volatility in the agriculture sector - CLSA

Recently, we have seen how accelerated climate change (El Nino to La Nina) has created high volatility in the agriculture sector. Rising food prices caused by flooding and draught have pushed inflation up from China to Indonesia. It even ignited social unrest in parts of the Middle East.

Closer to home, unpredictable weather coupled with a decline in natural predators is responsible for a recent plague of caterpillars (the insects here, not the heavy equipments) in parts of Indonesia. Though the phenomenon is centered largely in East Java, smaller reported outbreaks in Central Java, West Java, Bali and, most recently, Jakarta have prompted fears of a widespread infestation.

In Jakarta, caterpillars were found on pine trees and have lead into a debate on what is the best way to deal with these insects. The head of the affected neighbourhood suggested the best way to get rid of the pests would be to chop down the trees affected. The problem is that it’d cost US$35/tree to chop the trees down. Not cheap.

In East Java, the caterpillars have destroyed thousands and thousands of mango trees in the best mango producing areas in East Java. Luckily mango does not feature prominently in Indo CPI basket (probably less than chilli). And unlike chilli, it is certainly unrealistic to encourage people to plant mango tress in the backyard.

The point is that climate changes will translate into higher food and soft commodity prices in ways difficult to predict. Luckily, Indonesia is still very much an agriculture based economy where we are not too dependent on imports.

It is interesting to note that CLSA U rubber expert Dr Hiddie Smit is of the view that natural rubber probably has not yet seen its highs. He does see 2013 pricing moderating due to new supply from some of the large tree planting done in 2006, but 2012 could still see new highs (let me know if you would like to see the report).

Rubber is an important commodity for Indonesia. Indonesia is the world's second largest rubber exporter after Thailand. As pointed out by our plantation analyst Di Shui, the country has 3.5m ha plantings, 85% smallholders, average 1-2ha/farmer, implies at least 1.5m smallholder rubber farmers here. Higher rubber price is bullish for Indo consumption story.

For direct rubber exposure, London Sumatra (LSIP IJ) has 17.6k ha rubber plantings. Rubber contributed to 15% of revenue and 14% of EBIT in FY10. A US$1/kg increase to our rubber price assumption would drive a 7% increase in earnings for FY11.

Bakrie Sumatra (UNSP IJ) has 19k ha of rubber plantings. Rubber makes up 33% of consolidated sales, 33% of consolidated gross profits in 2010.