Agricultural nutrients and fertilizer producer The Mosaic Company (NYSE:MOS) reported net earnings of $2.65 per share October 1, and if the market’s reaction is any indication of the tenor for the upcoming earnings season, it’s time to strap ourselves in for a shaky ride for the rest of 2008. (Speaking of earnings season, another good read is: Five Tricks Companies Use During Earnings Season.)
Mosaic’s net earnings of $1.18 billion improved 384% from the $305 million posted a year ago. And that’s not one of those facade-laden growth rates, where one of the comparison quarters is thrown off by a huge one-time expense or gain. Mosaic’s performance was about as organic as nearly 400% can be - revenue growth was more than a double with $4.3 billion in sales as opposed to just over $2 billion last year.
Average prices for the company’s two largest revenue sources - potash and phosphates for crop fertilizers - are up well over 200% in less than a year, or as the company stated in its news release, "substantially" higher. The average rate for potash (most of which are set in medium-term contracts) was $488 per tonne, while phosphate sold for an average of $1,013 per tonne during the quarter. The rapid price increases have allowed gross margins to expand by 12 percentage points, from 26% to more than 38% in the quarter ending August 31.
When Did We Get So Optimistic?
Alas to any readers new to this slice of the ag sector, these blowout figures were not unexpected by analysts. Mosaic actually missed earnings estimates of $2.94, although it beat revenue-side estimates by about $200 million. The "miss" on earnings, combined with a planned slowdown in the production of its number-one product (phosphates), helped to send the stock into the slammer. On October 2, Mosaic was down as much as 30%.
The losses carried over into leading potash producer Potash Corp. of Saskatchewan (NYSE:POT) and Agrium (NYSE:AGU), both of which were down more than 20% in mid-day trading.
If the reaction to Mosaic’s earnings are any indication of the tone for Q4 earnings, I suggest we all pick up an extra bottle of Maalox (sold by Novartis NYSE:NVS) before next week. Mosaic was generally upbeat in its conference call, noting that fundamentals in the ag sector remain healthy. Strong underlying demand versus limited supplies of most agricultural nutrients should keep prices either stable or moving upward in the near future.
Analysts Making Me Cynical
The planned slowdown of phosphates - which makes up over half of Mosaic’s sales - is for between 500,000 and 1 million tonnes over the next few months, or between 6% and 12% of a full year’s production level. This is certainly noteworthy and will affect sales, but prices are expected to remain in the $1,020 to $1,080 range. Analysts have unfortunately missed the baton again; as soon as their precious estimates had to be notched down, they downgraded the stock, adjusting price targets down by as much as $40 per share! The typical sell-side analysts’ behavior is increasingly becoming a contrarian indicator for me. If they say "sell", I want to buy, and if they say "buy", chances are the stock is already up 50% in the past month and about to crest.
Potash Corp’s 20% stock drubbing October 2 is even more puzzling. Phosphates are much less important to Potash Corp, where the nutrient makes up less than one-third of sales. As the company’s descriptive name suggests, potash is the main driver of earnings, and Mosaic noted in its earnings call that pricing trends are still going upward for potash, and that global supplies are much tighter than for phosphates.
If These Guys Are Wrong, I Don’t Wanna’ Be Right
Potash Corp, Agrium and Mosaic all trade for P/E ratios (current year) well under 10. Forward multiples based on 2009 earnings estimates are all the way down to the four- to five-times level. If we are indeed already in a recession (or standing right at the precipice), then earnings estimates will be coming down across every sector.
However, if pricing for the ag nutrients has indeed stabilized at these higher levels based on fundamental supply/demand forces, maybe there isn’t the inevitable next shoe to drop. I for one do not want to bet against the secular trends here. World grain inventories are at 35-year lows, and many emerging markets crave more protein in their diet, which means more grain for feedstocks.
Parting Thoughts
The cash flow being thrown off by these companies is amazing. Mosaic is on pace to deliver more than $3.5 billion in operating cash flow over the next 12 months, or nearly 25% of the company’s total market cap. If they wanted to, Mosaic and Potash Corp. could start buying back 10-15% of their shares every year and take over the entire companies' private stock in less than a decade. If analysts keep their heads stuck in the dirt, it just may be the best allocation of capital from management’s perspective. (For more information regarding cash flow, see: How Some Companies Abuse Cash Flow.)
Subscribe to:
Post Comments (Atom)
No comments:
Post a Comment