The Real Reasons Fertilizer Stocks Are In the Dirt

Wednesday afternoon the sell-off in fertilizer stocks was reignited. Mosaic (MOS) released its latest earnings report and the results were good, but not good enough.

We were prepared for some rough times, but I don’t think any of us thought it was going to get this bad:

• Mosaic (MOS) down $104.
• Potash Corp (POT) down $139.
• Agrium (AGU) down $70.

 Sure, Mosaic is growing profits, margins, cash flows, and sales, but they missed expectations. In a market like this, missing by just a penny could easily result in a disastrous sell-off. 

Mosaic missed, and paid the price. Shares plummeted 40% on Thursday.

For anyone looking to “buy on bad news,” there’s a lot more to consider. This sell-off in once-darling fertilizer stocks has happened for a lot of reasons. And those same reasons are what will limit fertilizer stocks' upside from here.

1. Great Expectations, Big Disappointments

As I stated back in early August in reference to fertilizer companies,

Expectations were just too high. Nobody could live up to them…

From here it could be a long way to go before the uptrend resumes in these stocks.

It has been a long way down since then. The fundamentals haven’t been able to stop the downward momentum.

Big expectations usually lead to big disappointments.

2. Basic Current Valuation

I know the basic arguments: Mosaic has a forward P/E ratio of 4, its margins have been regularly expanding, it sold off Saskferco, and the agriculture story (emerging markets, biofuels, no new farmland, etc.), but it hasn’t played out too well over the past couple of months for fertilizer companies.

By all traditional metrics fertilizer companies should be considered “screaming buys.”

 

Company	Trailing P/E	Forward P/E	Price to Sales	Price to Earnings Growth
Mosaic	8.7	2.4	3	0.54
Potash Corp	15	4.4	5.8	1
Agrium	5.8	3.2	1.2	0.45

 

Nevertheless, they have done nothing but fall over the past two months and many investors are left scratching their heads. But this one isn’t too tough to figure out.

As the world is finally starting to realize, many of the forward estimates were a bit too high. After all, high commodity prices usually have some impact on demand. And in this case, although total revenues have increased steadily for the Big Three and margins have increased, no one is expecting the great times to last.

These are mining stocks and are highly cycle. You have to price those discounts into the market.

Granted, it’s going to take some time to bring new supply on line (it takes 5-7 years to bring a new potash mine on line), but it will come. Rest assured there will be more fertilizer supply coming, which will help bring fertilizer prices back down and significantly reduce the long-term profitability of many of these fertilizer companies.

3. Long-term Value

The long-term is probably one of the biggest issues holding back fertilizer stocks. We cannot forget the importance of fertilizer, after all, in the last 50 years the amount of arable farmland has dropped 37% on a per capita basis. So fertilizer consumption will not disappear.

High fertilizer prices have done one thing though; they’ve brought a lot of competition into the market. Potash is the perfect example. The following companies are expanding big into potash. Here are a few examples, though by no means all of them:

Mosaic – is still on schedule to ramp up its potash production by 50% over the next 12 years. In a plan laid out in April, Mosaic stated it will invest $3.15 billion in expanding its potash mines to increase production from 10.4 million tonnes to 15.5 million tonnes by 2020.

Uralkali (URALY.PK) – Despite some setbacks, Uralkali is on pace to increase its potash production by 35% by the end of 2010.

Rio Tinto (RTP) – Rio Tinto has been one of the top mining companies that has declared its intentions to move into potash mining. A little over a month ago the mining giant stated it will spend $3.5 billion to open a potash mine in Argentina.

At last report, Rio Tinto stated it expects this mine to produce about 2.3 million tonnes of potash in early 2012 and then ramp up to full capacity of 4.3 million tonnes by 2020.

BHP Billiton (BHP) – has been one of the most aggressive mining majors to jump into the potash race. BHP shelled out $284 million to buy out Anglo Potash last spring. Anglo held a 25% stake in BHP’s Saskatchewan potash project.

BHP expects this mine to start producing potash as early as 2012 and has not confirmed a timeline since the takeover. But it should be on line between 2012 and 2015.

Potash One (KCLOF) – is one of the leading potash “junior” companies. Potash One and a handful of others are still chasing after the big potash prize. Many are well funded and are actively laying the groundwork for a big joint-venture (i.e. with a foreign country that would put up a big loan in exchange for a supply agreement) or takeover.

These companies would need massive amounts of capital to go into production. If you look at some of their management teams, it would not be overly surprising to see one of them become a producing mine in the next few years.

4. Agriculture Commodity Prices have Plummeted

Finally, the price of agriculture commodities has quite a bit to do with how much fertilizer farmers are willing to use. If they’re getting record high prices for crops, there’s not much worry over some extra fertilizer costs. But when their profit per acre have dropped by 40% (which has happened recently) they’re going to tighten up the purse strings a bit.

Fertilizer demand does have some elasticity and it will be impacted by crop prices.Which are all interrelated. Corn prices might be high while soybean prices may be down, but they will reach equilibrium as farmers chase after the bigger cash crop.

So when you see Powershares DB Agriculture Fund (DBA) drop 35% from its highs earlier this year when the “food crisis” story really hit the mainstream, you know fertilizer demand (and profit levels of fertilizer producers) will surely follow.

As you can see, there is a lot more supply coming. We looked at a partial view of potash (Intrepid (IPI) has some plans, Russia’s Silvinet recovers from sinkhole problems, etc.), but as you can see, the same is true for most of the other forms of fertilizer as well. As long as we value fertilizer companies for their long-term profitability, it’s easy to understand how they all came crashing down to reality over the past couple of months.

There is a lot of supply coming and potash prices will likely stay around $500 to $1,000 a ton over the long term. They won’t be too high to attract aggressive amounts of new supply and they won’t be too low so that mines are going to have to be shut down. Potash prices will probably remain in a nice range where every company makes enough money (that’s even more likely since 2 cartels control more than 70% of world potash exports.)

Yesterday, Merrill Lynch (MER) analysts offered a pretty much bearish report on potash (all commodities in general for that matter) and I’m sure some others will follow. All of the downgrades will surely add to the selling pressure and will finally push these stocks to a bottom.

Of course, all this is pretty good news. There have been a lot of investors plowing money into the fertilizer sector over the past year (on the way up and the way back down) and it looks like most investors weren’t prepared. Fertilizer companies are still mining companies and there will be plenty of volatility.

Blame the hedge funds for pounding down the share prices or just look at it as a bubble that burst with the regular accompanying consequences, but I’m now starting to turn cautiously bullish on agriculture again.

This time around it won’t be a huge speculation fueled rising tide that lifts all boats. The long-term opportunity in agriculture is still there, but the biggest wins probably won’t be in fertilizer stocks, they’ll be in other agriculture subsectors.

Fertilizer stocks are in for a long period of ups and downs. I expect them then to have a few more months of rough going with plenty of false starts too. After all, there are still a few analysts with $300 and $400 price targets on Potash Corp that still have to turn negative before we can confirm a hard bottom.

Despite it all, anyone buying now should reasonably expect a 30% to 50% on Mosaic, Potash Corp, and Agrium despite any more ups and downs to come. Even with a lot of road blocks down the road, there is some significant value in the fertilizer producers.

Disclosure: No position in any companies mentioned

 

Comments

[peachberry_tea]

you've written an informative piece and my hat's off to you for that

i don't think much has been said here that hasn't already. yes the earnings estimate were aggressive on these firms, and yes these firms were undervalued. but this was all true even before the 25% plunge yesterday.. the market is nuts, period

at this valuation it's about time to buy in.. you could wait for another coupla analysts to revise estimates downward but that's really just timing a bottom, and no one can do that perfectly

short term you'll have to stomach volatility but this should be a fine play long term

disclosure: long POT

[cstauffer]

It is hard to argue that there was a lot of momentum in these stocks during the first half of 2008 and that for that reason expectations were too high. However, these stocks never really got significantly over-valued based upon even more realistic growth prospects. I believe that there is more a play here in recent price moves than a high momentum sector falling back to earth. If you take a look at non-fertilizer agriculture stocks such as AG, DE, and MON, they are also being hit extremely hard, while the world's grain inventories are still sitting at record lows. It is hard for me to believe that there has been significant demand destruction in the world over the last two months in soybean, wheat & corn to account for even a fraction of the multiple contraction that we have witnessed recently in agriculture stocks.

[irondoor91]

The longer one continues with fundamental analysis and value-based investing in these names, the more money will be lost. The question is, how are these companies going to perform in a deflationary environment, and how do they scale back to respond to it.

[cstauffer]

Fundamental analysis of the company behind a given stock is the only assessment of value for a given stock that is based in known inputs. Momentum caused by de-leveraging, sector rotation caused by program trades or false hope of a recovery in out of favor stocks or simply over-reaction to various reports that contradict long-term trends are much too unpredictable indicators for most investors to untilize. There is much more certainty associated with taking a company such as Mosaic, which today sells for a 2.5 forward PE and assign much more conservative earnings expectations and multiple to project a fair valuation for the stock. If this is done, it becomes very evident that the price of the stock today is significantly undervalued. These stocks are not dot.com stocks which had no earnings, no assets and no proven market. These stocks have substantial assets, strong balance sheets and an end market that is critical to the survival of the human race.

[jamookey]

Grain levels still at record lows.That statement says it all.Populations are exploding.Food shortages won't be an issue?I doubt that.The same reasons for the commodity gains are still out there.Reduced demand?how do you figure?Unless people start dropping dead at a high rate,I don't see the reduced demand.Look at oil.What has changed since they ran the price up to 149$?Do they think with cheaper gasoline that people will drive less?Don't look now but many areas in this country have no gasoline.I have had people fron N.Carolina to Florida tell me stations are out gas or getting shorted on their deliveries.Has Iran decided to play ball with the IAEA?See what I mean?Nothing has changed,but we are supposed to believe that there is more than enough oil,plenty of fodd so commodities are a dead issue.Bull.

[anopenmind]

I now realize how much sway Jim Cramer has on stock prices, having started his doomsday jabs at Ag's few months ago. One statement a month ago had him positive on Potash; then, negative, leaving one wondering "what did he mean?". Personal gain for Cramer? Analysts, including Morningstar, had POT tracking toward $410 few months ago; then, $270; now, who knows. Others this week said "farmers won't get bank loans for planting season", striving to drive Ag's further downward. However, Reuters reports: Rural banks in U.S. farm country are not freezing credit to customers like large money center banks, offering a bright spot in an otherwise gloomy economy, industry experts said on Thursday. Rural banks are able to do so because they rely on core deposits for funding rather than commercial financing from Wall Street investors and have largely steered clear of the subprime housing loans. Farmers have made good profits and have solid credit with their farm and equipment assets...and, people still gotta eat. Ag's are not similar to segments like autos, airlines, retailers. There is always the core growing demand. Despite doom & gloom, I'm staying put with Pot, Mos, Agu, Mon.

[manusceo]

Down slide almost totally a result of hedge fund unwinds and of course now the analysts jump in with downgrades--even though their targets remain 100-200% higher than current share prices!!!

[Socialism cannot compete!]

I was long POT and got longer a couple days ago. IMO, the drop was unwarranted. Sure, MOS missed by a bit...but they're *still* looking at tripling earnings over the previous fiscal year. The stock plummets 40%, even though potash pricing is still increasing? Thanks, but I'll hang in and take advantage of the panic selling. The real truth has nothing to do with the author's points, and everything to do with forced selling by the hedgies. Once folks stop panicking and capital flows back into the markets...the ags are going to spike.

Long POT.

[cstauffer]

Thanks for the posts. I am not alone, my sanity is intact. This market has ceased being a functional market and many people are trying to draw conclusions from the price movements of stocks during a time where forced selling is overwhelming rationale buying and pushing stock prices to unimaginal levels.

[CT Programmer]

I think cstauffer is right. This market is NOT FUNCTIONAL. A fwd PE of 2.4? That sounds like a company circling the bowl ready to go into bankruptcy. Connoco Phillips less than 6. RIG at a little above 6. The dry-bulk shippers are all below 3. These aren't fly-by-night companies. We're talking great cash flows and ample growth. Sure, more potash is coming on line. And you know what will happen? More people in emerging economies will add more meat to their diet, which requires 8 times the corn feed as a vegetarian diet. So you'll see demand go up to match. Ag had an incredible run (and I cashed in on a lot of that over the last year with a 100%+ return on YARIY). We won't see that kind of run again. But long-term these (and most of the rest of the market) will bounce back to its normal 15-20 PE range. Even if their current profits get cut in half due to supply increase, I think from their current price they have 100-200% upside. Bottom-fish if you want, but I bought them yesterday and will just sit and wait.

[bobbobwhite]

Me too, me too, and in conclusion, me too.

[leh]

manusceo is spot on--this is an institutional and hedge fund liquidation sale. You have to be a damn fool not to see MOS as a steal at these prices IMO, especially if you have an investment window of 1-2 years or longer.

[einstein p fleet]

There are so many factors at play, it makes your head spin.

Many people are comparing the "commodity" bubble to the dot com bubble. Frankly, I don't see the comparison at all. MOS may have missed, but they still made 1.2B for the quarter and trades at a forward PE of just over 2. How does one compare that to dot com companies that made little or no money and or were trading at triple digit multiples?

The build up in inventory shouldn't be a surprise considering the current credit situation. Farmers need credit to purchase seed, fertilizer, and equipment. Purchases have been delayed. Unfortunately, it's the height of planting season. I would be more inclined to worry about food shortages, than the price of MOS --- which is ridiculously cheap, along with the rest of the group.

In regard to more supply coming on line, I have a couple of thoughts. Firstly, if the business is so bad why would companies like Rio Tinto or BHP Billiton want to get in at the top? To the contrary, I would not be surprised to see BHP make a bid for one or more of these companies instead at current levels. POT is buying back a great deal of their own stock, which they considered extremely undervalued.

Once the hedge funds are done selling, credit returns to normal, and the market looks at the fundamentals, I'm sure that Mr. Mickey is right. When that will be, however, no one knows. I've been wrong on POT and MOS for 40 points each. Ouch!

[jegan ;-)]

Just looking at the chart of POT indicates to me that it has not bottomed. I don't see any new support until the High $80s on the weekly chart. It would be nice to see a turnaround. Maybe the bailout that just got passed will inspire something. I've heard too many investors talk about selling the news to expect a major bump.There are too many fundamental issues that would conspire against a market rally right now. Credit issues, lack of growth.... The list goes on. Where is the upside support. The fact that POT has a low multiple, or that 'people have to eat' are anecdotal, but not helpful.

jegan ;-)

[Duude]

I'm not seeing anything here speaking of how farmers can manage to get credit to make fertilizer purchases going forward. Its certainly a credit business.

[BxCapricorn]

It's amazing how the invisible hand of commodity based hedge fund sell-offs, is ignored. It's the 800-lb gorilla that moves the market, and here we all are, making believe that fundamentals mean something, while making up ridiculous reasons for a stock's performance. Mosaic volume was six-fold normal when it dropped 40%. I would not be surprised if in the future, companies decide that the lack of transparency of the hedge fund players in the US stock market, prompt companies to de-list. The casino that is today's stock market is kabuki theater at its finest.

[cstauffer]

BxCapricorn hit the nail on the head. However, as a fundamentally based portfolio manager, these situations allow us to either get into companies such as MOS at prices never imagined or average down existing positions, thus building a long position at a much lower cost basis.

[BxCapricorn]

And on Seeking Alpha, Trader Mark actually uncovers th gorilla in his post

seekingalpha.com/artic...

Which explains very clearly the dynamics that will make Q4 hard on stocks with real earnings, like the Ag sector.

[Metzenbaum Scissors]

Gentlemen,
Who doesn't get that it was over last week?

The rush to the exits ... began.

The prospects for ANY company's equity price are bleak. Get it? Bleak.

For your sake, stop looking at a leaf, and see the forest is a smoking hole.

If it wasn't enough for one to see AT&T was relying on OVERNIGHT financing last week to maintain treasury operations, then no amount of bad news will make it clear.

Disclosure: 100% double inverse index.

[zenstar666]

Interesting analysis. Totally pessimistic, although ending on a slightly optimistic note. Perhaps the most important reason for the current selloff is the financial crisis, which reason was missing from your analysis. Those reasons you listed as the cause of the decline would not hold water in the absence of this crisis. Can you imagine saying what you are saying now back in June of this year?

[uwatt]

Huh? I was waiting for the last nail and instead got the chirpy "significant value" close.

[Gotglasses]

My understanding about farming is that mined potash's competitors are petroleum based fertilizers. When oil goes down, they get cheaper.


On Oct 03 05:26 PM zenstar666 wrote:

> Interesting analysis. Totally pessimistic, although ending on a slightly
> optimistic note. Perhaps the most important reason for the current
> selloff is the financial crisis, which reason was missing from your
> analysis. Those reasons you listed as the cause of the decline would
> not hold water in the absence of this crisis. Can you imagine saying
> what you are saying now back in June of this year?

[Abbaman7]

Free cash flow. Nothing fancy. Just walking around money. The AG stocks that have gotten their share prices destroyed nevertheless essentially print money and they will continue to. Every one of them could just buy back their public stock relentlessly followed by massive dividend payouts when the growth slows. PCA has already begun to do this with successive 5% repurchases and Agrium has just announced its 5% program. MOS will likely follow. What better use of their money can there be when their stocks are so dirt cheap? I believe these stocks will be back, big time.

[Carl Martin]

I think the article should have been titled "The Five Reasons That Are Most Certainly Not The Five Reasons, Why Fertilizer Stocks Are InThe Dirt." To start with I believe that there are far more than" just five reasons" to explain what's going on with AG stocks, and none of these other well worn reasons were even mentioned. Apparently the author is not aware of anything like the credit crises, a world wide crises of confidence, hedge fund activities, fear, and most appropriate ignorance, to name a just a few in no particular order. Ignorance, by the way does not mean dumb or stupid. It means a lack of correct knowledge or information, or more simply, just not knowing. In that light, try reading this article all over again. If you still have doubts, try reading the articles written by Michael Smedmark at this web site.

[Carl Martin]

Excuse me, the name is Michael Shedlock, sorry

[SB-tiger]

The commodity bubble has burst. The valuations are based on current future price of the commodity. The prices are coming down rapidly - share prices are following.

Commodity prices are very cyclical. On the up move all kinds of stories are written - Chinese protein intake, world population growth,....But we know as demand increases supply quickly follows - the glut will crash the prices. There is no peak supply story for fertilizers.

This bubble was created by the hedge funds and the Wall Street marketing machine, they made their quick buck. Lot of gullible investors are now left holding the baby and dreaming.

With the deep recession and the great unwind on hand beware of commodities. These are the classic falling knives – they may not just cut your hands the big ones may actually behead you.

No position in fertilizers, out look very bearish.

[Abbaman7]

SB-tiger sounds as if he has his finger on the pulse of what is going on with the AG stocks but it turns out his finger is finding a pulse in jello. Conflating commodity prices with nutrient prices sounds reasonable but has no actual correlation; to wit: nutrient prices have not come down but share prices of the nutrient companies have plummeted. This is exactly the opposite of what we were told to expect with the share price decline FOLLOWING a decline in the relevant commodity prices. So we really need to look elsewhere for a coherent explanation. All this 'bubble' talk is so much blah, blah; sounds are trying to come out but nothing is being said. There is no reduction in the demand for key nutrients like potash as customers are all on allocation. Supply increases are years away if at all and then largely a result of expansion by the very companies whose shares were blown away.

I am not saying 'buy,buy,buy' in this sick environment. Just that companies, say, like Mosaic, that now trade at less than 3 times earnings but are sitting on billions of cash and generating billions more with no end in sight given their current growth rate, are companies more likely than not to make their shareholders richer, not poorer, in years to come.

[Farmer Chuck]

Gotglasses, in order to grow plants need nitrogen, phosphorus and potassium (NPK), all three of them. They do entirely different things. Potash provides potassium. Most nitrogen used for fertilizer is made from natural gas. There is somewhat of a correlation between the prices of fossil fuels and other commodities like potash, however, not because oil could be substituted for potash--that is wrong.

[einstein p fleet]

If SB Tiger is right, then the miner's strike at POT wouldn't be a problem. The fact is that the strike is creating a shortage causing deliveries of potash to be rationed and delayed until early 2009. MOS confirmed that potash demand was robust and there was pricing power due to short supply. That doesn't sound like a bubble bursting to me.

Carl Martin had it right --- there are more than five reasons that are driving stocks down and none of them have to do with the underlying fundamentals. Since when is a stock like MOS that makes 1.3B dollars, grows at over 300%, and trades at a forward PE of 2.5 a "momentum" play? Value and growth are not easy to find --- and no one seems to care given that they market is being driven by emotion and capital preservation.

I'm not smart enough to call a bottom to the market, but I spot a bargain. Get ready for major stock repurchases, increased dividends, and a lot of M&A activity. The market is creating some great buying opportunities.

[BxCapricorn]

The readers are once again, infinitely more intelligent than the poster. This article and the responses were reminiscent of Professor Mark Perry's, idiotic musings. I think back to December 2007, when the nutty Professor wondered how a world with a market capitalization of $63T could care about a silly $300B sub-prime problem?

mjperry.blogspot.com/2...

Oh god, how I laughed. Sure, why would an economics professor know about capital ratios, "mark-to-market&q... etc. The Professor thought we collectively created three times the world's wealth, by working our butts off from 2002-2007! Now we are told to believe that company's that continue to generate vast sums of money, based on feeding hungry people, are worth a third of what they were two months ago. There are some Seeking Alpha authors that have missed their true journalistic calling. Children's fiction.

[BxCapricorn]

I know, company's should have been companies...I was laughing too hard and my eyes were all teary.

[d_teller]

Ther's a really a' propos article in Atlantic Magazine, Sept. 2008, pp 28-29, with nice, easy to understand graphics, that shows the rise in food prices and the relatively increasing shortages in supply, since 1980.

And, recently, there was an article here on SA about the decreases of arable and agricultural land, coupled with a relatively obscure note: it takes about 2 bushels of soil (lost to farmers, because of erosion and contamination) each year per bushel of wheat produced.

The UN World Food price index has risen from <100, in Jan. 2000 to above 210