There will be more people. They will need to eat more food. The world will need to supply it.
So runs the simple and compelling argument for long-term growth in agriculture and all the companies that serve it – particularly the big North America-based fertilizer companies like Potash Corp. of Saskatchewan Inc., Agrium Inc., Mosaic Co. and CF Industries Holdings Inc.
But while the long-term case for fertilizer companies appears indisputable, the challenge for shorter-term investors is deciding which firm is best positioned for the next year or two. Not all fertilizer companies are likely to make your seed capital grow equally well, and some seem to offer far more upside than others.
Each company’s fate is tied to the types of fertilizer it produces. The three major types are potash, which contains potassium and chlorine; phosphate, derived from phosphate rock; and nitrogen, created from ammonia in a chemical process.
There is a limited amount of potash, found in a handful of places and controlled by a handful of companies. Phosphate is more common, but nearly all is found in just four countries, say Goldman Sachs analysts Adam Samuelson and Evan Stampler. Nitrogen is far more common, produced in 60 countries, they say.
The companies that sell fertilizer fall into two camps, depending on their primary products. The nitrogen names – CF Industries and Agrium – are trading at all-time highs, thanks to record margins in the nitrogen sector. The companies that depend less on nitrogen, such as Potash Corp. and Mosaic, are trading around half their all-time highs, set in 2008.
There’s a good reason for the decline of the potash powerhouses. Back in the short-lived peak days of potash, the mineral sold for more than $700 a ton, significantly above 2012’s levels of $400 to $500.
Few forecast a return to those levels in the near term; however, a number of analysts think 2012 represented a trough for potash. That suggests investors in potash producers could do well over the next few months.
“The near-term fundamentals have likely bottomed,” says Joel Jackson of BMO Nesbitt Burns. “The world generally de-stocked potash in 2012, and global shipments declined about 10 per cent even though consumption didn’t decline that much. This year, we expect consumption up just a little bit, but shipments up as much as 10 per cent.”
The Goldman Sachs analysts take a similar view, arguing that potash fundamentals are bottoming, and prices will rise later in the year now that Canpotex (the marketing organization for Potash Corp. Mosaic and Agrium) has signed contracts with China and India.
Mr. Jackson of BMO sees Potash Corp. as a “return of capital” story because he believes its free cash flow yield – a measure of how much money it has left over after paying for capital expenditures – will double in the next couple of years.
The company is concluding a number of capital investments in its mines, expanding capacity. Meanwhile, it raised its dividend by 33 per cent in January and the shares now yield about 2.7 per cent. Mr. Jackson, who has an “outperform” rating and $49 target price, titled a recent report “Paid to Wait for Largely Paid-for Growth.”
The Goldman Sachs analysts rated Potash Corp. a “buy” in December with a $46 target price when the shares were below $40; they’ve since risen to $42.
Goldman Sachs is even more positive on Mosaic, which was spun off by agriculture giant Cargill Inc. Share lockups and other legal restrictions related to the spinoff expire in May, and Goldman believes that if Mosaic wants to get aggressive in returning capital to shareholders, it could spend $10-billion (U.S.) to repurchase roughly 35 per cent to 40 per cent of outstanding shares and still maintain its investment grade credit rating. The firm sees a potential upside of 25 per cent to its target price of $68. (Mosaic currently trades around $62.)
The upside for the nitrogen sellers is harder to see.
One of the things driving their record margins is low costs – natural gas represents nearly 80 per cent of the expense of turning ammonia into nitrogen, Goldman Sachs says, and 2012 saw remarkably low natural gas prices.
As natural gas prices rise, and more nitrogen supply comes on-line, Goldman Sachs sees margins declining. That leads to its “sell” rating on nitrogen seller CF Industries ($204 target price, versus recent trades at $220) and “neutral” on Agrium ($108 target versus $112).
John Chu, a managing director at AltaCorp Capital, counters that nitrogen does have a couple of factors in its favour. Unlike potash and phosphates, farmers must apply it to their fields every year.
Moreover, the United States is still importing 50 per cent of its nitrogen from higher-cost areas, providing margin support even as nitrogen costs rise. “Even if gas prices go up in North America, you may still see strong margins for the North American nitrogen players.”
There is a larger issue lurking, however, and that is whether 2013 will be as good or better a year for farmers than 2012, when corn rose to about $8 a bushel.
Even bulls like Mr. Jackson acknowledge the strong relationship between corn prices and fertilizer companies’ shares. When corn prices are high, farmers are eager to boost yields and buy fertilizer. But when corn prices tumble, the opposite holds true and fertilizer sales dwindle. The worry now is that strong 2013 plantings coupled with successful yields could produce a glut of corn that pushes down crop prices.
National Bank Financial analyst Robert Winslow sees the agriculture sector at a cyclical peak, and says many of the sector’s valuations – particularly Potash Corp.’s premium price-to-earnings ratio – don’t reflect that.
“We’re secular bulls on agriculture – over the next 10 years, we think it’s a very good place to be invested,” Mr. Winslow said. “But in this current cycle, we’re rather cautious. We say go buy the [agriculture companies] when corn prices are at $4 and, when corn is up to $7.50 and $8, that’s when you sell. If corn rolls over and goes to $4.50, all these stocks are going lower – materially lower.”
|CF-N CF Industries||261.09||
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|MOS-N Mosaic Company||49.73||
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|POT-T Potash Corp. of Saskatchewan||38.48||
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