Seeking Alpha
Long/short equity, value, research analyst, commodities
Profile| Send Message|
( followers)

By G.C. Mays

Mosaic's (NYSE:MOS) fertilizer business yielded higher earnings in the 2nd Quarter of their 2012 fiscal year. The company reported earnings from continuing operations of $1.40 per share versus $1.02 in the year ago period (excluding the $1.27 per share gain from the sale of Fosfertil in the 2nd Quarter of FY 2011). Revenues increased by 340 million or 13 percent year-on-year to 3.01 billion. Revenue gains reflected higher selling prices for both potash and phosphate. However, tonnes sold in the second quarter were lower than the same period a year ago for both fertilizer types. Third quarter sales are being adversely affected by customer purchasing decisions due to global economic concerns.

Financials

The company continues to manage its balance sheet well, maintaining liquidity ratios that are superior to both Potash Corp (NYSE:POT) and CF Industries (NYSE:CF). Year-to-date, the profitability ratios of the company are ahead of last year. Gross margins for the 6 months ended November 30th were 28.4 percent compared to 26.2 percent over the same period a year ago. Operating margins are just as strong at 25 percent compared to 22 percent a year ago. The company continues to have low debt to equity levels compared its peers as well.

Potash

The average price received for Potash was $440 per tonne in the second quarter, up from $331 in the same period a year ago and down from $446 in the first quarter. Tonnes sold during the quarter were down slightly, to 1.76 million from 1.8 million a year ago. Year to date, tonnes sold are 3 percent higher. The company has produced 3.7 million tonnes of potash in its current fiscal year, slightly more than last years 3.1 million tonnes produced over the same period. According to the company, the fiscal year began with low potash inventories so they see no need to curtail production as they announced they would do with phosphate production in the third quarter on December 28th due to customers holding back on purchases.

Phosphates

While DAP prices averaged a strong $611 per tonne in the second quarter, tonnes sold were off by 13 percent to 3.2 million. The company cites global economic concerns, which I agree with. However, where we differ is that the company believes that crop nutrient demand fundamentals remain strong, simply based on the chart that each firm must have that shows global population growth and food demand rising at a near constant rate. While food demand will surely grow at the same rate as the population, the question for a fertilizer company is simply, "How many tonnes of fertilizer will we sell and most importantly, at what price?".

It surprised me to see that the company received a higher price per ton for phosphates in the second qtr ($611) than they had in their first quarter ($594) given the decline in crop prices since August. I then became aware of a realization lag on market prices for both phosphate and potash. Fertilizer buyers tend to delay their purchases when they expect the future market price to decline. Conversely, buyers tend to accumulate inventories before anticipated price increases.

For example, after peaking in 2008, tumbling market prices for grains and oilseeds led fertilizer buyers to expect declining farming economics, which played a large role in lower selling prices and volumes for concentrated phosphate crop nutrients and potash during portions of Mosaics 2009 fiscal year. If we look a Mosaics 2009 fiscal year, we can see how this played out as DAP fertilizer prices plummeted during the year along with Mosaics stock price.

DAP & Mosaic Stock Price Movement in Mosaics Fiscal Year 2009Source: The Mays Report

We can also take a look at market prices of selected grains and oilseeds during the same fiscal year. Note the EUR/USD exchange rate movement during this period as well.

Corn, Wheat and Soybean Prices during Mosaics FY 2009Source: The Mays Report

Mosaic maintained profitability during FY 2009 and the company will keep up its profitability during this slowdown, whether it's a cyclical or merely a seasonal one. The La Niña condition in South America gives us legitimate short-term bull and bear cases to present.

The bear case says that dealers and distributors are telegraphing their expectations of future price declines by delaying their fertilizer purchases as they have historically done. They see further declines in the EUR/USD exchange rate as we move towards March, when the Euro zone is once again forced to take some action, including kicking the proverbial can down the road yet again. The stronger dollar will have a continued negative impact on already weak export demand. Lastly, using company 3rd quarter estimates of 1.2 to 1.5 million tonnes of potash sold for between $430 to $460 a tonne and 2.2 to 2.6 million tonnes of phosphate sold for between $530 to $560 a tonne gives us a revenue range of 1.68 - 2.15 billion, which even at the high-end of the range is below third quarter fiscal year 2011 revenues of 2.21 billion.

The bull case says that the La Niña condition in South America will persist and push soybean and corn prices even higher. One could also argue that the correlation between the EUR/USD exchange rate and the grains and oilseeds has decoupled in the last 10-12 trading days. While that holds true for the crops it is not yet true for a stock that is still highly correlated to the EUR/USD exchange rate.

EUR/USD Correlation with wheat, corn, soybeans and Mosaic StockSource: The Mays Report

The European debt crises is introducing instability and uncertainty into the farming equation because of EUR/USD exchange rate volatility. The La Niña weather system in South America adds fundamental supply uncertainty to the mix and clouds what market participants will trade against, South American weather impacting supply / demand fundamentals or European weakness impacting exports?

The thing that makes financial markets work is market participants taking opposing sides of a trade. However, choosing sides of trade that have opposing outcomes with similar probabilities of occurring is like playing red or black at the roulette table. Sometimes the smart thing to do is to just sit on the side of the riverbank and watch the water go by.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Source: Mosaic's Q2 Yields Higher Earnings, But Q3 Customer Slowdown Looms