The agricultural sector should be of great interest to any investor with a long-term strategy. The global demographic development clearly indicates a steady and growing population worldwide. A population who will need food, water, houses, cars etc. Around 7 billion people live on our planet today, and this number will reach approximately 11 billion by 2050. Therefore an increasing demand for food is inevitable, and there are numerous companies to look out for on this area.
Due to the recent bull run and overflow of liquidity, dividend stocks in the defensive sectors have appreciated significantly during the last year, which is why many of these companies are either fairly valued or overvalued. These high valuations have also resulted in lower dividend yields. The traditional American investor should therefore try to look across the Atlantic towards Europe. Many undervalued dividend companies exists here partly because of the current debt crisis.
As a Scandinavian citizen I have a portfolio consisting mainly of undervalued European dividend stocks. The company I am about to present is a strong and global market leader within the agricultural sector with a low valuation and a high yield. I will focus this article on the Norwegian agro-giant and national treasure, Yara International ASA (OTCPK:YARIY). The company is also listed on the American OTC market and traded with a sufficient flow of volume. The ADR ratio is 1:1 meaning that each ADR share represents one ordinary share. Dividends are accrued annually as is the norm for European companies.
Yara International has its roots back in 1905 when it was part of Norsk Hydro. Back then the main product was mineral fertilizer, a product that helped farmers to boost their yields. Due to the effectiveness of these fertilizer products, Norsk Hydro received worldwide attention. In 2004 the agricultural division of Norsk Hydro was spun off into its own listed entity and Yara International ASA was born. Yara International has a market capitalization of approximately $11,2 billion and is represented on six continents with offices in more than 50 countries. Furthermore, sales spreads to more than 150 countries. Yara has 8.052 employees worldwide whereof the majority is employed in Europe followed by the Americas. The Norwegian government owns 36,2% of the company's shares, which should be regarded as a valuable support.
A wide range of products and services are offered mainly for the agricultural sector, which makes it an interesting stock for the conservative investor. Moreover, the product portfolio will be presented below:
- Yara has one of the widest selections of fertilizer products that ranges from mixed fertilizers to the micro-nutrients for plant feed. This is the core business. Fertilizers are essential in growing crops. Just as humans need minerals and nutrients for strong and healthy growth, so do the world's crops. Fertilizers help farmers to boost yields, and Yara produced around 21 million tons of fertilizer in 2012. Worth mentioning on this area is also the recent postponement of a $2 billion dollar expansion in North America due to increased construction costs and a current oversupply of nitrogen which has made the investment unfavourable at the moment.
- Yara produces and distributes ammonia, urea, nitrates, NPK and specialty fertilizers. Yara is a global and leading manufacturer on this area. 7 million tons of ammonia was produced in 2012.
- The company offers integrated solutions for the optimization of industrial processes, water treatment and prevention of air pollution, NOX reduction solutions for industrial plants, vehicles and vessels. Yara is also a front runner within these areas. One could argue that this product area is a sure future bet as well due to the global interest in reducing pollution.
- Solutions are offered within the areas of carbon dioxide (CO2) and dry ice. Carbon dioxide is available in three different forms: gas, liquid and solid dry ice. When CO2 is in the form of dry ice, it is used in e.g. beverages, food processing, airline catering and refrigerated transport.
- Solutions are also offered for the use of nitrogen. Nitrogen is a vital part in the production of ammonia, which is used in the manufacturing of urea and nitric acids. Nitrogen chemicals are used in conjunction with the production of fertilizer. Yara is the market leader in Europe.
- Finally, Yara owns an animal nutrition division that offers feed phosphates, feed acidifiers and purified phosphoric acid. Around 300.000 tons are produced annually.
According to Yara's latest impact review, agriculture is responsible for a quarter of all man-made greenhouse gases produced, while the production and use of fertilizer is responsible for only 2%. Yara helps farmers to boost crop yields while offering sustainable industry solutions to reduce pollution as well. Yara's fertilizer products are currently used on 50 million hectares of land by 15 million farmers who produce 160 million tons of grain annually. Improved productivity is the key to increase yields and reduce pollution. Yara offers solutions that improve the efficiency of the scarce resources needed to produce the 70% more food demanded by 2050.
Yara International has a very solid and sound financial structure as showed below. An interesting observation in the figure is the significant reduction of NIBD (net interest-bearing debt). The capital structure is therefore stronger than ever and ready for new investments and growth.
click to enlarge images
The revenue was strongly impacted by the financial crisis, which had led to a dramatic decline in fertilizer sales at the end of 2008. Due to the tough market conditions, Yara chose to focus on internal efficiency. As a result, purchases from third parties was reduced, the production got curtailed and inefficient plants were closed. Moreover, the capital structure was strengthened. Yara was put to the test and passed with excellence. Today the sales sources are also more diversified.
Since 2008 the gross margins have increased and the return of equity remains above 20 % except in the tough year of 2009. One should also take a look at the reduction of NIBD which has resulted in a dept to equity ratio of only 0,02. There is a strict focus on sustainable return to shareholders. The goal is that at least 45 % of the net income must be returned to shareholders through dividends and share buybacks, whereof at least 30 % must be returned through dividends. The dividend for 2012 equals to a yield of approximately 5,4% compared to the current share price. This is much higher than its peers and the payout ratio is only 35%. Furthermore, the postponement of the $2 billion dollar investment in North America could very well lead to a dividend for 2013 exceeding 30% of the net income.
A comparison of valuations
This comparison indicates that Yara International is relatively undervalued with a forward P/E of only 7,9x and the lowest P/S and P/B. How can such a strong and shareholder friendly company be traded with such a discount compared to its peers? To me it looks like a solid, long-term position with a high yield. A 40 % premium on the equity seems more than fair for this market leader. Furthermore, the equity is steadily growing indicating greater future book values. Because of the low P/E and satisfactory profitability, Yara currently trades at an earnings yield of 14 %. This is quite a return compared to more low-risk alternatives.
Yara International ASA looks like a strong case for the investor who seeks to diversify his or her portfolio by acquiring stocks outside of the US. The company is a global market leader in several defensive industries with stable growth outlooks. Who knows if the macroeconomic environment looks better or worse in five years? Will interest rates skyrocket, and will the US then be able to bring down debt? Will China's economy crumble by their own subprime crisis? Is France the next problem for the EU? No one knows for sure, but people will still need food, and the demand for sustainable and clean industry solutions are increasing worldwide.
If you want to exploit the growing population and demand for food and clean air, Yara seems like a rational investment. The company's fundamentals are strong due to the fact that they have no net debt, increasing gross margins and a high return on equity. Because of the high EPS and cash flow I expect increasing dividends in the future together with share buybacks. The relatively low valuation together with a high yield and strong fundamentals results in a satisfactory margin of safety. Yara International ASA is an obvious buy-and-forget stock.