Potash as Ash Can

By the time you read this, the crop report will be old news. We don't expect any big surprises, nor does The Street. The expectation is that corn plantings will be down, soybean plantings will be up, and cotton will probably get the weakest planting of all.

One of the more interesting plays on these kinds of numbers has been potash. Potash, which you can get from burning wood - but is more often mined - is a critical fertilizer. The three biggest demand sources are Corn, Soybeans and Cotton, in that order. So the algebra for the big potash companies is what the shifts will be.

Cotton, Corn and Soybeans can be interchangeable on the same acreage. So less cotton and more anything else is a plus, but less corn is a minus. It's safe to assume that the market has priced in the median assumptions, and that all today brings is volatility.

The "pricing in" in this case, is in the three big public potash plays: Potash Corporation of Saskatchewan (NYSE: POT), The Mosaic Company (NYSE: MOS), and Agrium Incorporated (NYSE: AGU). While all three have businesses other than potash, they are, in descending order, the big fish - with POT alone controlling 75% of the surplus Potash available on the spot market.

The three companies share a common exporter, Canoptex, jointly owned and focused on sales in Asia. While 60% of Canoptex's potash ends up sold on the spot market, the remainder is sold in long-term negotiated contracts, much like iron ore. As a joint marketer, it has tremendous pricing power and enters into long-term contracts with international firms - in other words, China. China and India have become tremendous sources of demand for bulk potash, and the bottom line is there aren't that many places for them to get it. Canada and Russia are pretty much it.

This year's big contracts with China and India from Russia were just struck, at a time when the spot prices are twice what they were last year ($625 per ton). This left the market salivating at the prospects of the big North American firms' prospects for high-margin, peak-priced contracts, saliva so far well justified as Mosaic announced a deal to supply India at the same prices on Friday. None of this is news to potash-supplier shareholders of course, and the result is fertilizer companies with P/E ratios that put Apple and Microsoft to shame (but which are increasingly common in hot commodities stocks):

Agrium Potash Mosaic Market Cap ($B): 10.3 50.52 45.62 P/E (ttm): 20.14 47.05 48.31 EPS (ttm): 3.24 3.403 2.13 Div & Yield: 0.20% 0.30% N/A

And this also comes at the end of a phenomenal bull run for the companies concerned.

One-year numbers like that make the commodities boom seem boring by comparison. But look at the volatility. These are heavily played stocks, subject to wild swings (as Brad recently pointed out). Analysts have been jumping on the buy wagon, earnings estimates keep getting revised up, and the China card is being played more and more heavily in every article. In a world where pure-plays in commodities are increasingly difficult to find, POT and MOS have represented rare speculative gems. Good for long-term holders, dangerous for newcomers.

The next four weeks are critical if you're playing the home game. Mosaic releases earnings on April 4, with Potash following shortly thereafter on April 24. This is a classic case where a micro-sector has gotten hot in a hurry, and the fever is about to peak. This doesn't necessarily mean anything is going up - new investors may indeed pile in as Jim "Bear Stearns is Fine" Cramer whips them into a frenzy over POT, but then, a lot of smart money was in these stocks last March and may be looking for the exit signs on bigger news-driven pops.

What it does mean is volatility. MOS's one-year volatility is already over 67% (vs. 25% for, say, the Goldman Sachs Commodity Index). The ride's only going to get wilder.

Comments

[MT Invest]

Great comments, good insight, and a reality check that smart traders should realize that even the best sectors (of which I know this is one for the next 12 months), is venerable to ups and downs.

Whether the volatility is because of Jekyll and Hyde hedge fund managers, or knee jerk reactions to crop news, government regulations, etc, the song remains that same that the facts remain that second and third world countries are rapidly repositioning and moving into the first world economic markets, and continuing to grow and expand their dietary choices. In some cases, the current and future demand is staggering in terms of scale, and even historically.

Emerging markets, emerging =More money=More Demand for More Food=More demand for More Crops=More AG Sector involvement=More Profits.

The best things about this is that not only go people have the opportunity to grow healthier, but that they absolutely have to have the products that the agricultural sector produces to do so.

Since these are really “must haves, or need based” products, even with the volatility, there is a significant amount of safety in them that most other sectors simply cannot offer.

Contrast the AG plays with the AAPL, RIMM, Dell, or IBM; the Financials, or even the big guys like GE, SI, and PG, and the differences become obvious. People can hold on to their old computers and cell phones until the next great innovation or until the economy gets better, and the GE or SI plays are rather safe, but rather slow moving. We have seen that other commodities that are tied to less “Need based elements,” can loose their future rather quickly (copper, gold, oil, natural gas), so I just keep coming back to how appealing the Ag sector looks now, and for the foreseeable future.

The view that there may be some wild and/or incremental swings is true. Yet the AG sector can be a great place for swing and day traders, and, if they have the fortitude, longer term investors that keep their eye on the bouncing ball. So, as you indicated, it has been, and may continue to be a wild ride, but compared to the other resent past, present, and near future choices, this is one play that I don’t want to miss.

[User 164820]

More people, higher per-capita income, more & better food will
drive agriculture - seeds, fertilizers, pesticides, herbicides, farm equipment - will all do very well in the long-term. Near-term the market is very volatile because of the financial markets and their possible impact on per-capita income. This is a bump in the road for the global economy. Everyone wants to enjoy good food and most will work hard for it. Modern farming technologies will be applied to satisfy the rapidly increasing demand for the forseeable future.

[Ross L.ansing]

I tried to talk my parents into buying all the stock of POT they could afford and their stock broker cried No No No ,,too risky ,big bad and scary , stay away and buy more of the stuff you can count on for the long term . They ignored him at my urging and made more money in 9 months than they have made in 9 years in the stock market . What they are digging out of the ground up north is a new kind of gold . Its only going to get better for those not afraid to believe.

[TN Jim]

"Everybody has to eat."

Not an original thought, but very true.