What the Heck Is Wrong With Fertilizer Stocks?

By all accounts, fertilizer stocks should be blazing hot. They sport some of the market's best historical and forward-looking fundamentals. Yet, the S&P 500 Fertilizer and Agricultural Chemical Index is only one of two (of a few dozen) industries with stocks that are - on average - in the red for the last six months.
Oh, don't misunderstand - they look great on paper.

Terra Industries (NYSE:TRA) and CF Industries (NYSE:CF) have trailing P/Es of 8.2 and 8.9 for cryin' out loud, and most of these stocks aren't far behind. So what's wrong with these stocks, and when will they shape up? The secret behind the answer is below, though the timing of the turn-around is still a little elusive.

Back to the Beginning
Just need to make sure we're all on the same page....

Fertilizer stocks basically doubled in price between mid-2006 and mid-2008, but don't assume it was anything the companies did. Fertilizer prices - potash and ammonia based ones in particular - went through the roof. On average, fertilizer costs increased by 83% during those two years. Why? For the same reasons any other commodity rallies - greater demand, limited supply and because manufacturers can charge that price and get it.

Stubborn to the Bone
Other commodity prices, stock prices and even crop prices for that matter don't move in sync. The CRB (commodity) index topped in early 2008. Stocks technically topped in late 2007. Corn, wheat and soybean prices all topped in the first half of 2008.

But fertilizer prices - and potash in particular - barely budged then. As August, 2008 turned into September, 2008, phosphate, potash and nitrogen prices were still on the rise. They didn't start to slide until late in 2008, and even then the price dip wasn't commensurate with the global economic implosion.

Though they'd never say so explicitly, companies like Potash Corp. (NYSE:POT), Syngenta AG (NYSE:SYT), and Mosaic Co. (NYSE:MOS) enjoy the fact that there are few major players in their arena, and as such they can collectively cut production (i.e. hold out) to maintain pricing pressure.

It worked, too. Potash prices only sank from a peak above $900 per ton in late 2008, to only the low $800 level earlier in the year. Only this year, farmers called these companies' bluffs by scaling back on potash and fertilizer usage, by as much as 30%.

That's also the reason Potash once again cut its revenue and earnings forecast (again). It's an epidemic that's not unique to that particular fertilizer company though.

Fast Forward to Today
The farmers are winning the war, and it's likely to come out of the hides of agricultural chemical producers. Translation? It may get worse before it gets better, for these stocks.

As evidence to my thesis, take the recent decision from Canpotex (which represents Potash, Mosaic and Agrium (NYSE:AGU)) to sell potash in India at $460 per ton. That's about half the price from late last year, and doesn't exactly say these companies are sticking to their guns.

Fertilizer companies may argue that the price break was given only because it was a massive 850,000 ton deal, though skeptics aren't hard to find. Those skeptical eyes are now on the lookout for a similar low price to Chinese customers. If China gets a bargain, that will be a sign that the farmers' hold-out has beaten the fertilizer companies'.

Bigger picture, it will also mean lowered margins and a diminished top line for the likes of Monsanto Inc. (NYSE:MON) and Mosaic.

The Outlook
So what may put an end to the fertilizer misery? Two things: the first is higher crop prices, and the second is lower crop yields (which actually go hand in hand). Neither is likely to be a reality in 2009 though, for three reasons.

It's too late to bother with fertilizer this season, which means demand won't likely improve until at least early 2010.
Corn prices - and most crops - are considerably lower than they were at the beginning of the year; many farms simply can't afford to utilize fertilizer.
Despite the lack of fertilizer use this year, crop yields are actually up this season; corn yields are close to hitting peak levels. It hurts corn prices, but forces the question "who needs fertilizer?"