The Good and Bad of Fertilizer Stocks

It seems like it’s been years since CNN Money opined, “Who needs Google and Apple? Agriculture companies are the new ‘it’ stocks.” But that was just six months ago.

Since then, agriculture stocks turned shooting stars to exploding supernovas. Leading the way down has been fertilizer stocks. Shares of former Wall Street and momentum chasing hedge fund darlings Potash Corp (POT:NYSE), Mosaic (MOS:NYSE), CF Industries (NYSE:CF), and Agrium (AGU:NYSE) have led the way down. And practically all of them have cut their production for 2009.

The sell-off has come from deleveraging hedge funds, mutual funds selling to meet redemptions, and the market realizing not all fertilizer companies are created equal. Meanwhile, the long-term outlook for fertilizer hasn’t changed much at all. Global demand for food will rise again, we’ve hit Peak Soil and most of the world’s arable is already utilized, and global soil qualities are in decline. Basically, farmers have to produce more from less and the only near-term solution is fertilizer.

So with the waters calming down a bit, fertilizer stocks are looking pretty good once again.

The Bottom Up
From a bottom up perspective, fertilizer stocks have remained very cheap relative to earnings. The forward P/E ratios are in single-digits across the board in fertilizer stocks. The worst is mostly priced in, although probably not completely.

A couple of weeks ago, a negative report on fertilizer from Goldman Sachs sent fertilizer stocks plummeting. Goldman’s Robert court stated, “U.S. farmers may plant 85 million acres of corn next year, down 2 million acres from this year and 5 million less than Goldman’s previous estimate.”

Just a week before that though, Merrill Lynch raised its rating on all the major fertilizer stocks to “buy.” Merrill cited solid long-term fundamentals and “attractive acquisition opportunities.”

One says buy, the other says sell…no help there (as usual). We can glean from the conflicting opinions, however, that fertilizer stocks are priced for an OK year. Sentiment is split. Some are expecting bad, others good. So we have to ask will it really be an OK year for fertilizer?

Well…if we look at fertilizer prices from a top down perspective, we’ve got some very solid potential for some and much less so for others.

The Top Down
When choosing fertilizer stocks though, you’ve got to look at each individual type of fertilizer. They all have different product mixes. The mix can make a big difference in the bottom line. For instance, nitrogen and phosphate prices have fallen off a cliff just like most other commodities. Meanwhile, potash prices have held up very well.

Nitrogen – Corn production requires a lot of nitrogen. Nearly 45% of all nitrogen fertilizer is used for corn. As a result, nitrogen prices are highly correlated to corn prices and demand for nitrogen moves in lockstep with corn plantings. So when corn demand for food, livestock feed, and ethanol is on the downswing, nitrogen demand will go right down with it.

A recent article in the Grant Tribune Sentinel (out of Grant, Nebraska – I find the local papers in the corn belt to be far superior to the big Wall Street researchers when it comes to fertilizer) says it best, “Demand for ethanol has declined with the drastically decreased crude oil and gas prices. Late harvest, high prices and wet soils limited corn belt nitrogen application this fall to about 50 percent of normal.”

That’s why nitrogen prices have tumbled and why the shares of nitrogen fertilizer producers have tumbled. The same paper goes on to say, “Barge traffic up the Mississippi is closed for winter, storage is full, and there are tanker ships sitting off Tampa full of ammonia that is being offered for less than $200 [per tonne], but there are no buyers and no place to move it.”

Prices down, no buyers at any price, tanker ships full of the stuff just waiting? Sounds like when oil prices were setting new lows. Of course, all this is a sign nitrogen prices are bottoming out.

Phosphorus – Phosphate prices have collapsed as well. They’ve fallen faster than nitrogen and global production continues to get cut back.

Last summer, when phosphate prices went parabolic, China started taxing all exports to keep as much of it in the country as possible. Last month, China dropped the export tax. That leads me to believe they have plenty of supply…probably too much.

The problem with phosphates is that extra supply isn’t going to get soaked up by the rest of the world either. Phosphate producers in Europe and North America have all announced sharp cuts in output.

Potash – From an investor’s perspective, potash is a much safer bet than phosphate and nitrogen. Potash is protected by a virtual monopoly. Canpotex (a consortium owned by Agrium, Potash Corp, and Mosaic) and BPC (Belarusian Potash and Uralkaly (URALY.PK)) together control 70% of the world’s potash exports. That’s a big reason why potash prices have held up. The latest reported price from November was $872.50 per tonne in Vancouver.

The other reason is the capital costs and time required to start a potash mine. It costs between $1.5 and $2.5 billion (heavily dependent on commodity prices) and 5-7 years to open a new potash mine. That’s why no new potash mines have gone into production despite the tripling of potash prices over the past few years.

That’s also why potash prices aren’t nearly as volatile and fertilizer producers which produce potash offer an added layer of safety.

At the end of the day it comes down to valuation, right now, we’re at the lower end of the range for fertilizer stocks.

As I said before, fertilizer stocks are priced for an “OK” year. And with fertilizer prices so low, less than stellar expectations are justified. The potash fertilizer producers, however, will likely have another “better than OK” year and that’s why I recommend sticking to them.

Barring a global depression, shares of potash producers (i.e. Potash Corp, Intrepid, Mosaic)will be some of the top performing stocks over the next five years or so until new potash production comes on line. The “reset” button has been pressed on the agriculture boom and the next year or two should provide plenty of opportunities to buy when expectations are low and the valuations are cheap. Right now, expectations are pretty low... Andrew Mickey in seeking alpha