The 2022/23 federal budget has delivered the third round of significant fiscal stimulus in as many years. The first in 2020 after the initial impact of the COVID-19 pandemic; the second as the spread of Delta variant derailed the economic recovery; and now the 2022 election-tinged instalment. While most of the stimulus was necessary, at some point the piper must be paid. Would the budget have been any different if it wasn’t an election year?

With cost-of-living expenses front of mind, households are the biggest beneficiaries. Sensibly, most of the measures are temporary. With today’s labour market forecast to grow further, the budget is designed to drive household consumption and underpin GDP growth. Forecasts show household consumption growth of 5.75% in 2022/23 up from 3.5% in 2021/22. If households don’t deliver, the GDP growth won’t either.

Public final demand or government expenditure is forecast to grow by just 1.25% in 2022/23. It follows the massive fiscal support that is expected to drive growth of 7.25% in 2021/22. This is the first of many steps toward budget repair over the next decade. The so-called booming economy does not require further meaningful government support, nor monetary settings at emergency levels.

The forecast increase for the Consumer Price Index for 2021/22 of 4.25% and 3.0% in 2022/23 looks optimistic. Household spending is tied to the headline inflation rate and any fiddling to soften the fact is futile and borders on deceit. Net exports are forecast to be a drag on GDP growth for the forecast period to 2023/24 with the prices of iron ore, metallurgical and thermal coal forecast to slump. The indicated prices appear pessimistic.

Business investment growth is optimistically forecast to rise from 5.5% in 2021/22 to 9% in 2022/23, while dwelling investment growth is set to decline in 2022/23 and contract in 2023/04.

With most of the budget’s cash splash temporary there is no incentive to make changes to our long-term company fair value estimates. Beneficiaries will be those exposed to increased consumer spending and the reduction in the fuel excise. These include supermarkets Coles, Metcash, and Woolworths and refiners Ampol and Viva Energy. JB HiFi and Harvey Norman will continue to benefit from the replacement of appliances from the vast flood damaged areas on the east coast and budget-driven demand.

The $18bn boost to federal government infrastructure spending increases an already bloated pipeline to almost $140bn. Listed beneficiaries include Downer and Seven Group. Dare I mention the under siege CIMIC could be one of the biggest. Ventia and Downer could benefit from increased defence spending.

Further fiscal stimulus on top of the estimated $250bn in household savings is likely to add to inflationary pressures. Demand is further stimulated while supply issues are far from resolved and shortages are evident across the economy.

A new era of elevated prices

Winding back the clock to this time last year, the world was on the cusp of an economic recovery. The worst of the COVID-19 pandemic looked over and economies were gradually re-opening. Inflation was rising but labelled transitory. Commentators hoped pandemic-disrupted supply chains would heal as demand subsided with reducing fiscal and monetary stimulus. Enter Delta and Omicron. The recovery was derailed, but optimism prevailed.

However, the global economic landscape changed dramatically with Russia’s invasion of Ukraine. The recovery is in jeopardy and hopes for transitory inflation lie shattered.

There are two major changes occurring which could mean inflationary pressures will be more persistent. First, the possible end to globalisation as we know it. Second, the seismic disruption affecting the global food supply. Let’s look at each in turn.

Onshoring will drive up costs and prices

Globalisation is broadly defined as the process by which the world has become increasingly interconnected due to the rise in trade and cultural exchange. It is a process based on the increasing interaction between people, companies, and governments. Its success relied on the growing interdependence of economies and cooperation. Improvements in technology and transportation fanned its growth with international trade as its launch pad.

International trade flourished thanks to cheaper and efficient seaborne transport. The birth of containerisation in the late 1950’s heralded a seismic change in global trade. Cost structures were reshaped, and cargo security improved considerably. Standardisation of container sizes triggered massive investment in purpose-built vessels, container-handling equipment, and port facilities. Lower shipping costs boosted international trade significantly. Rapid technological change in aviation added to the momentum not only in trade but global travel and tourism.

Developed-country capital connected with emerging-country labour, spawning the era of the multinational company. The globe effectively shrank. Offshoring became commonplace. Consumer demand in the developed world was fed by a network of lower cost offshore manufacturing hubs connected by efficient supply chains.

However, globalisation lost its momentum in the post GFC era. International trade as percentage of global GDP peaked around 2008. From just under 61 then, the World Bank’s Trade Openness Ratio, the sum of imports and exports of goods and services divided by total GDP, declined to 51.6 in 2020. The onset of the US/China trade war in 2019 would have accelerated the decline and other countries have ramped up protectionist rhetoric. Australia has already experienced the wrath of China. The COVID-19 pandemic only added to deglobalisation as international travel came to an abrupt and prolonged standstill and global supply chains ruptured.

The benefits of cheap labour have gradually declined as automation and robotics have replaced people on factory floors, production lines and warehouses. There is now an increasing reliance on skilled technology-savvy labour as the drive for self-sufficiency accelerates and geopolitical tensions escalate. Russia’s invasion of Ukraine tightened the deglobalisation screws. Spikes in energy commodity prices have driven fuel and transport costs to unprecedented levels, a further deterrent to international trade.

Onshoring is now in the political arena, with the US and China front of queue. Europe, reeling from the impact of the Russian/Ukraine conflict and consequent disruption to energy supplies, will scramble to avoid a recession. But onshoring by developed economies will be very expensive as higher cost domestic and regional manufacturing replaces cheaper offshore hubs. Inflationary pressures will be the result as prices reflect the increased cost of production. Many of the changes will be driven by political, rather than economic, calculus.

Food for thought

As the world watches oil and natural gas markets in chaos following Russia’s invasion, signals from global agriculture markets are also flashing red. Reports from the US Midwest suggest a perfect storm is developing in almost every input into farming. Costs are simultaneously spiking to historic peaks and supply availability is under pressure across the spectrum.

Higher natural gas prices directly impact ammonia and fertiliser prices. The availability of arable land is shrinking while global population continues to grow. This is increasing the importance of soil fertility, crop yield and plant maintenance or protection. Increasing food demand will only be satisfied by higher yields. As an aside, but critical in today’s disturbed environment, in terms of European arable land, Ukraine is in pole position. It ranks in the top five world producers of sunflower, corn, barley, and rye and 6th for wheat (Russia is 3rd).

The prices of critical inputs of nitrogen, phosphorus and potassium have also moved vertically. Russia is the second largest exporter of potash followed by Belarus and its state-owned miner Belaruskali has already declared force majeure following US and European sanctions. Interestingly, China stopped exports of phosphate in early October 2021. Ammonia and phosphate are the key inputs for fertiliser production. China is the largest producer of both.

Herbicides are a vital part of the farmer’s armoury, with weed control important to lift productivity. Glyphosate (Roundup) is the world’s most widely used herbicide despite health warnings. It contains both nitrogen (ammonia) and phosphate and prices have more than doubled. Substitute herbicide prices have coat-tailed glyphosate and shortages are widespread.

Farm machinery relies on diesel to operate and the chip shortages affecting automobile production schedules have similarly hit the farm equipment industry. There has been no price relief on either front, with diesel tracking oil and other refined petroleum products and new equipment prices reflecting disruption to supply. Shortages of spare parts and emission sensors also plague the farming industry.

Grain growers need to dry their produce to reduce the moisture content to prevent germination and spoilage during storage. Energy costs for drying are significant.

The combination of the above issues will result in meaningful increases in the underlying cost food production. Shortages are adding to upward pricing pressure, and they are unlikely to be fleeting.

Will the current demand-pull inflation caused by accommodative monetary and fiscal policies and hijacked by pandemic-related supply chain issues be replaced by the cost-push variety causing a prolonged period of rising prices?

The longer-term inflationary pressures from deglobalisation and rising food costs are before the associated costs of decarbonisation and ESG compliance are included. The latter are not insignificant, with some forecasts suggesting a mere US$100 trillion over the next few decades is possible. A new and elevated pricing structure is likely to evolve in coming years.

Nufarm seems well positioned

The above discussion leads me to suggest subscribers look at Nufarm. Firstly, I would urge reading the Nufarm Investor Event, Trading Update and Outlook material released on 3 February. Nufarm is the 9th largest crop protection company globally with exposure to Asia Pacific, European, and North American markets. Growth potential outside the Crop Protection nucleus also resides in Seed Technologies with particular emphasis on Omega 3 and the low carbon fuel Carinata.

Macro trends support a positive earnings outlook with the global crop protection market forecast to grow to $68bn by 2025. Growth platforms support management aspirations of revenue exceeding $4bn by FY26 from $3.2bn in FY21. Revenue for 1Q22 was up 36% on 1Q21.

Nufarm has been a 4 and 5-star recommendation since 2020 with an unchanged fair value estimate of $7.00. The company is now living up to our expectations and while now in the 3-star zone is still trading at a more modest discount to our valuation.
Declaration: My superannuation fund has held Nufarm since December 2020.

Observations

• BlackRock Group became a substantial shareholder in Magellan Financial Group on 18 March with a 5.36% holding via on-market purchases at prices between $14.00 (14 March 2022) and $34.86 (19 November 2021).
• Despite interest rate differentials in favour of the $US, the A$ has been a robust performer in recent months. In addition to surging commodity prices and the positive impact on the trade account, another reason has been the continued flow of offshore funds into the Australian equity market, attracted by the relative value compared to the US market and the dividend yield of just over 4%. This contrasts favourably with the S&P 500 dividend yield of 1.4% and the US 10-year bond yield of 2.39%. Offshore investors have picked up both market and currency gains. How long they stay around is debatable.
• The US bond curve inversion has spread and now includes 3 and 5-year/10-year and the 5/30-year maturities. Losses in the global bond market are massive. From US$18 trillion of negative-yielding bonds in late 2020 there are just US$2 trillion now and still falling. The next to go positive looks like the 2-year German bund, which has traded at a negative yield for 7.5 years.
• While budget repair and debt reduction are necessary and with record job vacancies, perhaps the blow torch should be set on the core of professional unemployed. There are still near 900,000 Newstart/JobSeeker recipients. Far too many in the current environment.

CIMIC update

The Independent Board Committee of two directors has unanimously recommended the $22 cash per share offer from Hochtief in the absence of a superior proposal. The Independent Expert has concluded the Offer is fair and reasonable to CIMIC shareholders other than Hochtief Australia. I gather it is not unfair or unreasonable for Hochtief!

As of business close on 29 March, Hochtief had increased its holding by 3.8 million shares from 22 March, representing 86.3% of the issued capital from 85.08% on 14 March. As Hochtief needs to acquire 75% of the shares it did not own prior to the bid, it requires almost 95% of the issued shares to effect compulsory acquisition. The current offer closes on 11 April.