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Title: Agriculture Headline: Grain Prices Fall on Evidence of Demand Destruction in U.S. Inventory Data Now Near Midpoint of Current Price Cycle

October 3, 2011

The NBF Daily Bulletin

Industry Comment

Agriculture

Grain Prices Fall on Evidence of Demand Destruction in U.S. Inventory Data Now Near Midpoint of Current Price Cycle
Industry Rating (Agriculture): Overweight (NBF Economics & Strategy Group)

Robert B. Winslow, CFA - (416) 869-7937 - robert.winslow@nbfinancial.com Associate: Andrew Gilbert - (416) 869-7571 - andrew.gilbert@nbfinancial.com USDAs September grain report indicates higher than expected U.S. stocks, sending grain prices tumbling The September on- and off-farm surveys showed total U.S. corn, wheat and soybean inventories ~8% (270 million tons) above analyst expectations. The higher inventories were led by corn, which saw inventories 17% more than forecasts. While U.S. inventories remain tighter y/y, the lower extent of this tightness in supply put significant downward pressure on grain prices last Friday. In particular near-future corn prices closed down US40/bu or 6.3% while wheat near-futures closed down US45/bu or 6.9%. Soybean prices fell US51/bu or 4.2% in sympathy. An index of corn, wheat and soybean prices shows the grains down ~22% since the late summer highs (Exhibit 1.) Rising grain inventories are a sign of demand destruction, which should be no surprise given how lofty grain prices have been of late We have suggested the increasing prospects for high grain prices to lead to a) a positive supply response from farmers, and b) demand destruction from key grain buyers. This latest USDA data, which shows upward creep in grain stocks, provides evidence to suggest that such demand destruction is indeed unfolding. While U.S. grain inventories are still down y/y, we believe high grain prices are pressuring cattle farmers (who buy grain for feed) and ethanol producers (who buy corn as feedstock). At the margin we believe these grain buyers are growing cautious in their purchasing (and thus production) behaviour, which is near-term bearish for grain prices. While grain prices are down ~22% from recent highs, nearing the mid-point of the current cycle, we contend it is still too early to grow constructive on the sector As demonstrated in prior research, there is a high correlation (~90%) between grain prices and our coverage list of ag equities. Therefore, with grain prices trending down and now near mid-cycle levels (Exhibit 2), we grow modestly less bearish on the sector. That said, we have no reason to believe grains have bottomed, as they remain well above our estimated cost of production levels. So, while the ag equities have come off materially from recent highs, we have not yet grown constructive on ag equities overall. Given the current price trajectory, we expect average grain prices to be materially lower in 2012, and thus we cut F12 estimates/targets across our ag coverage list Before we recommend investors aggressively buy the ag sector we look for: 1) grain prices to retrace to (or near) estimated costs of production (i.e., a sign of a cyclic bottom), or 2) supply shocks to drive grain prices back on a materially higher upward path. Meanwhile, with the strong downtrend now unfolding for grain prices, we expect 2012 average grain prices to be less robust than the high levels seen through the first nine months of 2011. As such, we reduce our F12 earnings estimates and target prices across our coverage list of ag equities. We also make two ratings changes, migrating to Sector Perform from Outperform for both Ag Growth International Inc. (AFN-T) and Hemisphere GPS Inc. (HEM-T). See Exhibits 3 and 4.

Exhibit 1: While U.S. Grain Inventory is Down Y/Y, the Latest Survey Showed Inventories Well Above Expectations, which is Bearish for Grain Prices
US Grain Stocks by Position and Month - USDA Survey 2010 Off farm 2,178,671 1,222,687 2011 Off farm 1,988,338 813,295 Analyst Consensus (Reuters) Total % Surprise N/A 963,245 N/A 17%

(1,000 bu) Corn June 1 September 1 All Wheat June 1 September 1 Soybeans June 1 September 1 September Total

On farm 2,131,400 485,100

Total 4,310,071 1,707,787

On farm 1,681,500 314,950

Total 3,669,838 1,128,245

209,900 812,100

765,737 1,637,517

975,637 2,449,617

130,915 641,500

731,331 1,508,573

862,246 2,150,073

N/A 2,035,073

N/A 6%

232,600 35,400

338,523 115,485

571,123 150,885 4,308,289

217,700 48,500

401,583 166,163

619,283 214,663 3,492,981

N/A 224,663 3,222,981

N/A -4% 8%

Source: USDA, Reuters, NBF Exhibit 2: The Index of Corn, Wheat and Soybean Prices is Now ~55% Above June 2010 Lows, but has Fallen ~22% from the Summer 2011 Peak

Grain Index (Equal Weight)

500
Estimated "Index" cost of production is ~267; at or below this level represents a near-bottom signal

Grains are ~55% above June '10 lows, near mid-point of latest price cycle

400 Index

300

200

100 May-05 Nov-10 Oct-06 Feb-08 Jan-04 Jul-09

Source: Thomson ONE, CBOT, USDA, NBF

Exhibit 3: We Lower F12 Estimates and Target Prices Across Our Ag Coverage List with a View Toward Likely Lower Average Grain Prices Next Year
Company Ag Growth International Inc. Alliance Grain Traders Inc. Cervus Equipment Corp. Feronia Inc. Hemisphere GPS Inc. Vicwest Inc. Viterra Inc. EPS Ticker F11E F12E AFN-T New Unch. $2.60 Old $1.95 $2.85 AGT-T New Unch. $2.50 Old $1.55 $2.65 CVL-T New Unch. $1.20 Old $1.30 $1.43 FRN-V New Unch. $0.00 Old ($0.03) $0.01 HEM-T New Unch. $0.00 Old $0.02 $0.07 VIC-T New Unch. $1.05 Old $0.60 $1.10 VT-T New Unch. $0.55 Old $0.71 $0.58 Target $39.50 $45.00 $27.00 $28.50 $17.00 $21.00 $0.55 $0.70 $0.85 $1.50 $12.50 $13.50 $11.00 $11.50 Rating Sector Perform Outperform Unchanged Outperform Unchanged Outperform Unchanged Outperform Sector Perform Outperform Unchanged Outperform Unchanged Sector Perform Comments Rating downgraded. GM and sales forecasts reduced to reflect lower int'l bin demand. Earnings driven more by grain volume than grain prices, and Canadian lentil volumes appear healthy. Estimates lowered in both the Ag and Construction segments, though CDN farmers had a strong 2011. Palm oil business is less affected by grain prices but arable land operation profits are affected. Rating downgraded. Ag-GPS sales more discretionary than short- and main-line farm equipment purchases. We make minor estimate revisions since we recently cut estimates on expected weakness in int'l ag. We recently reduced Grain Handling and Agri-products margins and thus make only minor adjustments now.

Source: NBF

Exhibit 4: Our Target Price Cuts Tend to be Deeper for Junior Fertilizer Companies with Larger, Higher Capex Projects to Fund
Company Allana Potash Corp. IC Potash Corp. MBAC Fertilizer Corp. PhosCan Chemical Corp. Verde Potash PLC Western. Potash Corp. Ticker AAA-T New Old ICP-T New Old MBC-T New Old FOS-T New Old NPK-V New Old WPX-T New Old NAVPS ff fd $1.61 $2.42 $1.50 $1.86 $5.61 $5.71 $0.71 $0.81 $8.28 $9.58 $0.93 $1.21 Target $1.40 $2.15 $1.35 $1.80 $5.50 $5.75 $0.60 $0.70 $8.25 $9.50 $0.85 $1.15 Rating Unchanged Outperform Unchanged Outperform Unchanged Outperform Unchanged Outperform Unchanged Outperform Unchanged Underperform Comments WACC raised 50 bps to 12.5% as finance risk increases in an environment with lower grain and equity share prices. WACC raised 50 bps to 11.5% as finance risk increases in an environment with lower grain and equity share prices. Assume 2012 equity raise at lower share price, increasing fully financed share count. Lowest finance risk among peers. WACC raised 50 bps to 12.0% as finance risk increases in an environment with lower grain and equity share prices. WACC raised 50 bps to 14.0% as finance risk increases in an environment with lower grain and equity share prices. WACC raised 50 bps to 13.0% as finance risk increases in an environment with lower grain and equity share prices.

Source: NBF

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