A fertilizer stock with a excellent growth rates and a P/E multiple of 10? Sign me up. That is exactly why I recent bought calls on China Agritech (OTCPK:CAGC).
Food prices have been a tear lately, but can they continue the momentum? I think they can. The drought in Russia has been quite well documented, but for much of 2010 the perceived strength of the U.S. Harvest has helped offset this weakness. Recent news about the U.S. Rice harvest may exacerbate the rise in food prices, and consequently, fertilizers.
Below is a chart of the DBA which is an ETF which tracks the prices of agricultural commodities. As you can see, on a longer term basis, we are in the midst of a gap reversal. Technically, it should be pretty clear sailing until about $33, which was a stopping point on the way down from the highs off the bubble. (Click to enlarge)
The bubble. Glad I brought it up. What caused it and what has since changed? In my opinion the biggest driver of the bubble was and still is on the demand side. As the world population continues to grow, food will become a more a valued commodity. Very simple. People need to eat.
Also what people eat makes a huge difference. To produce 1 pound of beef you need about 7 pounds of crops. This means that a shift in the diet of countries that have been largely vegetarian would have a dramatic effect on food prices. With a growing middle classes in emerging markets, and greater availability of meat-based food alternatives (see McDonald's expansion), the consumption of meat is very likely to continue to grow.
The use of corn for ethanol was also a very well publicized issue in the bubble era. Despite the lack of media attention the use of corn for ethanol (at least by the U.S.) has grown. See the figure below.
As for the supply side. There was a major wheat crop disruption in Australia in 2006, and other smaller disturbances existed. But it isn't like we aren't having similar problems today, and these issues will continue to randomly occur in the future. So for the sake of argument, I am willing to call crop disruption factors a draw.
From the currency perspective, food prices also seem cheap. Governments all over the world have printed money during the crisis, and QE2 is also on the horizon. It seems like the currency "race to 0" is as frantic as ever, evidenced by all-time highs in Gold, Silver, and Palladium. This should also be driving food prices higher.
I think everyone can agree, another food price bubble would be a terrible thing for the global economy (and the globe for that matter). So the solution? Increase supply with better fertilizers, and lots of them. I have played virtually any and all of the fertilizer names (AGU,CF,IPI,MOS, MON, POT) during this run, some more successfully than others, and I don't think their relative outperformance is going to stop.
But why now am I opting for CAGC over these other names? Cheap valuation, and greatest alpha (basing this on upside, not recent path). Here is a list of the estimated Price to Earnings ratios of several Ag stocks.
Clearly, CAGC is the cheapest of the bunch by this measure. CAGC also sports a healthy YOY sales growth rate of 120%, and good efficiency ratios. What is holding CAGC back? I think it boils down to trust and transparency. Many small Chinese stocks suffer from ridiculously low valuations, and schizophrenic price movements because of this issue (CTFO and CHBT to name a couple). But recently on October 8th, CAGC announced they would be contacting a "Big Four" auditing firm to check their books. To me, this process is essentially an attempt to say to the investing world: "We are this cheap. And, no we aren't a scam". And personally, I believe them.
So bottom line. The issues that caused the food price bubble in 2007 are still around. But for the sake of the world, we do not want to revisit those levels. That's why fertilizers will be increasingly important in the years to come. Pick your pony, right now I like the upside of CAGC.
Disclosure: Long CAGC calls, Long CTFO stock