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Macquarie Group Ltd (ASX:MQG) thinks the drought could deliver 2 buying opportunities

The bearish crop forecasts from the Australian Bureau of Agricultural and Resource Economics and Sciences (ABARES) are weighing on shares exposed to the agriculture industry, but it’s not all bad news.

The government department has slashed its FY19 winter crop forecast along the east coast of Australia to 9.4 million tonnes from its earlier projections of 14.8 million tonnes. If this comes to pass, it will mark the lowest output in a decade.

While the impact of the drought is well flagged and highlighted by several companies during last month’s profit reporting season, ABARES’ forecast is probably a lot worse than what most experts were expecting.

One stock that could come under more pressure is Graincorp Ltd (ASX: GNC) even though the market has lowered its earnings expectations for the grain logistics and marketing group.

But Macquarie Group Ltd (ASX: MQG) believes there are more consensus downgrades to come on the back of the latest ABARES predictions as the forecast is lower than the broker’s 11 million tonne estimates.

Another stock that is likely to feel the pressure is port and freight company Qube Holdings Ltd (ASX: QUB).

According to the government department’s forecast, Queensland’s crop yield will tumble 38% and Credit Suisse notes that Qube has a big exposure to that state.

“Transport and handling of agriculture products contributes 20%-25% of Qube’s Logistics segment revenue and ~10% of Qube’s total revenue, but the impact to margin from changes in agricultural volumes is even larger than the contribution to revenue,” said Credit Suisse.

“This is due to Qube shipping grain and other agricultural products in shipping containers that would otherwise be returned overseas empty and incur a cost to Qube rather than a revenue opportunity.”

But there are two stocks in the sector that are worth buying on the share price weakness, according to Macquarie.

The first is fertiliser supplier Incitec Pivot Ltd (ASX: IPL) as its earnings are more dependent on prices than on volumes. The company’s investor day last week also highlighted the resilience of its fertiliser business.

“We estimate -$15m 2H18 EBIT impact from drought, which is pretty good in context. This also reflects strong distribution sales into sugar and pasture markets offsetting weak top dress urea markets (broadacre cropping),” said Macquarie.

“Near-term [fertiliser] outlook remains solid with $25/t lift in Black Sea ammonia prices last week to US$350/t, which bodes well for a further lift in Tampa ammonia at month-end.”

The other stock is Nufarm Limited (ASX: NUF), which issued a profit downgrade recently due to the drought.

But there are a few potential positive catalysts this financial year for the stock. These include a successful bedding-down of its European acquisitions and sales of its omega-3 enriched canola seeds.

Macquarie has an “outperform” recommendation on Incitec and Nufarm with a price target of $4.16 and $9.55, respectively.

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Motley Fool contributor Brendon Lau owns shares of Macquarie Group Limited and Nufarm Limited. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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