Is a Super El Niño on the horizon?
Exacerbated by climate change, El Niño may be on the verge of causing significant damage. On top of current inflation, new upward pressures on commodity prices and, consequently, a decrease in consumer demand could potentially fuel a stagflation scenario, especially in EMs. Against this backdrop, companies such as ABI, Heineken, or Unilever may find themselves on the losing end, while Suedzucker, Aryzta and especially Ebro Foods could manage to rise above the fray.
El Niño has officially arrived and is expected to last between 9 to 12 months, starting from September. The last El Niño event in 2016 contributed to making that year the hottest on record. Today, it appears that global warming is poised to exacerbate the impacts of this phenomenon, and likely to create a Super El Niño. Despite the fact that El Niño occurs every 2 to 7 years, it remains relatively misunderstood in the world of equity investment. While we wouldn’t claim to be experts in a complex subject like this, it’s paramount for us to explain in a straightforward way how this event works before discussing its potential consequences and providing an overview of our Food & Beverage coverage.
El Niño is a term used to describe the warming of the Pacific Ocean’s waters. Normally, the waters are warm in the west (south-east Asia-Australia) and cold in the east (Central/Latin America and parts of the southern US). The prevailing wind patterns, known as the trade winds, blow from east to west, pushing the warm surface waters toward Asia and away from the coast of LatAm. This movement also allows cold deep-sea water to rise to the surface in the eastern region. The presence of warm water primarily explains why Asia-Australia experiences more rainfall compared to Central-Latin America, which tends to be drier. Warmer water leads to increased evaporation, resulting in more cloud formation and, consequently, higher levels of rainfall. When El Niño arrives, it disrupts the trade winds, and sometimes even reverses their direction. As a result, cold deep water doesn’t rise, warm water from the west starts moving eastward, creating a patch of warm water in the central and eastern Pacific Ocean.
El Niño, or rather, the master of bad timing
Although El Niño unevenly affects the whole world, the regions near the Pacific Ocean experience the most significant effects. Areas like South-east Asia, Australia, and certain parts of Latin America, such as Brazil, may experience extreme heat, while heavy rainfall is expected over the Andes, the southern United States, and Mexico. It triggers a domino effect that disrupts the climate in other regions worldwide (chart below).
Source: AlphaValue
The critical question is: how does this geographical event impact the entirety of our F&B coverage?
The disturbance in the climate, including things like severe floods and periods of extreme drought, has led to substantial economic damage. These losses were estimated to be between $5.3tn and $9.7tn for El Niño events in 1993 and 1998, as reported in a recent article by geography specialists Christopher W Callahan and Justin S Mankin. El Niño tends to coincide with an economic slowdown worldwide, especially affecting emerging countries (chart below).
Source: AlphaValue,Christopher W Callahan and Justin S Mankin 2023 “Persistent effect of El Niño on global economic growth”
Across the Pacific region, many countries are the primary producers and exporters of the most commonly consumed commodities worldwide. The extreme weather conditions brought about by El Niño are poised to devastate the production of a significant number of staple crops, including rice, sugar, wheat, corn, soybeans, and many others. A decrease in harvests will be synonymous with inflationary pressure on these products, as we have already witnessed in 2016 (charts below).
Rice futures rose by c.+37% between May and October 2015
Raw sugar futures rose by c.+125% between September 2015 and October 2016
The upward pressure on commodity prices could potentially sustain the ongoing global inflation. In EMs, c.30% of household budgets are allocated to food expenses, which is twice as much as in developed countries. On top of current inflation, a further squeeze in household purchasing power may dampen overall demand, especially in EMs (chart below).
An ALMOST homogeneous overview
If commodity prices increase, it would affect our entire F&B coverage. Having pricing power will be critical to protect margins while consumers continue to struggle with the ongoing inflation. Nevertheless, some companies are more affected for specific reasons.
Beer industry
Although ABI’s exposure to EM positions (c.65% of company’s sales) the company perfectly to benefit from the markets with the strongest long-term growth potential, the arrival of El Niño could disrupt this trend in the short term. Indeed, Central-Latin America is one of the regions the most impacted by the phenomenon and it is the one of the top markets for ABI (accounts for c. 50% of the group’s top line). A slowdown in the economies of these countries would have a significant impact on the company.
Heineken has a lower exposure to EMs (c.50%) compared to ABI. However, its substantial presence in Mexico (c.19%), Brazil (c.11.0%), and Vietnam (c.6.0%) is also putting the company in the spotlight.
Carlsberg, with a strong presence in Europe (c.67%), is the company least exposed to a potential decrease in beer demand in EMs.
Spirits industry
When it comes to spirits, which are considered luxury discretionary goods, the situation is somewhat different. The industry tends to be resilient, and a price increase doesn’t necessarily lead to a decrease in demand.
Pernod Ricard, with a substantial presence in EMs, especially China (c.12%) and India (c.12%), finds itself in a less advantageous position compared to its peer Diageo, which has a lower exposure to these markets. When we look at how an economic downturn in these countries affects Pernod Ricard, we see that the results are very different from those of the beer industry.
Nonetheless, a drop in household purchasing power is never good news. The premiumisation trend, which has been the real growth engine over the last few years, won’t be challenged, but it might hit a roadblock.
Remy Cointreau’s exposure to China (c.30% of groups sales) could be problematic. While inflation remains very low, the country is marked by a property market crisis and historically high unemployment rates, especially among young people (aged 16-24). These young individuals are significant consumers of cognac and spirits in general. If we add inflationary pressure to these existing demand challenges, it’s unlikely to result in a good cocktail.
Campari may have to scale back its marketing campaign for the roll-out of Aperol in countries such as India and China if demand is affected more than expected.
Food industry
A fresh rise in costs for companies such as Danone, HelloFresh, and Unilever, whose consumer demand is still under pressure from inflation, wouldn’t likely be welcomed as good news. The situation could be more challenging for Unilever, as approximately 60% of its revenue comes from EMs, including India, Brazil, and Indonesia among its top five markets.
For Ebro Foods and Suedzucker, the situation is really different. As reminded in our last idea kicker on the company, Ebro Foods serves as a natural hedge against the erosion of consumer purchasing power caused by inflation and the broader phenomenon of global warming. The price elasticity of rice, which approaches zero, enables Ebro to implement a robust pricing policy. If El Niño drives up rice prices, Ebro Foods will have no problem passing on its prices and maintaining consumer demand.
A potential significant risk that we would see is for cocoa- related stocks as the key production countries are in the El Niño risk area. We would see the main impact on Barry Callebaut which, as a supplier, depends on volume growth. Large-scale consumer price increases would impact volume demand from outsourcing partners like Hershey, Mondelez and Nestlé. For our branded consumer food producers – like Nestlé and Lindt – we would see mainly second-round risks, as companies using the key raw materials (cocoa, coffee, sugar, and dairy) use hedging and can work on price increases. However, as currently seen in 2023, large-scale input cost increases can lead to pressure on margins if consumers trade down from (premium) branded products to alternatives (i.e. hard discount).
Subscribe to our blog
From losing ~6% in a single day to outperforming a weak sector, know why the stock is still worth a ...
SocGen’s valuation curse and “filling the value gap”
AlphaValue Daily Ideas, 04/04/2024
Continue to reap benefits by diversifying in mining.