High Water Stress Exposure May Exacerbate Grain-Price Volatility

U.S. grain prices have fallen considerably in 2022 despite the Russia-Ukraine war and rising inflation, and were close to where they began the year as of mid-August. One factor in the reduced price could be the optimism about grain crops in the northern hemisphere (where harvests start in September). But this summer’s prolonged hot, dry weather may present an early warning of longer-term water stress and grain-price volatility. Food and grocery companies, with high exposure to this key issue and a low current return on assets, may potentially be under the greatest pressure.

The U.S. Agriculture Department has predicted roughly at-trend U.S. corn yields this year despite less-than-ideal soil conditions. Key corn-growing areas in Europe have also suffered recent heat waves and drought. If these trends persist, U.S. and European harvests could see reduced yields this year, and food companies and retailers could see higher input costs. Bespoke procurement agreements and commodity contracts can defray the impact, but these may be only short-term solutions.

Longer term, companies that rely on adequate water and other favorable crop-growing conditions could be exposed in two ways. First, most hedges eventually expire and must be repurchased or renegotiated, and if grain-price volatility increases those hedges could get more costly. Second, if grain prices rebound, food companies and grocers may face social or political backlash if they pass higher input costs on to consumers too quickly or too steeply. As higher temperatures and less-reliable rainfall become the global norm, the best-positioned companies should have strong financial fundamentals and be less reliant on water-dependent inputs.

Future water stress may expose food companies with weaker financial position

Chart lines represent averages; ROA based on most recent available data; chart includes packaged food and meat constituents of the MSCI ACWI Index (n=67, as of Aug. 12, 2022). Source: S&P CapIQ, MSCI ESG Research LLC