Mosaic Misses Earnings and Brings Down the Sector

By Julian Murdoch

Last week, Mosaic announced - and missed - its earnings. The miss wasn't by much - $2.65/share versus $2.94/share expected - and the guidance wasn't terrible. But the guidance was realistic, with the company mentioning they'd be scaling back production to better match demand and presumably draw down what have been flush inventories.

So of course the whole sector is worth half what it was a week ago.

What's happened is an old-fashioned price-to-earnings collapse. As the chart below shows, the P/E for Mosaic has fallen from the lofty heights of 40-50 down to the 20s, and now, into the single digits.

Let's stop and think for a minute about what this means. It means that for Mosaic to be fairly priced here, you have to believe the agricultural game has completely changed. That earnings growth (which has been phenomenal) is not only coming to an end, but that earnings may actually be headed for a dramatic decline. In 2006, with quarterly earnings fairly flat, the market felt a fair P/E for the stock was around 20. As earnings rose, so did the P/E, up into the 40s. Last week, the market felt a fair P/E for Mosaic was back in the 20s - a kind of rational retrenchment from the fever pitch of midsummer. This repricing, which we've written about in commodities for a few months now, held basically in line with a declining market while the credit crisis was fever-pitched.

And yet now, despite the passage of the Fed bailout, these fertilizer stocks are somehow worth less than half of last month's value?

Clearly Mosaic CEO Jim Prokopanko must have said something really horrible in the quarterly conference call, right? Let's see what he said (Reuters): 

"To say no, there are going to be no implications [on the farm economy from the credit crunch], that would be careless and whistling past the graveyard. But, we see the farm economy as solid, and our reports are that banks are still lending to farmers." 

Huh. Well, that sounds fairly straightforward. Was that really worth the half-price haircut?

Let's turn our linking eye toward the Midwest, because naturally a paper printed closer to the Corn Belt must have the answers. This from the Minneapolis Star Tribune: 

"Mosaic, the world's largest producer of phosphate and potash, said it will cut phosphate production by 500,000 to 1 million metric tons over the next several months. That's about 10 percent of the company's annual production. Potash Corp. of Saskatchewan, another large fertilizer company, in September idled about 30 percent of its production capacity because of a labor strike." 

Throughout this, there's no evidence of rapidly falling fertilizer prices. Prices remain high, but reserves are still substantial and production's being cut. Sounds a bit like OPEC to me.

In fact, there is definitely some outcry that the Canadian potash companies are something of an unregulated monopoly. Cargill, the privately held agricultural behemoth, still owns a majority stake in Mosaic, and has been under the gun on monopoly charges of its own in the past. 

But even putting aside the issue of whether the fertilizer industry is some sort of cartel conspiracy, how are we supposed to process this decline? On Jim Cramer's sweaty Mad Money show last week, Cramer exhorted his disciples to stay away from Mosaic in the wake of its fall, saying it was a momentum stock that had fallen out of favor. I find myself in the uncomfortable position of agreeing with him - as we said back in March, these companies made us nervous, if only for the volatility. And he did in fact call to short POT on September 13. Yes, the potash stocks were mo-mo classics, and yes, they took a hard mo-mo fall.

But are the end markets for these companies really that bad? To be sure, the corn contract has come down a lot, and U.S. corn is a huge demand driver: 

But we're still well above the pre-boom numbers. I can't see corn heading back to $2.50/bushel anytime soon, and corn in the ground means the need to keep yields up, and that means the need to buy fertilizer. The cuts in production at MOS and POT have much more to do with maintaining the supply balance appropriately. The big producers and agricultural agencies have been explaining the supply glut for ages, but it never really hit prices. In February, the United Nations told us that: 

"While demand for basic food crops, for high value crops such as fruit and vegetables, for animal products and for crops capable of being used to produce bio-fuels is likely to remain strong, it is expected that increased fertilizer consumption required to support higher levels of production will be adequately catered for by growing supply worldwide." 

There's no surprise here, and markets are, eventually, supposed to price public information in.

What about ethanol? Isn't that a big part of the end-demand story? Well, we've had evidence for some time on exactly how much impact ethanol demand has. Just this September, the last crop report suggested that the demand from ethanol plants would remain stable at about 4 billion bushels - or roughly a third of corn production in 2008. Nobody is suggesting that demand will suddenly plummet, although there is a reality here - that an uncertain economy will cause belt tightening, and part of that tightening will include driving less, and thus, less ethanol will be needed. (Also, with oil down, ethanol becomes that much less attractive.)

I can't help but think that these are all marginal changes in the picture - not drastic, inexorable signs of failure and despair. It's hard for me to imagine a world in which the 2009 corn plantings drop 40 percent, or that demand for fertilizer drops 40 percent. I can't help think that Mosaic with a P/E of 6 represents a real buying opportunity. I mean, do you think you can get it for a P/E of 3 next week?

Comments

[Socialism c...:]

"I mean, do you think you can get it for a P/E of 3 next week?"

Heh. Actually...maybe! I mean, there's no longer any rationality in the market. Why not 3?

2008 Oct 07 05:51 PM

[urbanhiker:]

You are trying to use logic in a market that is in a freefall panic mode. I wouldn't be surprised to see MOS P/e substancially lower. I own Dryships which now has a P/e of 1.3

2008 Oct 07 06:57 PM

[rsinvestor:]

According to Bloomberg, MOS forward PE is actually 2.89 after today's dismal decline, so there's your 3 PE target. I also own Dryships in the 20's, currently it's forward is 1.5PE, with a forward PEG of 0.02. That's not a typo. Fundamentals mean nothing right now, but they will someday.

2008 Oct 07 10:50 PM

[Boudi:]

This article use facts to show the pure writer personal views. There is nothing scientific in this report. Inexperienced people can buy but professional will not bother even reading it. I would say it is pure facts manipulation.

2008 Oct 08 01:29 AM

[CT Programmer:]

At any other time, Mosaic would be an incredible buy. I bought them when they dropped 30% in one day. Now they're down another 20. I don't kick myself for buying them. I only kick myself for not getting them cheaper. They will get back up there, but that's another 20% I could have had. That's the problem with this market. Over the last year, any given stock can swing 5+ points and that's a "normal" day. Used to be you were giddy over it bouncing 2% in one day. Fertilizer companies and dry bulk shippers (plus oil, gas, copper, gold, etc.) are getting --- let's just say it --- RAPED lately. Prices are acting like all the business has dried up. Genco (GNK) was way up there at $85 about a year ago. I picked them up (happy at the time) in the $60's thinking it was a great bargain. Now here they are near $20. I never in my wildest dreams would have imagined they'd be that ridiculously low. And that's the problem with this market now. Time after time, value investors get screwed as the prices continue to drop irrationally. But I'll be picking up more GNK and MOS in the near future. They'll piddle around for the next year or two, but long-term they are screaming buys at this price or anywhere within 50-100% of it.

2008 Oct 08 07:38 AM

[einstein p ...:]

Channel the stock from 32 to 35, leaving a bit on the table. Company is cheap and looks like it wants to put in a bottom.

2008 Oct 08 06:37 PM

[einstein p ...:]

No pain, no gain. MOS is cheap by any metric --- depending on your time horizon and pain tolerance.

Bought POT today again at 82 an sold 3/4 of the position at 98.

I own both of these stocks much higher and am underwater. Doesn't mean you can't close the gap and trade around a core position. I agree with Smart Stops --- you have to be cautious. That said, you also have to buy stocks that are channeling, have great fundamentals, and are willing to own for the long term.

The world is not coming to an end --- it's just a lot more cynical and difficult than the past. Maybe that's a good thing.

2008 Oct 08 07:44 PM