The Market Hates Mosaic: Phosphates Not Up to Snuff

Well, the market is not at all happy with Mosaic's (MOS) results. When you take a step back and look at the big picture everything still looks fine, but the stock market is not about the big picture - only "beating estimates" and/or "raising guidance"; if you don't, you are toast. Mosaic is now toast based on how people will treat it.

The stock is now lower than it was a year ago, despite these metrics:

• Phosphate prices this reporting quarter: $1013
• Phosphate prices 1 year ago: $407

149% price increase.

• Potash prices this reporting quarter [FOB]: $488
• Potash prices 1 year ago: $164

194% price increase.

But again, it doesn't matter right now because expectations on earnings per share were not met; also some language on their phosphate business will spook people who expect continues 150% growth rates, I guess. I assumed that at a PE of 5-6, expectations of some slowdown were baked into the stock price, but I guess that was an optimistic take.

I do want to highlight the price trends and management commentary in both nutrients that Mosaic is focused on:

1. Phosphates 1 year ago: $407
2. Phosphates previous quarter: $754
3. Phosphates this quarter: $1013 (This strong upward price momentum leveled off toward the end of the quarter, causing the average realized price to fall slightly below Mosaic's guidance range)
4. Phosphates price guidance for next quarter: "Mosaic's average DAP selling price, FOB plant, for the second quarter of fiscal 2009 is estimated to be between $1,020 and $1,080 per tonne.

So after increasing 150% year over year, phospates pricing is leveling off but still projected to be at a slight increase over the current quarter next time around. Was the expectation that phosphates was going to $2000 next year? I thought the stock's 50%+ drop in 3 months was compensating for this, but I am wrong on that take based on the negative reaction to the report.

If prices stay in a 20% band +/- in the next few years the level of cash flow created will be immense. And this is no longer priced as a "growth stock" - so again, 5 or so PE ratio should compensate - but I guess expectations were STILL too high even after the enormous drop in stock price.

The one thing that is definitely not a good thing in the short run is the following comment:

Mosaic intends to reduce planned phosphate concentrates production by 500,000 to one million tonnes over the next several months, in response to high inventory levels.

People will panic on that, but further in the earnings report:

Inventories for phosphate producers increased from the low levels of a year ago; however, phosphate fundamentals remain positive and demand is expected to rebound once inventory levels are normalized. Momentum has slowed in the Phosphates business near-term due to the combined effects of soft seasonal demand, higher customer inventory levels and falling raw material costs. We remain optimistic about the second half outlook for phosphates and will be well positioned to capitalize on that outlook."

On to the potash side of the business:

1. Potash 1 year ago: $164
2. Potash previous quarter: $335
3. Potash this quarter: $488
4. Potash price guidance for next quarter: "Mosaic's second quarter fiscal 2009 average MOP selling price, FOB plant, is estimated to be $560 to $620 per tonne."

So potash continues to increase in price and in fact, unlike some end of quarter weakness in phosphates, it appears the current quarter it showing even higher prices than the previous. This should be no surprise considering the spot price for potash is double what Mosaic was contracted at this current quarter. Again, we show no weakness in potash and inventories are at record lows. The problem for Mosaic is phosphates is 2.5x as big a business as potash. But again, the phosphates business is growing incredibly year over year and even a 'flattening' of pricing would derive a huge cash cow.

Natural gas has dropped 40+% since last quarter, crude oil has dropped 30% since last quarter, while phosphates has increased nearly 35% (but flattened towards the tail end of the quarter), yet the stocks in all these sub-sectors of commodities have all been treated the same. It is what it is but again, the stock price is now lower than the 1 year ago when the prices for the products and the earnings were substantially lower. But that does not matter in a "shoot first, ask questions never environment."

Mosiac earnings were $2.65 this quarter, and $0.69 a year ago, to put it in perspective. This report actually reminds me of Apple (AAPL) in January 2008 when a disappointing earnings dropped the stock enormously but I believe it was at a near 30 forward PE ratio at the time. Mosaic now approaching 4.

Not that fundamentals matter but some other metrics:

• Net sales in the first quarter of fiscal 2009 were $4.3 billion, an increase of $2.3 billion, or more than double the amount in the same period a year ago.
• Operating earnings were $1.5 billion, or 36.0% of net sales, up from $449.6 million, or 22.4% of net sales last year.
• Net unrealized mark-to-market derivative losses impacted gross margin by $114.8 million, or $0.18 per share, compared to net unrealized derivative losses of $30.1 million, or $0.05 per share, a year ago.
• Cash flow from operating activities was $561.5 million for the first quarter of fiscal 2009 compared to $438.4 million last year.
• Mosaic's gross margin for the first quarter fiscal 2009 was $1.6 billion, or 38.1% of net sales, compared with $521.8 million, or 26.0% of net sales, a year ago
• Mosaic also recognized a foreign currency transaction gain of $86.7 million. These positive factors were partially offset by higher raw material costs in the Phosphates segment, increases in Canadian resource taxes and royalties in the Potash segment, and aggregate net unrealized mark-to-market derivative losses of $114.8 million primarily in the Potash and Phosphate segments.

Phosphates detail:

• These price increases more than offset a 7% decrease in sales volumes to 2.1 million tonnes, higher sulfur and ammonia costs, and net unrealized mark-to- market derivative losses of $74.6 million. The decline in sales volumes was primarily due to North American customer carry-over inventories from this Spring.

Potash details:

• The increase in operating earnings was primarily a result of higher selling prices. This increase was partially offset by significantly higher Canadian resource taxes and royalties, net unrealized mark-to-market derivative losses of $41.8 million, and the impact of a 9% decrease in sales volumes.
• The Potash segment's total sales volume was 1.9 million tonnes for the first quarter which was lower compared with year-ago first quarter volume of 2.1 million tonnes. The decline in sales volumes was primarily due to lower beginning inventory levels available to meet customer demand, despite comparable production volumes.

Since "cash is king" of late:

• Mosaic ended the first quarter with $2.2 billion in cash and cash equivalents. Cash flow from operating activities in the first quarter of fiscal 2009 was $561.5 million, up from $438.4 million a year ago. Mosaic's total debt as of August 31, 2008 was $1.5 billion compared to $2.2 billion as of August 31, 2007.

Outlook:

• Inventories for North American potash producers declined to record low levels in August 2008 and strong global demand continues for potash. Inventories for phosphate producers increased from the low levels of a year ago; however, phosphate fundamentals remain positive and demand is expected to rebound once inventory levels are normalized.
• Phosphate sales volume guidance for fiscal 2009 has been reduced to a range of 8.0 to 9.0 million tonnes, with the majority of the reduction expected in the second fiscal quarter.
• Potash sales volume guidance for fiscal 2009 is unchanged at 8.2 to 8.6 million tonnes.

So it is what it is - the bears will have multiple arguments now. They can say that the phosphates business is now dead and going back to 2004 levels. They can say the company says this is a 1 time hiccup (phosphate inventories) and only second quarter volume will be impaired, but the company has no clue and this is a clear sign of demand destruction (but why only in phosphates and not potash?) and the game is over. Even though phosphate pricing is still up 35% since the previous quarter. They can say earnings guidance for 2009 is garbage and needs to be cut significantly. Maybe it is all true. Somehow I doubt that, but really, in this type of market, you cannot even make a tiny misstep and this will be considered a large misstep so we're going to be taking bitter medicine.

For May 2009, Mosaic had an estimate of $13.99 going into today; this quarter estimate was $2.94. They missed this quarter by about 30 cents, and we'll assume a similar miss next quarter on $3.40 as potash strength offsets (ahem) "weakness" on phosphates. And the same for the following 2 quarters so - $1.20 of a miss for the year. This brings Mosaic down to $12.80 EPS for their "year end" of May 2009. In after hours the stock is being demolished, down below $55 ... this will give the stock a Price/ Earnings of 4.3 on my lowered estimate of May 2009 earnings.

Now I will be open to any argument for the following year (2010): spot potash is currently at $1000+, so even at the guidance of $560 to $620 for the coming quarter, Mosaic should easily be able to get to $700-$800 in potash prices in their "2010" (June 2009 to May 2010) year. Phosphates is an open question since it fluctuates far more - could be the same as this quarter, could be lower by 20%, could be higher by 20% by the time we get 12 months out. I don't know, no one knows. The bear argument I suppose is it could drop by 50% by then? Again, if the world no longer needs food I'll buy that... otherwise, not so much.

Next year, analysts are in for $16.90 - with potash supply and demand favorable until 2011+, and assuming the rest of the world actually continues its modernization and urbanization in 2010+ (i.e. everyone who moved to a city does not go back to farming), a $13-$15 range for 2009 should still be very doable. If you just repeated this current quarter 4x with no growth, you are looking at $10 as a floor as EPS for "2010".

So:

• Bear case $10
• Mid case $13
• Bull case $15+

Obviously the question is what PE ratio do you apply for a commodity stock whose growth is "slowing". Bears will argue once the growth slows it deserves to have a punishingly low PE ratio. We are currently at 4 for the year ending May 2009 and 4.3 by lowered estimates for May 2009. I guess I cannot rule out a 2 or 3 PE ratio anymore. I was joking about that before, but anything is now possible.

So again, this type of analysis is useless right now. Much as Apple was pole axed as the "end is near" trade happened in that name last winter when the lemmings were not satisfied, so will this one be. I'd have a much more negative view if you told me phosphates were going to drop 30-40% in price and Mosaic was trading at a 25 multiple... but even a 35% drop in phosphates pricing would take pricing ALL the way BACK to.... last quarter's pricing. And the company is forecasting a slight uptick in phosphates pricing next quarter, not any drop at all. Most stocks trading in the $50s, $60s, $70s don't have $12, $13, $14 worth of EPS behind them, but this is not most markets and you cannot disappoint the horde in a market absent of logic.

I was hoping for a buyback announcement but instead Agrium (AGU) announced one - figures.

And with that, we are switching to a portfolio of Wells Fargo (WFC) and homebuilders which can do no wrong. Every commodity or global growth stock now seems headed to single digits. Or so says the market.

Disclosure: Long Mosaic in fund; no personal position

Comments

[CT Programmer:]

If someone wants to sell me stock in a great company, that is already seriously undervalued because of general market conditions, at a 30% discount... well, all I can say is "thank you".

2008 Oct 02 12:33 PM

[huangjin:]

The coal stocks are in a similar situation, with P/Es in the low single digits after massive earnings estimate hikes this year.

MOS earned only $0.97 in 2007. I expect economic activity to decline below the levels seen in 2006 or 2007, so shouldn't I expect MOS earnings to fall back to those levels?

2008 Oct 02 12:41 PM

[monkeyfurball:]

Good read on Mosaic. The market is nutso right now. I'll average down as this stock falls. The world is not going to stop eating food. Look at Monsanto today. They raised the eps for 2008. Fact is, farmers need fertilizer for all those extra seeds Monsanto is selling. Once again, the market is nuts.

2008 Oct 02 12:49 PM

[G23ROCKS:]

I bought today, Mark. This market is nuts.

2008 Oct 02 01:01 PM

[User 226404:]

What about demand? What happens when demand dwindles as slow down (if not R) globally persists for an extended period of time? What will happen to fertilizer pricing?

2008 Oct 02 02:29 PM

[JasonC:]

Look at a 5 year chart. This is another bubble bet on hyperinflation that is busting out, comprehensively, as it becomes clear the endgame is deflation not inflation, and the economy is going into recession. None of these huge speculative commodity price increases is going to stick. Not one. Prices for everything are going to fall to 2004 levels or below, just like real estate prices will. The end of the world crowd bet on hyperinflation but somebody forgot to tell the Fed, and it isn't there.

2008 Oct 02 02:32 PM

[David White:]

I think this period was a necessary adjustment downward. Expectations were too high. Then it appears that the brokerages houses are to some degree manipulating the market so that the move downward it bigger than one would expect. The market conditions play into their hands also. I am sure they will make money on the big moves as they seem to be orchestrating them. As a trader/investor I just need to sync into what they are going to do a little bit better.

Longer term, I think we are in a bull Ag market. The worl population is growing at the same time the farmable acreage worldwide is shrinking. This means farmers will continually have to produce larger crops from smaller acreages. Fertilizer is a main element in allowing them to do this. The long term trend for fertilizer is still going to be up. The bottom is unikely to fall out. Pessimism reigns today. Tomorrow may be a completely different story. Potash demand looks strong. Potash inventories are extremely low. Potash margins are over 50%. Phosphate may be hurting a little, but MOS and POT are still going to do great. People are not going to stop eating. In that sense the Ag stocks are effectively staple stocks. We just have to wait for the rebound. This seems likely to be very close to the bottom.

2008 Oct 02 04:07 PM

[haydete:]

Given the info regarding potash, does this bode well for POT?

2008 Oct 02 08:50 PM

[John-Galt:]

POT seemed a better bet, but at these prices I may add some MOS now that the pain is in for POT as well.

It's not just the world eating more, but eating better. Regardless of what happens with Chinese and Indian and Russian economic growth (which will affect steel, coal, and copper), it is notable that once a population shifts to higher protein diet it does not change back peacefully. Chinese leaders especially know this, and will let almost anything drop except food production and availability. They are also locked into potash contracts for at least a year, which is part of why potash has firmer pricing duirng this silly period.

2008 Oct 02 10:17 PM

[Earnest:]

I shared your frustration. It's hard to stomach that fundmental doesn't count anymore. It's more like an cat-mice game by the analysts. I wonder why Merrill downgraded the sector but did not lower the "price target"? Even S&P has $165 for CF, which was down a good 35% with MOS.

In looking at MOS's earning estimates in the past few quarters, only 4 analysts gave estimate and with a difference of 0.20. How's that an earning estimate statistical signaficance? Ironically, one of the 4 actually raised estimate last month! So, are our analysts only look at rear mirror?

2008 Oct 02 11:06 PM

[Alexander77:]

I think MOS is still strong company, investors are just dumping everything


On Oct 02 11:06 PM Earnest wrote:

> I shared your frustration. It's hard to stomach that fundmental doesn't
> count anymore. It's more like an cat-mice game by the analysts. I
> wonder why Merrill downgraded the sector but did not lower the "price
> target"? Even S&P has $165 for CF, which was down a good 35% with
> MOS.
>
> In looking at MOS's earning estimates in the past few quarters, only
> 4 analysts gave estimate and with a difference of 0.20. How's that
> an earning estimate statistical signaficance? Ironically, one of
> the 4 actually raised estimate last month! So, are our analysts only
> look at rear mirror?

2008 Oct 03 01:35 AM

[peachberry_tea:]

I understand your frustration... our only consolation is to buy more MOS/AGU/POT etc. and let the market figure this all out. Short term the market can price this crap to hell for all I care.

My only concern is that "the market is crazy" is too easy an answer. While I see and agree with the arguments you're making (they're sound) I'd still like to ask questions - it's simply prudent investing.

With decreased crop prices do farmers still have high enough margins to user fertilizer at the current quantity/prices? How much of that $.30 cent miss was already offset by decreased natural gas prices?

2008 Oct 03 06:43 PM

[dwab:]

I do not think that I have ever seen a price drop like that in a company stock price that reported revenues in the billions, coupled with a sound balance sheet. Even the most drastic of downgrades still sees MOS trading above $100 within six months. The p/e of this company is tremendously skewed, due to the psychological state of the investing population. In other words, fund managers and individual investors alike, do not want to get burned by yet another bubble bursting, in yet another sector. With the poor economic news and the financial 'episodes' that unfold on a daily basis, the aforementioned assertion is understandable. Many believe that ag is next on the chopping block. On a positive note, at least MOS got its thrashing from the street, and can now concentrate on making money, without the pressure to beat estimates. The fear of a slowing economy was priced into MOS within one after hours trading session. In this type of economy, I would rather just take the medicine all at once, instead of massive fluctuation, or a slow and painful drain of my assets. One year from today-- many investors will look back and decide that the downward price movement of a day ago was unwarranted in the extreme.

2008 Oct 03 08:17 PM

[Dan Lewis J...:]

@JasonC

The fundamentals of commodities are still there and the supply conditions will be even worse now that new investment has all but disappeared.

Tell me the next time someone finds a new, large oil reserve that will cost sub $50 a barrel to extract.

2008 Nov 25 03:23 PM