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Michael Filloon, Split Rock (390 clicks)
Oil & gas, small-cap, research analyst, growth at reasonable price
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How does one navigate these incredibly difficult markets? Is it possible for an investor to have success even if he does not have the ability to sit by the computer all day long placing trades? The initial crumbling of the financials made it easy for Bears, but as many of these companies have disintegrated, it has become a very iffy situation placing bets to the downside, as any new news could cause one of these banks to take off or the market to go up 500 points. On the other side, it is difficult to invest in stocks as it is difficult to know which companies will go under. Circuit City just announced they will be closing the remainder of their stores, another company to be chucked to the wayside as they were unable to obtain financing to either sell the company or keep it going until the consumer recovers.

The first and most important decision in making an investment is with regards to sectors. Before looking at any individual stocks, first find a sector that seems oversold. If a sector looks good, any stock within that group will benefit from the good news of the other stocks. These can be checked by following any of the ETFs that are sector based.

Currently, I am not very excited about anything consumer oriented. The reason for this is sentiment, as it is emotion based and can be difficult to gauge. Even the best companies in the world are finding it difficult to navigate the current environment, as disposable income has all but disappeared. A good example is Apple (AAPL), which has held up well, but has come under incredible pressure. The stock is selling for around $80 a share and that is with $30 per share cash on the balance sheet.

The banks are another difficult area to figure out. Although the US government is doing everything they can to nationalize the banks without nationalizing them, many of these will be left as only preferred stock and investors could lose their entire investment.

Those who have read my writings know that I am a pundit of agriculture. First and foremost, this sector is a need, not a want. We need food, and with corn, soybeans and wheat below inventory averages, these stockpiles will need to be built back up. Many of these stocks took it on the chin last week as the USDA report came out with abysmal numbers with respect to commodity prices. Many people thought we were going to see $8 corn, but now it looks like it will be closer to $4.

When dissecting these numbers, it seems as though this could be a buying opportunity. The reason is yield. Since we are running out of fertile land, yield is the only way to increase food production. Many of these once boring companies have become technology based.

The current environment in the United States adds bullishness to this area. After $4 a gallon gas caused the crushing of the US dollar not too long ago, many Americans are screaming for alternative uses with respect to energy. There are current technologies that will work but only one is cost effective. Liquefied and compressed natural gas could be a huge success until we are able to use other technologies such as hydrogen (although this seems to be a long way off). Since the United States feeds the world, it behooves them to use food to fill our cars. Not only is it renewable, but also pushes up the price of agricultural commodities, helping with our massive deficit. It also decreases the amount of pollution, another big topic on the Hill.

The election of a Democratic President also bodes well. Not only does this give the Democrats the Presidency, it also secures legislation as there will be no veto. Democrats have long been proponents of farmers and will continue to be. Supporting crop prices and continued subsidies will help this sector going forward. For these and many more reasons, I have placed together a list of companies that I believe have the best chance of making some serious cash for their investors.

1. Monsanto (MON)

This was a very difficult decision to make with respect to the top spot, but it was made because of seeds. The use of fertilizer can be put off, but plants cannot grow without seeds. Monsanto has watched their company grow at supersonic speed due to Round-Up Ready and all sorts of drought resistant technologies. Monsanto is not only the leader in this space, but also has the closest thing to a monopoly.

Their last earnings release tells the story (see conference call transcript). As analysts were decreasing their estimates, Monsanto continued to outperform. They not only sell the number one herbicide on the planet, but are expecting to be releasing the first drought resistant corn seed relatively soon.

One reason Monsanto is well positioned going forward is the ease with which their products work. Round-Up herbicide basically kills all weeds. The problem with Round-Up is that it kills plants just like it does weeds. The new Round-Up ready seeds are resistant to the herbicide so a farmer can plant corn and then spray right over the top of his/her crop. Not only does this reduce weeds, but it also decreases the time it takes in application, making it possible for the farmer to plant more acres while increasing yield.

Monsanto also increased their dividend by 10% after knocking the cover off the ball with respect to earnings. Their quarterly earnings growth of 117.2% seems to be just the beginning of a multiyear move in this stock's price. The implementation of gene alterations for farming are just beginning, as their current triple stack looks to be a driver until Monsanto can get FDA approval for their drought resistant corn seed. Even more exciting would be an approval from Europe to use gene altered seeds. This is possible as farming becomes a more competitive environment.

2. Intrepid Potash (IPI)

Fertilizer stocks all look good going forward, but right now potash seems to have much more pricing power. Fertilizer is made of three components. Nitrogen is generally the largest amount and is the easiest to get on line when world usage increases. This is the cheapest and fastest element of fertilizer to increase production of. Phosphorous is the second piece of the fertilizer puzzle. This nutrient is based on sulfur rock and although the most expensive per ton, it takes is the second most expensive to come on line, and takes the second longest. The most important is potash, or potassium. For a very long time there has been a large surplus of potash. Steadily increasing population and emerging markets increasing meat consumption has created a demand for potash. Since it is mined, it is very expensive and time intensive to create new production.

IPI is the only true potash play in the United States. They supply 1.5% of global demand and 8.5% of United States demand. It is estimated that Intrepid's potash production capacity will increase 7.9% CAGR from 2007 to 2011E. Since January of 2007, Intrepid's list price for potash has increased from just under $200 a ton to approximately $800 per ton in December of 2008.

Looking at indexed prices of potash since January of 2006, this commodity has not seen one decrease in pricing as compared to 61 declines in the price of corn or 82 in the price of nickel. Urea has seen 20 and DAP has seen 14 for the same period of 153 weeks. Intrepid's 100% link to potash is comparable to Potash Corp.'s (POT) 34%, Mosaic's (MOS) 24% and Agrium's (AGU) 6%. Intrepid's potash sales are 64% agricultural, 28% industrial and 8% feed. Not only does this company have aggressive growth going forward, but also operates with zero debt.

3. Compass Minerals (CMP)

CMP is not a true agricultural play, but a large portion of its business is associated. Unlike Intrepid Potash, Compass Minerals produces sulfate of potash (SOP) as opposed to muriate of potash (MOP). MOP is used as a fertilizer for crops and also in the oil and gas drilling sectors. Sulfate of potash is used as fertilizer for citrus fruits that have a low tolerance for chloride.

To give an idea of how specialized SOP is, MOP currently has 70 million tons of production per year, where SOP is just 7 million tons. Since 2003 CMP has seen their operating earnings increase 21% CAGR. The fertilizer segment alone has seen an increase of 70% CAGR. Fertilizer is now 36% of their operating earnings. That is up 16% from just last year.

The value of SOP can also be seen as specialty crops are only 3.7% of crops harvested but produce 37% of total crop revenues. Specialty crops also have a much lower percentage of cost with respect to fertilizer and could stand much greater price increases. The average selling price for SOP in the fourth quarter was $946 per ton. This is at the same time that companies like MOS have lowered MOP projections of average selling price to approximately $520-$540 per ton.

Generally, companies produce SOP by purchasing MOP and then causing a chemical conversion with sulfuric acid. CMP uses lake brine extraction, which is much more cost effective.

Currently, CMP is planning on a production of approximately 400000 tons of SOP. By 2011, they will expand by another 100000 tons. CMP states they will be able to bring on another 400000 tons of SOP after this without increasing MOP purchases. CMP believes they will be able to expand usage of SOP by educating farmers that do not currently use specialized fertilizer. Sugarcane, blueberries and other crops should all benefit from its usage.

Compass has a healthy business with respect to salt. This remainder of their business is centered in highway deicing and water conditioning. Pricing with respect to this has been good, even in the downturn, and should continue to be so.

4. Sociedad Quimica Chile (SQM)

This company is much like Compass with respect to its specialty fertilizer. They are much more levered to specialty fertilizer than CMP is. They currently have 49% of the world's market share of potassium nitrate. This is much like sulfate of potash as it has usage with respect to high value crops. It is completely natural, has fast absorption, is water soluble and chlorine free. 55% of their current business revenues is plant nutrition. 15% is iodine and derivatives. 11% is lithium. 6% is potassium chloride, while the remainder is garnered from fertilizer trading.

They have outreach to the rest of the world that is quite impressive. They have a local presence in 20 countries.

By the second half of 2010, they will increase potassium nitrate production by 300000 tons. There are currently no new projects announced with respect to this fertilizer.

In 2008 they produced 860000 tons of KCL and SOP. It is estimated that in 2011 they will increase to 1.2 million tons. A very important change to the company looks to be their merger with Anagra SA. This will cause price synergies, allowing the company to save on costs.

5. American Vanguard (AVD)

Of all the companies on this list, AVD may be the most interesting. With a tiny market cap of under $300 million, it isn't quite a household name. What sets AVD apart is their business structure. Over the years, they have acquired effective older products that have been replaced by newer, more effective ones.

Their products include insecticides, fungicides, herbicides, and other agricultural products. The world's increased demand for corn has placed AVD in a unique position. Since many of their products are levered towards this crop they have emerged as a company that took older products and can market them together to better serve the farmer. The revitalization of mature agricultural products has worked well for AVD. By purchasing the rights they are then able to market the product to areas that have either stopped or never used. Since some of these products have been used less, many weeds that have a tolerance are still susceptible to their products.

In 2006, their technologies were used with Monsanto's trait resistance corn. AVD's Smart Box application system was used with their insecticides to increase yield by 12 bushels per acre in a major university study. Also, Impact herbicide is now being recommended as an addition to Round-Up for glyphosate resistant weeds and grasses. This works well with Round-Up Ready corn. Glyphosate resistance has been increasing due to the large applications of Round-Up. These resistances can only increase with time, leading to more use of Impact herbicide.

It would not be surprising if this company is purchased due to their small market cap and glyphosate resistant weeds. Their addition to the S&P Small Cap 600 will lead to an increase of purchases of stock for index funds, and should increase over all valuation of the stock.

Agriculture is becoming a technology investment as the old boring companies now have to develop products to compete. The irrigation systems of VMI, special seed coating of LNDC, and biodegradable plastics of ADM are all profitable plays in this environment. Current valuations seem quite low and anyone with a mid to long term investment timeframe should think about this sector. The recent $2.1 billion dollar offer by CF for TRA is evidence that companies think there is value here.

Disclosure: Author holds MON stock and call options, SQM stock and call options, CMP call options, IPI stock and call options, CF call options and POT call options

Source: At Least Five Agricultural Stocks with Upside