Dan Barkley:

And Kelly, take us home.

Kelly:

Thanks, Dan. So our biggest takeaway is just how dramatic the change has been in one year. And I think nowhere is that more evident today than in the supply chains. And I think it's crystal clear that the companies themselves learned a lot about their supply chains and will be investing in supply chains even to a greater extent going forward.

Kelly:

So last year the food supply chain was so stretched at the grocery industry. And now supply chains are being stretched on the food service or food away from home side. And as flexible as employees have been over the last year, it's just evident that you cannot start and stop the global supply chain for food on a dime and expect no friction. So we're working through that friction now, but these extreme scenarios have allowed the companies to learn a lot about their strengths and weaknesses in their supply chains. And I think we'll see a lot of investment across the food supply chain going forward, as well as investment in employees.

Dan Barkley:

That's great. Obviously one of the hot topics of the conference was a conversation about inflation. So Kelly, maybe first with you, what are you seeing from an inflation perspective across your coverage, and how are the companies managing?

Kelly:

Sure. So a lot to talk about on inflation, and I think importantly, to put the current environment into historical perspective. So we are currently expecting high single digit food inflation. The last time we were anywhere near that high was a decade ago in 2011, and that was in the five to 6% range. Prior to that, it reached as high as 7% in the late 2008. But levels higher than that have not been seen since the late 70s or early 80s. And that would be in the low double digit range, which we're not expecting today. But what's interesting is that we've done a lot of work on the consumer stimulus here in the US. And the state of the consumer suggests that they're in better shape than recent memory to digest and above normal level of food inflation. In a normal environment, we would say low single digit could be a positive.

Kelly:

So perhaps the threshold is a little bit higher today than what would be normal, but at the end of the day, the inflation, not only in food, but across the consumer landscape will be eroding the purchasing power of consumers. And I think what we heard at the conference, was some companies starting to admit that the potential for inflation to be a little ahead of their plans, from just even a couple of months ago. But we're also hearing that some of the inflation may be induced by the labor-related challenges across the supply chain. And there's this expectation that some of that could subside by the fall timeframe. And so we'll be watching closely to see if the rate of change could moderate by then, which I think would be a positive. And what we've been talking a lot about in our coverage across food and food retail and distribution, is that the distributors can really pass through the inflation. There may be a little bit of a timing lag, but it's the retailers that have to deal with the end consumers.

Dan Barkley:

That's great. Ken, how about in your universe? How are they thinking about inflation?

Ken:

Inflation has been really the topic du jour. This inflation is different than what we've seen over the last 15 to 20 years in two ways. First, it's broad based across commodities, packaging and logistics, which means it's pervasive and affects everyone. As a result, the packaged food companies believe they can take pricing across their entire portfolios. Second, it's demand driven, exacerbated by supply constraints, which means it will be around for at least another year. Although we think the rate of inflation will slow after the pent up consumer demand wanes and supply constraints ease, we will still be left with China and renewable diesel driving inflation. What this means is that it is still a very favorable environment for agribusiness and protein companies.

Dan Barkley:

And Joel, you've got a slightly different perspective. With commodity prices having stepped up material over the last year, what are the impacts of the growers and the crop input producers?

Joel Jackson:

Right. Growers, particularly in the US, really have struggled to be profitable up until this year. Farmer incomes have been marginal despite subsidies, as crop prices have been lackluster following many years of strong yields and good production. And this has definitely led to deteriorating balance sheets and lower liquidity for farmers. And in turn, has limited fertilizer, seed, and crop protection chemical price upside. In the seeds market, for example, large seed producers, like Bayer and Portaba, have not been able to raise prices sufficiently to cover large research and development budgets. And growers have not been paying the proportionate share of having higher yielding seeds that produce higher revenue for them. In fertilizer, we've seen prices barely higher than marginal costs, and that's led to quite low margins, production curtailments, and other negative outcomes.

Joel Jackson:

Suddenly, with corn prices no longer trading generally before $4 per bushel, and now it's $6, even higher. And we're seeing similar increases in other crop prices, will suddenly [inaudible 00:09:27] are set up on paper this fall to earn near record profitability, and they want to do anything they can to ensure strong yields this year. This along with higher cost curves because of the general commodity inflation we're seeing, this has led to the highest fertilizer prices in close to a decade, and expectations for much higher seed prices starting the second half of the year. So sentiment is bullish among growers and crop into producers for a sector that has generally been depressed for years, and we're likely to see higher farmland values, as well.

Dan Barkley:

Those are great perspectives. I think the second big topic that we wanted to do a little dive on, coming out of the conference was around ESG. Ken, BMO's approach is to integrate ESG into our fundamental research. How has the packaged food industry progressing on its own ESG initiatives?

Ken:

That's a great question. With the meteoric rise in ESG investing, we tackle the ESG topic within the food industry. In a report we published a couple of weeks ago, it was entitled "Mission Impossible: Assessing ESG risks and opportunities in the US packaged food industry." Our key finding in the report is that the pace at which the US food industry is executing on ESG has accelerated markedly over the past few years. And now we're actually on a mission to debunk the perception that the US industry are not a favorable ESG investment. In fact, we expect companies that are accelerating the ESG initiatives to enjoy the greatest valuation premiums over time, as the ESG initiatives become more appreciated by the market. But what really distinguishes the best in breed are those what we call super powers, a focus on or a specialty area, such as regenerative agriculture, such as General Mills. So again, what we think is that the US packaged food industry is really tackling this issue and making serious progress.

Dan Barkley:

And Joel, how has the topic of carbon management and farming come along, and will it be a benefit or a burden for farmers and crop input producers?

Joel Jackson:

Thanks. Earlier, if you asked me what the largest takeaway was from the farm Drucker conference, I gave a different answer. But I could have also answered that the monitoring and monetization of sequestered carbon and farmland, and just the general assessment of sustainability of crop production, how stakeholders will deal with it. Well, that's become one of the most talked about topics among growers and the broader agriculture industry. Many believe that farmland management is one of the largest contributors to climate change. With ag having the potential to move from being a net emitter of CO2 to a net sequester. Soils are known to have strong, carbon sequestration properties. And emissions can be reduced and sustainability scores improved, by following different ag practices, such as no till farming and optimal crop input application. Actually, many firms do follow these practices. What we are seeing is the potential for two revenue streams to be established over time, to encourage growers, to peg more carbon in the soil, and be more sustainable.

Joel Jackson:

First, straight carbon credits from government sources in various countries, if growers can lower carbon emissions. Second, and what's really interesting, is the concept of food and ingredient companies contemplating demanding the grading of source grain, based on sustainability and carbon metrics. Perhaps offering higher grain price premiums to products sourced for more sustainable farms. Now, the issue here is how to monitor the farms, assess sustainability, allow farmers to collect carbon credits, and feed this data to grain purchasers. Many leading crop input and technology companies, as we speak, are working on tools for this, with the dreams of a hydrogen economy starting to percolate, nitrogen fertilizer producers also seek to sell lower carbon fertilizer at premiums. Or to get growers to pay up for such products, the hope would be farmers could get incremental revenue from the ways I just described.

Dan Barkley:

Thanks, Joel. Why don't we switch to the future, and what we're seeing and what we're thinking about. Kelly, I'm going to start with you. What is retail media and why are retailers investing in these capabilities?

Joel Jackson:

Sure. So the simple answer is that retail media has actually been around for a long time. What we're talking about today is really digital retail media. So that means basically advertisements on e-commerce and retailers apps. And what that could include is everything from sponsored search, display ads, even digital out of home. So if you're checking out at a grocery store or a gas station, and you see a screen with an advertisement, that would be retail media. And so what has happened as retailers, both large and small now, they have taken notice to what Amazon was able to do with their platform, generating a multi-billion dollar advertising business. Now, for a retailer, advertising is a very high margin business. Obviously, food retailers operate on historically pretty low margins. So as food retailers have gone deeper into e-commerce, and clearly the last 12 months and the pandemic has really accelerated that penetration of e-commerce, and probably pulled forward a trend that was happening by years.

Joel Jackson:

So just for context there, we probably went from a low single digit penetration of grocery sales being online or digital, to now low double digit range, which was basically almost overnight. So as that low margin part of their business has increased, retailers have really been developing capabilities to capitalize on this high margin advertising dollar business. And that can include on their own properties, and sometimes even off property, because retailers have valuable first-party customer data. So some of the large retailers, like Walmart and Kroger, are doing this in-house with their own capabilities and building out their tech stacks. Albertsons is one that spoke about this at the conference last week. They are even building some more capabilities in-house and an investing here. And even some of the small and large retailers can work with a third-party provider, such as Quotient, who was also at the conference. So retailers are very focused on driving that digital engagement with their consumers in order to go after this high margin area of their business, which may be able to help them buffer some of the margin pressure from a growing e-commerce business.

Dan Barkley:

That's fascinating. Joel, how about you? You've done some recent work on digital agricultural data science software analytical tools for crops and equipment suppliers, and you're suggesting this technology is simple table-stakes. What are your perspectives around this today?

Joel Jackson:

Thanks. In March, we publish a thematic deep dive on digital agriculture, entitled "Digital ag: powerful analytics tools" but so far, only table stakes. The report talks about the big data analytics software and automation tools developed over the past decade and supplied by crop producers, ag equipment makers, and some independence. The tools attempt to create actionable and predictive agronomic intelligence for a farmer to manage planting, the fields, and yield. Bayer and Deer are the industry leaders here. There are many large competitors including Cartiva and Nutrient. Look, almost a decade ago, companies like Monsanto had big aspirations to charge farmers large, discreet, per acre fees for digital ag analytics. But our bottom line is today, the promise never panned out. Truly paid acres are now only tiny, with growers struggling to justify return on investment. Plus, ROI is difficult to quantify. Farming has many variables, such as weather, pests, product decisions, luck, human actions, and good datasets take years to generate.

Joel Jackson:

So digital ag is clearly now not influential in driving farmer decisions. In turn, almost all suppliers, despite investing billions in this so far, well, they now largely bundled the software with core crop input products and services for free or near free as table stakes and throw ins. For these crop input suppliers, value creation stems from promoting digitization as a means to better understand your growers and better tailor advice to those growers and identify product and service upsell opportunities. Therefor, while the tools do add some value, standalone digital ag providers not connected to crop input or equipment sales, despite any independence, will likely continue to struggle to be profitable solely on advice tied subscriptions. And to really monetize these tools one day, digital ag likely requires clear evidence of direct ROI for farmers. Those could stem from input cost savings, such as reducing nitrogen fertilizer spend without sacrificing yield, or supporting revenue streams, for example, on farm carbon management.

Dan Barkley:

Quite a difference in expectations from what seems like a short while ago. Let's move to close out the podcast, and we'll go with one final question. Staying with the future, I'm curious about what a trend is that you would expect a year from now that few are talking about today? Why don't we start with you, Kelly?

Joel Jackson:

Sure. Such an interesting question and so many ways to take this. But one of the things that we thought about just coming out of the conference and given some of the work we've done on the state of the consumer, is just this notion of membership fee fatigue. And if you think about how many memberships consumers are being asked to join today, I think you could get to a point where consumers increasingly become more discerning on the memberships that really bring a lot of value and convenience, and that some on the periphery may get streamlined. And particularly, again, when we come out of this consumer environment here in the US, where consumers wallets are not being massively supplemented by stimulus dollars like today. So we did some work and have estimated that the magnitude of consumer stimulus checks that have hit wallets for consumers in the US in 2021 is nearly twice as large as it was in 2020. And 2020 was pretty unprecedented, as well.

Joel Jackson:

So this kind of came up at farm to market, but I think it may have fallen under the radar. And one example was when we were speaking with Kroger, who's obviously the second largest food retailer in the US, they mentioned some challenges with a test that they're doing for an online grocery delivery membership. And they kind of suggested that consumers already get a lot of free perks with their existing loyalty program and that adding a fee onto that is difficult. And so just curious if that may be one of the first signs that we're seeing, which will be interesting because investors really love those recurring revenue streams for obvious reasons. So this will be, I think, something interesting to watch as we move into next year.

Dan Barkley:

Over to you, Ken.

Ken:

We think there are really two key trends that will probably emerge over the next couple of years. The first one, we would not be surprised if investors restart the conversation about food versus fuel, as inflation takes hold and policy focuses on the environment. The second one, which it links, again, to the ESG side of it, is we think that carbon capture will become the topic for next year across our industry.

Dan Barkley:

And lastly, Joel.

Joel Jackson:

I think a few people in the investment community are really talking about the stresses and strains on farmers, and perhaps how technology can start to solve some of these problems. The stresses we see come from sustainability and carbon management, labored shortages, and aging farmer demographic. While perhaps digital ag isn't that valued for assisting growers in their input decisions, better analytics and data science tools could possibly help growers deal with many of these other problems I just mentioned.

Dan Barkley:

That's great. Well, let me say thank you to all, especially you, Joel, Kelly, and Ken. Great insights from you. And once again, congrats on a successful farm to market conference. Hopefully you've enjoyed the podcast. We continue to focus on ways that we can provide a forum for our clients to engage and pass along our insights in a very relevant and digestible way. We're looking forward to next year's conference. It will be the best ever. And hopefully what we'll do is we'll see you all in person.

Bert Powell:

That was Dan Barkley, BMO capital markets group head. Joel Jackson, fertilizers chemicals analysts. Kelly [inaudible 00:22:05], food retailer analyst. Ken [inaudible 00:22:08], food and agribusiness analyst, sharing their takeaways for the BMO 16th annual farmer marker conference. We're pleased you could join us for this edition of BMO's podcast.

Speaker 8:

To access our full disclosures, please visit ResearchGlobal0.BMOcapitalmarkets.com/public-disclosure.

Michael Torrance:

Thanks for listening to Sustainability Leaders. This podcast is presented by BMO Financial Group. To access all the resources we discussed in today's episode, and to see our other podcasts, visit us at BMO.com/SustainabilityLeaders. You can listen and subscribe free to our show on Apple podcasts or your favorite podcast provider. And we'll greatly appreciate a rating and review and any feedback that you might have. Our show and resources are produced with support from BMO's marketing team and Puddle creative. Until next time, I'm Michael Torrance. Have a great week.

Speaker 2:

The views expressed here are those of the participants and not those at Bank of Montreal, its affiliates, or subsidiaries. This is not intended to serve as a complete analysis of every material fact, regarding any company, industry, strategy, or security. This presentation may contain forward looking statements. Investors are cautioned not to place undue reliance on such statements, as actual results could vary. This presentation is for general information purposes only and does not constitute investment, legal, or tax advice, and is not intended as an endorsement of any specific investment product or service. Individual investors should consult with an investment, tax, and/or legal professional about their personal situation. Past performance is not indicative of future results.