Mosaic's Outlooks Confirm Bullish Thesis

Mosaic , a farm chemicals manufacturer, handily exceeded estimates again, but shares failed to make an upside move in Tuesday trading. After the close on Monday, MOS reported EPS of $1.88, up 308% from last year's 46 cents in earnings.

Shares of Mosaic gained over 250% in the past year, and it is clear that investors are getting a bit skittish after the ag group's meteoric ride. The "lock it in" mentality is understandable given the current weak market conditions that leave investors with a quick-trigger attitude to selling.

The crux of the current bull-bear debate in MOS is the same for Potash , Agrium , and the rest of the ag sector. It centers on the sustainability of intense fertilizer demand in the face of two potential downside risks.

First, a global slowdown markedly cooling demand, which would lead to reduced product pricing. Second, the potential for reduced corn demand for ethanol production. Corn-based ethanol, as opposed to other plants, is intensive in its use of fertilizer. And there are fears that a new Presidential administration might lift the 50 cents tariff on Brazilian sugar-based ethanol.

I partially agree with a short-term bearish argument on the ag sector if the ethanol import tariff were repealed by a new Presidential administration. It is estimated that 30% of the U.S. corn crop in 2008 will be used for ethanol.

If the import tariff is repealed, then the ag stocks would sell off sharply, as estimates would need to be revised down. That would present the stocks with tough year-over-year comparisons.

But I never underestimate the power of the farm lobby and the desire of Washington politicians to pander to so many voting districts in the country's heartland.

But with or without ethanol subsidies, the future is bright for agriculture fundamentals. The main upside driver is the rise of the middle class on a global scale. The demand for higher-quality protein-based food rises in lockstep with global wealth creation. In simpler words, most people would prefer a nice juicy rib-eye steak instead of rice and beans.

Protein may be quite tasty, but it is a very inefficient form of energy transfer. I repeatedly fall back on a key statistic as part of my bullish ag thesis: it takes significantly more grain to grow and harvest the equivalent amount of protein. Specifically, 8.3 grams of grain are required to produce the equivalent one gram gain in cattle weight. It takes 3.1 grams of grain for pork, and chicken takes 2 grams.

As incomes rise, the average kilograms of meat consumed per year will inevitably rise worldwide. I believe the rest of the world will catch up to Uncle Sam's eating habits, so let's run some numbers.

The average consumption of protein in North America is roughly 120kg per year, with the developing world averaging approximately 32kg, and Africa consuming only 20kg. Basically, the world is going to see a four- to sixfold increase in demand for protein over the next generation.

Either Americans begin eating less steak and more potatoes, which I don't see happening anytime soon, or the world is going to need more fertilizer for the ensuing protein demand.

Goldman Sachs reiterated its "America's Conviction Buy list" rating on Mosaic and notes, "Fundamentals are great. Prices are moving higher and with corn acreage expected to increase significantly next year ... demand should be strong in the U.S., and globally and capacity remains constrained.

"The company is generating plenty of cash that will be used to fund the recently announced potash capacity expansions ... In our view, the recent stock-price meltdown is not indicative of the strong fertilizer fundamentals that currently don't seem to be of investor concern, but we believe will once again become relevant."

On the conference call, the company remained steadfastly bullish, stating that it continues to see strong market conditions. It sees a tight supply balance next year with the market environment exceptionally strong for fiscal 2009 (which ends in May).

The demand for fertilizer is growing at much faster rates today than in the past. In other words, there is no demand destruction at current price levels, as many bears claim.

Of note, management says that China, as one of the main global players, is the key swing factor in the phosphate and potash markets this year. It estimates that China will sharply reduce its fertilizer exports due to a 135% export tax imposed by the government on April 20.

And two points on fertilizer pricing. First, even with elevated prices, it still pays to use fertilizer. An industry survey estimates that crops achieve a net return of over $3 for every $1 invested in fertilizers. In some cases, the return is even higher. For example, an Indonesian palm oil farmer gains $9 for every $1 he spends on balanced plant nutrition.

Second, even with a $100-per-ton increase in potash prices, that would add only $0.03 to the cost of a bushel of corn.

Finally, a metric that speaks for itself. MOS is now trading at eight times fiscal 2009 consensus estimates of $15 per share. Taking all of these factors into account, I believe that these fertilizer stocks, and Mosaic in particular, represent a solid investment at current levels.