Building an Agriculture Income Portfolio

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 |  Includes: AGU, CF, MOS, POT, TNH, UAN
by: Todd Johnson

Food remains a constant necessity throughout the world. Populations continue to grow and their nutritional intake is central to their health and well-being. Nutrition plays a primary role in societal day-to-day requirements. This is a sector I want to allocate additional funds to due to the strong demand versus available supply. My investing requirements, however, include dividends and cash flow.

For agriculture equities that don't offer significant dividends, I will implement a covered call option strategy. The strategy is referred to as a buy-write strategy. A buy-write option strategy requires the simultaneous purchase of common shares and selling a covered call representing an equal number of common shares.

Agrium Inc. (NYSE:AGU)
Agrium is a leading producer and marketer of nitrogen fertilizer and potash. The company is broken into three core business units: retail, wholesale, and advanced technologies.

Analysts estimate AGU will earn $7.20-per share in 2011. The stock is currently priced at a reasonable valuation: with a 12.3x P/E multiple. The dividend yield is inadequate for my income needs, so I will implement a buy-write strategy.

  • AGU Stock Price: $88.63
  • Current P/E Multiple: 12.30x
  • AGU Dividend Yield: less than 1%
  • Estimated 2011 EPS: $7.20

My option strategy is to be long 100 AGU shares and sell 1-October call, $92.50-strike price, contract. The buy-write trade will result in the following holdings:

  • Long 100 AGU shares: $8,863.00
  • Short 1-Call: AGU Oct 2011 92.500 call (AGU111022C00092500)
  • Premium Received: $410.00
  • Break Even Point: $8453.00
  • Max Profit: $797.00 or a simple 9.43% return



The potential loss for this investment ranges from $1 - $8,452. The cash outlay is $8,453. Click to enlarge:


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CF Industries Holdings, Inc. (NYSE:CF)

CF Industries Holdings is a worldwide leader in the production and distribution of nitrogen and phosphate fertilizer products. The two core business segments are nitrogen fertilizer and phosphate fertilizer.

CF owns over 70% of below mentioned Terra Nitrogen Company, L.P. (NYSE:TNH). TNH has been a stock outperformer for the past 5 years. CF may eventually take TNH private, but until then I will own TNH and collect the quarterly distributions.

Analysts estimate CF will earn $12.50 per share in 2011. The stock is currently priced at a reasonable valuation: a 11.65x P/E multiple. The dividend yield is inadequate for my income needs, so I will implement a buy-write option strategy.

  • CF Stock Price: $145.69
  • Current P/E Multiple: 11.65x
  • CF Dividend Yield: less than 1%
  • Estimated 2011 EPS: $12.50

My option strategy is to be long 100 CF shares and sell 1-November, $150-strike price, call contract. The buy-write trade will result in the following holdings:

  • Long 100-CF shares: $14,569.00
  • Short 1-Call: CF Nov 2011 150.000 call (CF111119C00150000)
  • Premium Received: $1,245.00
  • Break Even Point: $13,324.00
  • Max Profit: $1,676.00 or a simple 12.58% return



The potential loss for this investment ranges from $1 - $13,323. The cash outlay is $13,324. Click to enlarge:


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Mosaic Co. (NYSE:MOS)
Mosaic Company manufactures, blends, and sells crop nutrients and animal feed products. The phosphates business unit represented approximately 70% of 2010 sales. Potash represents 29% of MOS's 2010 sales.

Analysts estimate MOS will earn $4.15-per share in 2011. The stock is currently priced at a reasonable valuation: a 16.60x P/E multiple. The dividend yield is inadequate for my income needs with less than a 1% yield, so I will sell a covered call.

  • MOS Stock Price: $68.88
  • Current P/E Multiple: 16.60x
  • MOS Dividend Yield: less than 1%
  • Estimated 2011 EPS: $4.15

My option strategy is to be long 100 MOS-shares and sell 1-December, $70 strike price, call contract. The buy-write trade will result in the following holdings:

  • Long 100-MOS shares: $6,888.00
  • Short 1-Call: MOS Dec 2011 70.000 call (MOS111217C00070000)
  • Premium Received: $600.00
  • Break Even Point: $6,288.00
  • Max Profit: $712.00 or a simple 11.32% return

The potential loss for this investment ranges from $1 - $6,287. The cash outlay is $6,288. Click to enlarge:

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Potash Corp. of Saskatchewan, Inc. (NYSE:POT)

Potash Corporation of Saskatchewan Inc. is a key international integrated fertilizer company. Approximately 50% of its sales are in potash. The Canadian firm also produces and markets phosphate (about 30% of sales) and nitrogen (about 25% of sales).

The management team is strong, experienced and the company has been a market outperformer in the fertilizer sector.

Analysts estimate POT will earn $3.20-per share in 2011. The stock is currently priced at a reasonable 18.07x price-to-earnings multiple.

The dividend yield is inadequate for my income needs, so I will implement a buy-write option strategy.

  • POT Stock Price: $57.83
  • Current P/E Multiple: 18.07x
  • POT Dividend Yield: less than 1%
  • Estimated 2011 EPS: $3.20

My option strategy is to be long 100 POT-shares and sell 1-November, $150-strike price, call contract. The buy-write trade will result in the following holdings:

  • Long 100-POT shares: $5,783.00
  • Short 1-Call: POT Jan 2012 60.000 call (POT120121C00060000)
  • Premium Received: $460.00
  • Break Even Point: $13,324.00
  • Max Profit: $1,676.00 or a simple 12.58% return



The range of potential losses range from $0 - $5,322. I do not plan on purchasing a protective put on agriculture stocks. Click to enlarge:


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Terra Nitrogen Company, L.P. (TNH)

Terra Nitrogen Company, L.P. manufacturers and sells (wholesale and retail) nitrogen fertilizer products. TNH's key product is "urea ammonium nitrate solutions". Terra Nitrogen GP Inc acts as the general partner. CF is the majority unit holder with ownership of over 70% of TNH shares.

I am late to act on TNH. I was cognizant, aware, and did not act to buy TNH during its early stages. The current yield is acceptable to me. I won't sell a covered call at this time. I recognize CF may take this equity private based upon its 70% ownership stake.

The 40.3% total annualized rate-of-return is significant. This company is in the right place at the right time. The TNH distributions are worthwhile without selling any covered calls.

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CVR Partners, LP (NYSE:UAN)

I remain long UAN from the early days of its 2011 IPO. August 4th is the date for the second quarter results.

CVR Partners is focused upon the nitrogen fertilizer business. This business is explicitly focused upon the production of ammonia and urea ammonium nitrate (UAN) fertilizers.

CVR Energy (NYSE:CVI) owns 70% of UAN. UAN's yield is expected to be 10% based upon the initial IPO. The agriculture market has favorable fertilizer pricing for UAN. UAN's core products have increased in value since the IPO price.

Disclosure: I am long AGU, CF, MOS, POT, TNH, UAN.