Protecting Capital Amidst War, Drought, Famine & Rising Food Prices

Consumer Staples Stocks, Food, Famine & POLITICS

In this paper, we are going to be talking about food prices and profits. Let’s get our political views on the table so you understand our beliefs and biases. True story.

I took my daughters, 10 and 12 years old, down to Washington DC. We live in Boston. Family road trip. Old car, 78 degrees by the time we hit Philly, AC broke, traffic, couple little kids. Eight hours. Loved it.

Among the activities on the trip, we go on a long tour of our Capital’s monuments. There are MAGA hats and Biden T-shirts. I’m a little anxious. The tour guide explains the genesis of the Federal Trade Commission:

Tour Guide: So, on our right we have the FTC. In the age of the Robber Barons, some people became so rich they were not just above the law, but they were using their influence to change the laws. These people and their companies had to be brought back to earth as they were exploiting the American public and the public was angry. If you are wondering what they do today, you are not alone, because nobody has any idea.

The entire group exploded into laughter. MAGA hats were talking and laughing with Biden T-shirts. There was a lot of nodding, agreeing and discussion. A wary group of strangers suddenly became a jocular and warm collection of people. Not following the joke my 12-year-old asked, “What is going on dad?”

I replied “the guide’s joke reminded everyone that we have far more shared values than the media would have us believe. Where there is communication there is compromise and kindness.” With that, we hope you will realize that we are delivering the facts as we find them. We do not enjoy delivering the message below.

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Year Over Year Changes in Food Prices:

The chart below shows long term food inflation. You want to be “short” that line? We suggest we may be racing towards a reprise of the 1971 – 1984 period where food price inflation exploded. Our reasoning for this prognosis rests on spending patterns, fertilizer, and water with war being a new and tragic addition.

Before we dive in, we would be remiss if we did not highlight the superlative work on drought (Buy Me a River) and renewable diesel (Diesel for Dinner) by the world’s most erudite Chicken at Doomberg.[i]

A Brief Explanation of How Drought & Water Scarcity May Accelerate Rising Food Prices

Let’s quickly revisit the following basics from our earlier work:

• In July 2021 we explained that Americans spent less money on food than any time since 1960 – there was a lot of historical “room” for consumer spending on food to rise based on history
• We highlighted that Brazil, a critical supplier of food, was in its first drought in over 100 years, a situation that has only deteriorated since we first wrote about it
• We stated the largest and most cost-advantaged fertilizer stock, CF Industries was a buy because…
• …our work on oil and gas stocks hammered home that dire shortages in natural gas – the basic input for fertilizer – were sending the world towards a global famine prior to the war in the Ukraine

Some of the recent food inflation has rightly been blamed on the Covid-19 pandemic. Our view is that the pandemic merely touched a match to a combustible mix of clearly unsustainable energy and water policies.

National Geographic’s documentary Water & Power: A California Heist explains how a few businesses exploited the state’s resources leaving the American public in a difficult situation. Now consider Columbia University’s recent synopsis of research which explains that “…the drought that has enveloped southwestern North America for the past 22 years is the region’s driest megadrought since at least the year 800.”

We are not climate scientists and make no claims to such expertise. What we can do however is read. And one of the most stark concerns in all this is that the mismanagement of water supplies combined with “droughts” are leading to “water scarcity.” There is a difference.

With roots stretching back to 1873, the World Meteorological Organization’s (WMO) resources on water are essential reading. They explain that droughts are temporary and last from weeks to a few years. Droughts emerge from natural climate variability. Water scarcity however is an entirely different animal.

Water scarcity is a “long-term to permanent” problem caused by “…a gap between available supply of and expressed demand for freshwater in a specified domain, under prevailing institutional arrangements.” Unlike droughts which come and go, water scarcity causes brutal environmental degradation and desertification.

As the WMO’s chart shows, the interaction of drought (temporary) with water scarcity (the systematic use of water in excess of available supply) interact to create disaster. An end to long-running droughts can no longer rectify the critical deficiencies from water scarcity. A growing portion of the world is there or well on its way.

In 2010, KCR made it clear that we were not in the forecasting business. We were and are in the Moneyball business. Our work takes today’s market fundamentals and puts them in the context of history. Period.

We are not writing about water due to some painfully misguided belief we can predict rainfall. We continue to find new ways to look foolish but predicting precipitation will not be one of them. For the sake of the world, we hope all the research we have read on the topic is upended by bountiful rain in all the world’s growing regions.

The War in Ukraine is Amplifying an Already Dire Crisis

We bring water up because the world is in a water crisis. And the timing could not be worse. As Fortune reported, the situation in Ukraine sparked fears of global starvation and the worst food insecurity level since World War II.

Arif Husain, the chief economist of the World Food Program, described Ukraine as “…a country of 40 million people, but they produce food for 400 million.” As Jack Bourne’s brilliant summary of the crisis notes “…massive investment, by companies like Cargill, Bunge, and Glencore…doubled Ukraine’s [food] exports since 2012.”

That progress is collapsing. As the International Food Policy Research Institute (IFPRI) explains, “In the early 1990s, following the breakup of the former Soviet Union, the region was a net importer of grain. Today, Russia and Ukraine exports account for about 12% of total calories traded in the world.”[ii]

The chart below is fearsome. As the Financial Times explained, the soaring cost of food may cause a wave of severe global instability. Other research notes that rising food prices caused the Arab Spring. The negative external shocks of surging food prices have a history of triggering flashpoints going back centuries.

These issues are exacerbated by the intractable nature of conflict. Hunger is an ancient and common weapon of war. As Reuters and Canada’s National Post reported, the Russian military is targeting grain storage facilities, infrastructure and shipping. To repeat: rising food prices have destabilized countries and regions for centuries.[iii]

KCR posts these facts with a heavy heart. We hope the anger and suffering abates sooner than later. Our job is to try and take the information, good and bad, and work to find ways to protect your capital.

What History Can Teach Us About the Importance of Staples in A Complacent Stock Market

Against that backdrop, the KCR team marvels at the market’s complacency. The news is filled with speculation about what the Fed will do. Celebrity CEOs still grab the top stories. We don’t get it.

Do you feel the market’s pricing structure has digested what is going on? Despite a -40% decline since we panned Snapchat it still trades at over 10x price to sales and relies on stock based comp to fund operations. We believe pricey novelty stocks are on the way “out” and the basics will once again come into vogue.