The Inflation Cycle of 2002 to 2015 - Uhlmann Price Securities

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Industrial Portfolio Strategy The Inflation Cycle of 2002 to 2015 ⎯ April 19, 2002 -56- Legg Mason Wood Walker, Inc. ports, where demand is believed to be greater and less subject to political considerations. Despite the competitive pressure, we believe Chinese agriculture should not be underestimated. Chinese production of corn, wheat and rice grew from about 100 MMT in the early 1960s, just before a disastrous famine, to 200 MMT in the late 1970s, as labor and land were applied to the shortage problem. Since China introduced certain agricultural market reforms in 1978, followed by an additional round in the mid-1990s termed the "Governor's Grain Bag" policy, total agricultural staples production rose to about 390 MMT in the late 1990s, an increase of 90% in two decades. China set its tariff rate quotas (TRQs) high enough for corn and wheat that they are unlikely to be a problem for exporters to China in FY02, and notably absent is a TRQ for soybeans, of which China has been a prodigious importer. In fact, Chinese imports of soybeans represent about 20% of the global oilseed trade, and China imported approximately 14 MMT of soybeans last year. China has maintained a liberal import policy with respect to soybean imports to feed its growing domestic needs, so we are not alarmed by the genetically modified organism (GMO) talk, which may simply be posturing to protect other segments of the Chinese farming sector. Exhibit 45 – Key Drivers In Meat Product Trade U.S. Meat Consumed Per Capita 25,000 20,000 15,000 10,000 200 lbs. 180 lbs. 160 lbs. 140 lbs. 120 lbs. 100 lbs. Meat Consumption Is Income-Dependent 1935 80 lbs. $5,000 $10,000 $15,000 $20,000 $25,000 $30,000 $35,000 Real GDP Per Capita ($96, Uses GNP pre-1947) Meat remains one of the most exciting stories in agricultural trade. In 0 Exhibit 45 we show that meat consumption is income-driven, the world U.S. Meat Exports, 000s Tons (Left) meat market is growing, and we believe U.S. market share should benefit Source: USDA, Legg Mason estimates 2002 to 2015 5,000 0 12,000 10,000 8,000 6,000 4,000 2,000 1980 1980 1982 1984 1986 1988 1990 1971 1992 2001 As previous commodity charts have shown, the peak rate of consumption growth in the U.S. occurred at roughly the same time, from the mid-1930s to the early 1970s, or from about $7,500 of per capita real GDP to about $17,500 per capita. This may have implications overseas, in our view. The World Meat Trade (000s of Tonnes) Is Strong LM Estimates Dietary enrichment has boosted the 2001 to migration from grain to poultry. Typically, the 2015 = next step is to pork, then beef. 5.3% CAGR 1983 1980 to 2001 = 5.8% CAGR U.S. Meat Exports 1980-01 = 10.3%/yr. 1986 1994 1996 1998 2000 2002E Beef Pork Poultry 2004E We See U.S. Meat Exports Rising 1989 1992 1995 1998 2001 2004E 2006E 2008E LM Estimates 2007E 2010E Poultry 2010E Beef 2013E Pork 2012E U.S. Meat Exports 2001 to 2015E = 5.9%/yr. U.S. Meat Market Share % (Right) 2014E 60% 50% 40% 30% 20% 10% 0%
Industrial Portfolio Strategy The Inflation Cycle of 2002 to 2015 ⎯ April 19, 2002 -57- Legg Mason Wood Walker, Inc. now that competitors’ currency-related advantages in market share have begun to run their course. Agricultural analyst Bill Hudson has stated that in 1900 only 5% of the world could afford fresh meat every day, by 1950 the number was 20%, and today it is about 35%. We believe that the worldwide meat intensity of use penetration rate should rise to approximately 60% to 70% by 2050, almost doubling from the current level, with global population growth added to that figure. High-value products, which include meats, are approximately two-thirds of total U.S. agricultural exports, and have been the lifting force for U.S. farm exports for the last two years. High-value products added $2.1 billion more than the prior year to U.S. agricultural exports of $53 billion this year, versus a $77 million decline in bulk grain exports. Currently, exports account for 10% of U.S. beef production, 7% of pork and 17% of poultry. In the 1990s alone, the grain and oilseed equivalent of U.S. meat and poultry exports has increased by about 400 million bushels, since one unit of additional meat trade is equal to approximately 3.6 units of grain as feed (although poultry is less grainintensive than beef or pork). Meat stimulates feed grain consumption, but at a decreasing rate. Greater meat production efficiencies and the popularity of the less grain-intensive poultry industry have had a moderating effect on feed-grain demand, and from 1964 to 1999, the global production of meat and poultry rose by 450%, with only a 110% feed grain consumption increase. Of course, the increased share of poultry in the meat diet was a factor. In fact, poultry has been the star attraction of U.S. agricultural exports, with U.S. poultry export growth of 10.6% from 1980 to 2001, and 2001 exports of 6.2 billion pounds, or about 20% of U.S. production, with over one-half of that volume going to China and the FSU. We look for U.S. poultry exports to grow at a rate of 6.8% per year from 2001 to 2015, perhaps assisted by a weaker U.S. dollar that allows for greater export cost advantage. In recent years, U.S. total meat exports have been hurt by animal disease concerns the world over, and economic recessions, and the USDA expects total U.S. meat exports to increase only 0.5% in the current fiscal year. There are short-term impediments on the supply side. For example, if the liquidation phase of the cattle cycle were to come to a close this year, it is possible that animals bred in 2003 would not be ready for beef production until 2005, possibly restraining beef exports in the intervening period, and leading to substitution. Still, the long-term export picture is exciting if developing countries continue to embrace meat in their diets. From 1997 to 2001, Chinese beef imports rose 50% to 90,000 metric tonnes, pork imports rose 206% to 450,000 metric tonnes, and poultry imports rose 31% to 1.9 MMT. Using 1995 data, if we index the U.S. to equal 1.00 and examine total annual meat plus fish consumption in various countries, the Japanese consume 0.81x the U.S. level, South Korea 0.74x, and China only 0.23x. Fish is less of a factor in the U.S. and, to the surprise of many, China. China's increasing preference for meat shows up in the substitution numbers as well. From 1990 to 2000, Chinese consumption of food grains (rice and wheat) declined 13%, while China's population expanded 11%. A lack of cold storage and transportation infrastructure in China may restrain growth in the import of meats, but given that China has abundant labor and restrictive land and water resources, we are optimistic that China's competitive advantage will gravitate toward laborintensive crops such as fruits, vegetables, and specialty crops rather than field crops and certain meats. U.S. Agricultural Exports and Deere Stock The implications of greater farm industry prosperity are favorable for machinery sales, and thus Deere & Company. North American industry farm machinery inventories as a percentage of forward-12- month sales for 100+ horsepower, two-wheel drive (row crop) tractors are currently 29%, which is well be-
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The Inflation Cycle of 2002 to 2015 - Uhlmann Price Securities

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