By G C Mays
The latest chapter in the European debt crisis has given rise to uncertain economic expectations in the eurozone, which has raised fears across the globe and contributed to lower fertilizer stock prices. Has the recent sell-off created a buying opportunity for fertilizer stocks? If so, which stocks are the least expensive?
Cream of the Crop
At a recent closing price of $157.01, CF Industries (CF) trades at 1.6 times sales and 2.0 times book value, and both measures are below their respective peer group averages of 1.9 and 2.6. Using the price-to-sales multiple the company's shares are now valued at about $192, which is $27 below the shares' relative value of $219 when I wrote my analysis of the company's Q1 earnings titled "CF Industries' Strong Q1 Sales: Have Nitrogen Prices Peaked, Or Is There Room To Run?" on May 7. Nitrogen prices being at business cycle peaks remain the highest company-specific risk for CF Industries in my opinion. That said, UAN and ammonia prices, which typically account for roughly 70 percent of Q2 sales, remain strong while UREA prices are beginning to turn lower. The company also has a strong balance sheet.
Shares of Mosaic (MOS) have suffered this year as the company had to cut production in its fiscal third quarter to slow growth of its Potash inventories while dealers held back on restocking. However, dealers must eventually refill their bins with both potash and phosphate. Potash prices have been firm for many months as producers have been unable to raise prices due to swelling inventories. What we don't know is if prices will rise due to sudden demand after spring planting, or if producers will lower prices in response to dealer concerns about price risk as well as to cut those bloated potash inventories. Mosaic also has a solid balance sheet.
On a price-to-sales basis, Agrium (AGU) is less expensive than both CF Industries and Mosaic. However, recent acquisitions have strained the company's balance sheet. This can happen when a company makes a number of acquisitions over a short period. The company's liquidity ratios are inferior to both Mosaic and CF Industries as well as the peer group median average. It's degree of financial leverage is also higher than those companies. Financial leverage is the degree to which an investor or business is utilizing borrowed money.
One company in the group that Agrium is like in this respect is Potash Corp. (POT), a company that also has liquidity and financial leverage ratios that are inferior to the peer group. However, what sets these two companies apart is sales per share, which is why Agrium is relatively inexpensive and Potash Corp. is not.
Click to enlarge image.
Source: The Mays Report.
Agrium is also unique in that its retail stores give it a presence both upstream and downstream in its value chain.
Just because companies are cheap doesn't mean they won't get even cheaper. The bull case for buying the fertilizer stocks at these levels is: one, dealers refilling those empty bins and, two, a recent hint of drought weather conditions could send crop prices higher if crop conditions are below expectations and the dry weather persists.
The bear case or case for exercising caution is as follows: One, persistent European debt refinancing concerns will see the U.S. dollar gain strength against the euro and Chinese yuan, making exports to those areas more expensive and negatively affecting crop prices. Two, if nitrogen prices have in fact peaked this cycle and begin to fall, the earnings of nitrogen producers could be reduced. Three, potash and phosphate producers have to make price concessions when dealers begin to restock, thus reducing their earnings.
Of the three companies, in my opinion Mosaic has the least amount of downside risk, followed by Agrium and CF Industries.
Prior to the debt crisis in Europe returning to the forefront, my bias was to the upside beginning in the second half of the calendar year on the basis of dealer restocking. With Europe and now dry weather increasing crop price volatility, the picture is now a little less clear. Investors with a long-term time horizon could use this as an opportunity to initiate or add to existing positions. For those with a trading or short-term time frame, the liberal use of stops might be the most prudent thing one can do. Signs of a weakening dollar may signal a return to relatively higher prices.