Do The Fertilizer Stocks Really Stink As Bad As The Market Thinks?

Includes: CF, MOS, NTR, SOIL, TNH
by: Henry Stokman

Mosaic Co. (NYSE:MOS) is one of the world's largest fertilizer suppliers with operations all over the world. The company is primarily engaged in the production of phosphates and potash nutrients for agricultural crops. Due to weak global demand this year the fertilizer market this year has not produced the best returns for fertilizer stocks. Last month, Mosaic reported its Q4 earnings. The company reported revenues of $2.69 billion with an EPS of $1.14 per share. These numbers unfortunately were below last year's numbers of $2.82 billion with an EPS of $1.19 per share. The biggest disappointments came from the comments regarding the continued lower global potash demand this year that has resulted in lower market pricing compared to last year's levels. These lower potash prices have affected margins for the company resulting in 1.1% decrease in gross margins. This decrease also negatively affected the firm's overall operating income, which came in at $621 million this quarter down from $671 million the year prior.

Even amongst these head winds Mosaic continued to seem optimistic on the future of potash market pricing and the overall market presence of Mosaic. That bullishness on those prices is so strong that Mosaic announced that it planned to continue to direct operating capital toward the expansion of its potash processing capacity. During the call the company reaffirmed that its project was on time and budget.

This move to expand potash capacity has also been seen in Mosaic competitor Agrium (AGU). Agrium currently is in the middle of a $1.5 billion investment in an extra 1 million tons of capacity scheduled to be completed in 2014.

Unfortunately, this Tuesday Uralkali announced that it planned to break its partnership with Belaruskali and planned to increase its production by roughly 4 million tons annually. This news is particularly not good for the world's potash cartels and fertilizer stocks. Prior to Tuesday's news Uralkali, Belaruskali, Mosaic, Potash Corp. (POT), and Agrium controlled roughly 70% of the potash market. This breakup is estimated to cause potash market prices to decrease by 25% worldwide pushing potash prices down into the $300 per ton level. This news caused significant sell-offs in the prices of stocks across the entire fertilizer space at market open. Mosaic's stock price decreased 24.5%, Potash Corp. decreased almost 23%, Agrium lost 8%, Terra Nitrogen Company (NYSE:TNH) lost 4%, and CF Industries (NYSE:CF) shed almost 3%. Obviously, the firms with the greatest exposure to potash lost the most, but the news shook the entire sector.

Prior to the news potash prices were averaging around $420 per ton. As nice as that price may sound to most now it was still considerably below the $500 per ton average that the market saw for most of 2012 and the $600 per ton highs that was seen in 2011.

Potash Outlook for the Remainder of 2013

As much as the Uralkali news has negatively impacted the prices of most fertilizer stocks it is important to understand how the supply and demand factors affect the price of potash. Potash is a fertilizer product that farmers do not need to apply every year like they do for most nitrogenous fertilizers. Due to the variability in demand the prices of the fertilizer commodity can swing quite a bit. Potash demand is also indirectly tied to the price of corn and soybeans. Depending on high or low the prices of those agricultural products directly determines the margin and profit that farmers are able to make. This profit margin allows farmers to have more free cash to spend on higher end fertilizer like potash.

Other factors that also affect the demand story are the fact that China for the last several years has been heavily subsidizing potash costs for their farmers. The country has been doing this so much in the past several years that they have indirectly caused over production and a flooding of the market. This too has not helped the market price of potash.

Last year during the height of the U.S. drought that propped up the prices of agricultural commodities demand for potash from farmers who had excess capital increased as well as pushing prices of potash north of $500 per ton. Being that so many farmers came into the market and bought potash last year, it makes sense that prices this year would begin to retreat since all the farmers that purchased potash last year do not need to buy again this year. This decrease in demand has ultimately decreased the overall market price of potash.

As prices continue to come down that decrease might just be the needed catalyst to push emerging markets like China and India as well as farmers to re-enter the market and buy potash while prices are approaching a multi-year low. This influx of demand might just be the thing that is needed to push prices of potash back up. It is also important to note that fertilizer companies like Potash, Mosaic, and Agrium also have pricing power still and are able to decrease their own production causing a supply glut.

What Happens to the Fertilizer Stocks from here?

At this point in the game it is very hard to know how the new influx of supply is going to affect potash prices or the stocks of fertilizer companies. One thing that we do know for sure is that the market has now priced in the worst case scenario, especially for names like Mosaic, Agrium, and Potash Corp. The biggest unknown that remains is how fertilizer companies Mosaic, Agrium, and Potash Corp. will respond to this news. If Mosaic for example continues to forge ahead with its potash expansion plans the current price of the stock might be completely justified and fair. Although, it seems extremely unlikely that given this news that both Agrium and Mosaic would continue to move forward with their production capacity investments. Additionally, due to the contracting margins (Mosaic currently at 28.5% down from 29.6%) that these fertilizer names will continue to face with potash potentially being worth 25% less, I think it makes sense that production will be cut across the board. Once capacity is reined in I think it also makes sense that longer term potash pricing will slowly return to the levels that were seen just a week ago.

Until we find out more I think that on Tuesday the market was able to test and hold some new interim floor prices in Agrium, Mosaic, and Potash Corp. Assuming that all things are equal (I know they never are) the reduction in potash pricing to $300 still leaves room for profits and increased growth. Below I have highlighted a few reasons for why I don't feel that this sector and these stocks specifically are dead money.

· Given the news and the most likely capacity trimming reaction from Potash Corp. Agrium, and Mosaic it is very likely that prices of potash should stay in the $300 per ton range and not continue to fall below the $100 per ton production cost

· New demand caused by the sudden 'sale' price in potash should help provide a strong floor in the price of potash helping to stabilize the prices of fertilizer stocks

· The decrease in potash pricing might prompt market consolidation creating even greater market share and shareholder value for Mosaic, Agrium, and Potash Corp.

· Most importantly the overall global demand for agricultural products is going to do nothing but continue to grow. Those agricultural products all demand premium fertilizers like potash. According to the FAO by 2015 world demand for fertilizer will begin growing by 4% to 5% annually, which should also longer term help prop up the price of potash

Overall, I view Tuesday's price action as a buying opportunity for any of the previously mentioned fertilizer names. Personally, I used the sell-off to add to my existing Mosaic position and I will continue to do so with any additional weakness. I know that sentiment for the sector in the short to medium term is going to be negative, but I feel that long term given the above listed reasons that sentiment will reverse and the current market prices will be viewed as a bargain and great entry price.

Disclosure: I am long MOS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.