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Talk to anybody who returns from any emerging market country, and the consistent message is clear: The poor are now part of a rising global middle class -- and they’re hungry. The chronic hunger they once felt is now satisfied through the disposable income they earn every day. And it’s unsurprising that the largest populations in the world also reside in the fastest-growing countries. Here’s what is surprising: Many top investors seem to have the memory of goldfish and think that the “food play” is over. Really? Not so fast, investment rocket scientists of the world. With global food supplies struggling to keep up with increasing demands, the notion that the GDP of emerging markets will grow rapidly -- but their demand for food won’t is comical at best. The “out of sight, out of mind” mentality is playing tricks with some investors again, which makes a stock like Agrium (NYSE:AGU) very interesting.

Although farmland is a renewable resource, it is limited in quantity at any point in time, so the solution to a global increase in crop demand is not easy. As the world economy strengthens and emerging markets continue to grow, we anticipate the demand for food (and their corresponding prices) will only increase. The only viable solution is to increase yields from current farmlands, which makes Agrium a valuable player.

We rate Agrium a BUY due to improving profitability and its ability to capitalize on global food trends. We also believe there will be heightened demand for products that increase crop yields. The trade here is increased global food demand, the time is now, and the play is Agrium.

Big-Kid Benefits and Sturdy Margins:

AGU is the largest agricultural retail operator in the U.S. What investors often overlook is that it’s also a producer of phosphate, nitrogen, and potash. Part of the firm’s differentiating advantage lies in how it generates its nitrogen in Canada and benefits from better natural gas pricing than European and U.S. competitors. Cost advantages like this and cutting out middlemen are keys to what has this firm firing on all pistons.

Our interest in this company has to do with profitability trends we have identified and illustrate below:

Profiability Growth Trends2007200820092010TTM
Gross Margin30.3%32.1%21.3%25.2%25.9%
Operating Margin15.7%19.4%6.4%10.5%11.5%


We like the idea of holding the bigger kids on the block when possible and here it can obviously pay significant dividends.

Hungry for More Power:

In our view, the industry has bottomed out, but retail agriculture remains fragmented. Agrium could snap up small competitors to expand into new markets, consolidate its global market share, and/or increase its negotiation leverage with suppliers. Without question increasing global demand for food has increased revenue growth but we like to see more than one avenue of growth such as this.

Use Mouthwash to Clear the Lingering Bad Taste:

When the global economy crashed, so did potash prices. While this left some investors with a bad taste, it’s time to gargle and look at the fertilizer sector again. After all, “bad things” must happen in the short term if any investor wants to buy low and sell high.

It isn’t 2008-2009 anymore and we are pleased to see strong indications of improvement. In particular, we loved that quarterly revenue growth (year over year) increased 64.29 percent. Better yet, this wasn’t a one-time event; we have identified positive top-line growth over multiple periods.

Top Line Growth Trends09/201012/201003/2011TTM
Revenue2,0092,3462,95411,626
Operating income3974394661,333

*All numbers in USD Million

Arable land per person on a global basis is declining. Why? One reason that doesn’t immediately come to mind is the increased demand for meat from emerging markets like China and the proportionate increase it creates for cattle grain. Everyone understands that an increasing global population will increase demand direct grain consumption by people. But many forget that the demand for meat also increases the demand for grain. The only solution is to increase yields through chemicals and fertilizers from such as AGU.

A Quick Play By the Numbers:

From a price multiple perspective, we think AGU is undervalued. For example, the industry average price/sales ratio is 2.9, but AGU trades at 1.2. Given AGU’s strong recovery, we’re surprised it’s not higher, but we aren’t going to complain about the opportunistic valuation. And since AGU’s forward price/earnings ratio is only 10.7 (compared to the S&P/TSX Composite’s 14.6), we see this as a nice discount. Based on these two metrics, it looks like AGU trades at a reasonable price.

Conclusion:

Arable land per person is decreasing, potash prices have bottomed out, and the global economy is in recovery mode. To us, it sounds like all the factors that Agrium (NYSE: AGU) needs to go higher are positive. In addition, from a price multiple valuation, the numbers look fair to favorable. For investors interested in a play on higher food prices and growing global population, this is the name we like along with Mosaic (NYSE: MOS).

Source: 3 Reasons Why Agrium Will Rise with Explosive Global Food Demand