Ride The Rally In Fertilizer Stocks: Corn Production Can't Take The Heat

Fertilizer Update - Declining Corn Yields

The ongoing drought and severe heat conditions in the Midwest belt have deteriorated the already suffering corn production. According to the recently released weekly crop progress report by the United States Department of Agriculture (USDA), the supply of corn, which is in good to excellent condition, has further dropped to 48% from 56% in one week. Even last week, the USDA reduced its rating of good to excellent corn to 56% from 63%. As a result, corn prices have escalated by as much as 30% in the last month, and Chicago corn futures have surged to 10-month highs this week.

The United Nations' Food and Agriculture Organization (FAO)'s senior economist and grain analyst, Abdolreza Abbassian, recently said,

"Corn is such a driver now in terms of market sentiment -- for at least a few weeks if not months -- anything that goes wrong beyond what the market has anticipated would certainly create turmoil in the market."

Although, this year, corn production was estimated to be at a 75-year high by the USDA, very high temperatures coupled with little or no rain will now adversely affect corn yields. As a result of this reduction in corn yields, the demand for fertilizers in the next planting season is expected to receive a huge upsurge.

Fertilizer stocks gained as a result of this positive catalyst. CF Industries Holdings (CF) gained by 3%, Potash Corp (POT) by 2.5%, and The Mosaic Co. (MOS) by 1.4%. We maintain our bullish outlook for the Fertilizer Industry in the short-term amidst declining yields and rising prices of corn. However, in the long-term, surplus capacity is expected for nitrogen and potash fertilizers, and the rate of supply growth is expected to increase the rate of demand growth.

As we already mentioned in our previous article, one bushel of grain corn requires 1.4 lbs. of potash, 1.25 lbs. of nitrogen, and 0.6 lbs. of phosphate. So, a reduction in corn crop yields will impact those fertilizers' firms significantly, who have higher potash and nitrogen exposure.

• CF Industries is a buy because of its high nitrogen exposure, high gross margins, production boost due to reduction in natural gas prices and the North American planting season, and cheap valuations.
• We reiterate our recommendation of a long position in Potash Corp. because corn crops need potash the most, and POT is the world's leading potash producer. In addition, a contract between Canpotex (a potash making consortium in which POT has the largest share) and Sinofert Holdings, has led to an increase in POT's sales. A new contract with Indian buyers is also expected in 2H2012.
• The Mosaic Company has lucrative growth potentials, as well as an increase in fertilizer-making capacity, as a result of the resolution of its Potash tolling dispute. MOS is also a potential buy.

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