Depending on which side of the table you're sitting, the agricultural situation in South America — severe drought and credit crisis — presents either an upside or a downside. Hot, dry weather conditions in both Brazil and Argentina appear to be taking a toll on soybean and corn production and yields, while the world financial crisis looks as it will severely reduce new equipment purchases.

From the U.S. grower's perspective, Barry Bannister, analyst for Stifel Nicolaus, puts it this way: "If there is going to be a drought that boosts pricing power for [U.S.] farmers, it is better if it happens to someone else's crop, and moreover it is better if it happens to a major export competitor's crop."

But for equipment-maker AGCO, the decrease in planted area and tight credit environment points to a drop off in sales in a market that brought 19% of its sales revenues in 2008.AGCO expects total retail sales of tractors and combines in Brazil and Argentina to decline 15-20% in 2009.

Expected Production Decline

On January 8, the Brazil Agriculture Ministry reduced the corn crop estimate due to drought to 52.3 million metric tons from its 54.4 million ton estimate made a month earlier. Estimates for Brazil's soybean crop were also reduced to 57.8 million vs. the December estimate of 58.8 million tons.

Reduced production of soybeans in Argentina could be even more dramatic, with one source suggesting that it could fall from the 49.5 million metric ton estimate in January to about 42 million tons by the harvest season.

These scenarios point to increased pricing leverage for North American producers. And when farmers have money, they buy new equipment.

Equipment Purchases Slow

The anticipated decline in corn and soybean production is beginning to show up in slowing sales of ag equipment in Brazil and Argentina. In late January, Deere & Co. laid off 502 employees at its factory in Horizontina, Brazil. The company had reduced its workforce by 200 workers at the same factory in October after Argentine clients canceled orders to buy combines.

"The decision was necessary to readjust the production level of grain harvesters and planters at the factory to the market demand in the face of the retraction caused by the world financial crisis and the drought in Argentina and Paraguay," Deere said in a statement.

Argentina's current soybean crop could fall 17-25% from the previous season due to a severe drought, according to the country's grain exchange.

Deere said in November that it expected a drop of 10-20% in sales in South America for the 2009 fiscal year. Argentina is Deere's main external market for its Brazilian-made harvesters, accounting for about 50% of the company's exports in 2007.

December Ag Sales Data

According to December sales data from Associação Nacional dos Fabricantes de Veículos Automotores (ANFAVEA) in Brazil, total farm tractor sales were 2,895 units, up 47% year over year, while combine sales were down 4% year-over-year at 426 units.

"Although 2008 sales were strong, the 2009 outlook is much weaker," notes Ann Duignan, analyst with JP Morgan. Tractor sales for the full-year 2008 were up 39% year-over-year at 43,417 units. 2008 combine sales were up 88% year-over-year with 4,458 units, below 2004 peak levels of 5,598 units.

"Brazilian soybean production in 2009 appears to have material downside risk given poor weather conditions during the early stages of the growing season," Duignan reports. "Lower production and poor farmer economics represent risks to tractor and combine sales this year. This may be partially offset by expanding sugarcane production, though this could potentially come under pressure as well. As a result, we expect a significant slowdown in combine sales and a decline in tractor sales, which should be less severe than combines."