Buying Fertilizer Stocks In Lieu of Camel Futures

Commodities are clearly in the midst of a bull market. On a daily basis, we're being deluged with stories of rising gasoline prices, rice shortages, soaring demand for steel, etc. These high prices will certainly encourage the development of new supply in time. A nearer-term impact will be product substitution when feasible. If steak costs too much, buy chicken instead. If the price of rice is too high, substitute potato. If the cost of cocoa soars.....bad example. I'm still buying cocoa.

The following example of the substitution effect is from a recent article in the Financial Times. It has me seriously thinking of swapping my Accord for some sled dogs.

Farmers in the Indian state of Rajasthan are rediscovering the humble camel.

As the cost of running gas-guzzling tractors soars, even-toed ungulates are making a comeback, raising hopes that a fall in the population of the desert state’s signature animal can be reversed.

“It’s excellent for the camel population if the price of oil continues to go up because demand for camels will also go up,” says Ilse Köhler-Rollefson of the League for Pastoral Peoples and Endogenous Livestock Development. “Two years ago, a camel cost little more than a goat, which is nothing. The price has since trebled.”

The shift comes not a moment too soon for a national camel population that has fallen more than 50 per cent over the past decade, to about 450,000, according to government figures.

Market prices for these “ships of the desert”, which crashed with the growing affordability of motorised transport, are rising again as oil prices soar.

A sturdy male with a life expectancy of 60-80 years now fetches up to Rs40,000 ($973), compared to Rs5,000-Rs10,000 three years ago, according to Hanuwant Singh of the Lokhit Pashu-Palak Sansthan, a non-profit welfare organisation for livestock keepers. Entry-level tractors cost around $4,000.

As far as I know, there are no camel futures or ETFs, and I'm not suggesting you mail order a caravan of camels in the hope of reselling them for a tidy profit . Remember, you have to pay for shipping, feed them, and pick up after them. And then there's the spitting. Oh, the spitting!

The point, as usual with commodities, is that the end of the bull for any particular commodity will eventually come from falling demand, rising supply, or both (two years spent getting an MBA for that insight). Product substitution is just one factor to keep an eye on. In the short-term, we're more likely to see it in the agriculture space than metals or energy, given their relative fungibility.

My preferred way to gain exposure to the agriculture space without the risk of betting on specific crops has been through the fertilizer space, which has been enjoying and is likely to sustain favorable supply/demand fundamentals. With these firms, we don't have to worry too much about product substitution. Yes. Different crops have different fertilizer needs, but there's nothing in the immediate future likely to totally replace potash and nitrogen use.

This past week, I added to positions in Potash (POT) and Mosaic (MOS). Both of these stocks have pulled back roughly 15% in the past 10 days as investors began rotating out of the the commodity space in general. I believe these names (and Agrium (AGU) which I also own) are in a secular (rather than cyclical) bull market. Their earnings growth is terrific, their valuation looking into 2009 is attractive (low double-digit P/E for both), and they're generating a ton of free cash.

Key fertilizer supply is constrained and demand continues to grow given the rising populations and dietary demands of the developing world. The rising prices of agricultural commodities is increasing the demand for fertilizers in order to maximize crop yield and also increasing the ability of farmers to pay higher fertilizer costs. These are the types of names that institutions will want to own given their fundamentals, valuation, and stock performance. This share demand support is likely to limit downside barring a significant adverse change in fertilizer supply or demand.

My strategy with these names has been to lighten as they've gone parabolic or become too large a portion of the portfolio and to add when we get these 10-20% pullbacks. A core position has been maintained regardless of price action. Should the stocks continue to fall in the coming weeks, I fully expect to keep adding.

Disclosure: The author is long POT, AGU, and MOS and currently has no camel position.

Comments

[jeff a]

I do not have an MBA... I don't even know a lot about the market but I have spent a great deal of time in Asia and the rising demand for higher protein foods is not going away soon. I also know that people run to AG and commodities when the dollar weakens and despite Larry Krudlow's rantings I see no evidence that the dollar will gain against other currencies.

I'm long MOS but will probably trim it considerably if the ethanol mandate goes away.

[sliman]

I am also long MOO and YARIY (largest world wide ag company from Norway. Vey cheap).

[ramankandola]

AGU is going higher today in the morning ! check related news ...

May 5 (Bloomberg) -- Incitec Pivot Ltd., Australia's largest fertilizer maker, raised its full-year earnings forecast after first-half profit almost tripled because of higher prices for crop nutrients driven by surging global food demand.

Net income rose to a record A$169.8 million ($159 million), or A$3.367 a share, in the six months ended March 31, from A$57.2 million, or A$1.133, a year earlier, the Melbourne-based company said today in a statement.

Rising food prices are ``threatening to plunge more than 100 million people on every continent into hunger,'' the United Nations said last month. Incitec today raised it full-year earnings forecast 16 percent on expectations of higher average fertilizer prices driven by food demand in China and India.

``Worldwide there is a drastic food shortage looming,'' said Peter Russell, head of research at brokerage Intersuisse Ltd. who has an ``accumulate'' rating on the stock. ``I don't see any reason to see the share price or the prospects for profitability to come back.''

Incitec fell 50 cents, or 0.3 percent, to A$171 on the Australian stock exchange at the 4:10 p.m. close of trade in Sydney. The stock has surged more than threefold in the past year, compared with a 9.1 percent decline in the benchmark S&P/ASX 200 Index.

The first-half profit compares with the A$175 million median estimate of four analysts surveyed by Bloomberg News by phone and e-mail.

Record Prices

Potash Corp. of Saskatchewan Inc., the world's largest crop- nutrient maker by market value, said last month first-quarter profit almost tripled and Agrium Inc. last week reported profit of $195 million, from a loss a year earlier, as record crop prices increased demand for agricultural nutrients.

``The increase in fertilizer prices is clearly as a result in global forces, specifically the significant increase in the demand for food,'' Chief Executive Officer Julian Segal said today on a call with reporters. ``The industry consensus is that over the next few years prices will stay high at current kind of levels, and then probably taper off a little bit.''

Prices for diammonium phosphate, known as DAP and produced by Incitec, more than doubled in the first-half, the company said. DAP for immediate delivery increased to $1,195 a ton as at March 31, up from $433 a ton as at Sept.30, 2007, it said.

Food Crisis

``With the big economies of India and China developing at this rate and the standard of living improving in these economies, clearly there has been a tremendous increase in demand for food,'' Segal said in an interview with Bloomberg Television.

The global food crisis is an ``unprecedented challenge,'' UN Secretary-General Ban Ki-Moon said last month. Ban will chair a new UN taskforce to counter the effects of soaring food prices that are putting basics beyond the reach of the world's poorest people. The World Bank has warned the crisis may trigger civil disturbances in 33 countries.

``Fertilizer is an answer to that problem,'' Segal said. ``The only way to cope with the increased demand for food is to produce more food with the same arable land and the only way you can do it is using more nutrients.''

Full-year earnings before interest and tax may be A$850 million, Incitec Chief Financial Officer James Fazzino said today in a separate statement. That compares with the A$700 million to A$730 million forecast made on March 6.

``Fertilizers are obviously the central component of growing food,'' Tom Elliott, of hedge fund MM&E Capital Ltd. said in an interview with Bloomberg Television in Melbourne. ``We'll see probably another, better profit from Incitec this time next year.''

The company will pay a first-half dividend of A$2.04, compared with 69 cents a year earlier, Incitec said.

[hook]

all the good news in these stocks is pretty obvious

[sliman]

OK then go buy some financials LOL LOL

[Amidwesternneighbor]

jeff a - was that a deliberate misspelling (Krudlow vs. Kudlow)? C'mon now...Larry has some valuable insight and I don't blame a guy for wondering how much lower the dollar can sink. We are at historic levels and it's pretty clear the Fed will not lower much more, if any.

[solar jim]

I'll go with/agree with the Krudlow spelling. He's ridiculous. He's a pull string doll that every time you yank it, "goldilocks economy" comes out. Really? C'mon Larry! For a guy with a PhD in Economics, he's got his head seriously far up his ass. I mean, the guy still believes in trickle down supply side economics. GW the first (daddy - the smart one) had it right with the "voodoo economics" line.

I'd really like to see where his own money (Krudlow) is invested to see if it's anywhere near where his brilliant advice says you should invest your money at.

[GOLD]

A second wise man is found posting on Seeking Alpha!

The first being Eli Hoffmann. Thank you for the daily updates. I also use 24/7 wall which provides fairly current market info.

Nice article. It's nice to see someone that doesn't lump all commodities together and can see the play that is still left in fertilizer. Just like every stock that drops by 1/2 is not necessary cheap. Every stock that has a monumental rise is not necessary expensive. As with every ass class (expect maybe fine art and luxury homes) Income = value. JP Morgan who is no newcomer to this game and maybe could be considered by some to be the king of the hill in the investment banking game is calling POT 2009 eps at $18. Yes 2009 is far off, but, what if they are right. Where does that put POT. Could someone comment on the 3 for 1 split that POT has listed on there website. That would make a catchy HEADLINE and would likely create many links for SA.