Agrium: A Bearish Play On Natural Gas?

| About: Nutrien Ltd. (NTR)
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With another record year behind them, Agrium (AGU) is facing 2012 with a very optimistic outlook. Agrium's primary product is nitrogen fertilizer, which is produced primarily from Natural Gas. Fortunately, gas prices are at an all-time low and Agrium is not hedged into forward contracts in a way that would substantially reduce this decline in the price of their primary feedstock.

Agrium had a record year in 2011, earning $9.81 per share up from $4.63 per share in the prior year. This growth was due to an expansion in revenues primarily, but also in gross margins. In 2011, Agrium saw gross margins of 28.0%, up from 24.6% in the prior year. This can be expected to continue to improve, as natural gas prices averaged $3.48/MMBtu for AECO-C (the relevant gas price for Agrium) in 2011 yet AECO-C is trading at only $1.55/MMBtu on April 18th, 2012. This represents over a 50% decline in Agrium's primary input cost compared to their 2011 results.

Fertilizer Demand

The outlook on fertilizer demand is mixed, with a 2011 International Fertilizer Association report estimating overall annual average growth in demand at 2.6% for the next three years. The demand for Nitrogen fertilizer, Agrium's primary wholesale product, is expected to grow at only 1.6% on average for the same period. Global supply is expected to move into a slight surplus position over the coming years. This may have a negative impact on wholesale margins for Agrium; however, this may be offset by the decline in natural gas prices, as well as the strength of their retail portfolio.

Excess capacity is expected to expand in other fertilizers as well, but Potash and Phosphate don't have the same advantage of declining input costs at this time. This strengthens the argument for Agrium at this valuation, especially relative to their peers.

Major Acquisition and Retail Activities

In December 2010, Agrium completed the acquisition of AWB Limited, which included the Landmark line of stores in Australia. Landmark is the leading agricultural retailer in Australia with sales of $2.2 billion in 2011. As Agrium continues to integrate this acquisition into its retail portfolio, we would expect margins to improve.

Agrium's retail activities should not be confused with consumer products. Agrium's primary customers are farmers and large scale users of crop nutrients, crop protection and seeds. Crop nutrients and protection together represent 77% of their retail sales. This represents additional retail margin on fertilizer products that Agrium's pure play wholesalers are not realizing (yet, as discussed later, wholesalers are trading at a higher forward P/E).


Agrium also trades at a relatively cheap price compared to their peers. Agrium is currently trading at 9.15x forward earnings, whereas firms such as Potash (POT) and Mosaic (NYSE:MOS) are trading at much higher valuations, 12.11x and 11.68x forward earnings respectively. These are not completely comparable, as Agrium has a far more substantial retail exposure than either of the other firms. However, the retail side of Agrium's business does provide some protection in periods with weaker wholesale fertilizer demand.


Agrium will report their 2012Q1 earnings on May 9, 2012, and the mean analyst estimate is $1.02 per share. However, there is considerable divergence in estimates for Q1, with $1.27 per share on the high end and $0.79 per share on the low end. For the year, the mean analyst estimate is $9.40 per share with a range of $8.18 to $11.56. Due to the level of natural gas prices during Q1, we believe Agrium will approach the higher end of the analyst estimates.

How to Trade Agrium

Agrium, in the absence of any discussion around natural gas prices, does offer an attractive valuation compared to its peers. This is especially true if you value the retail business as a potential cushion during times of declining wholesale revenues (not that I anticipate that in the next few years). If someone is looking at taking a position to profit from the ongoing stagnation, or even further decline, in natural gas prices, Agrium looks even more attractive. With already stronger than average margins, however, one needs to be cautious at how much Agrium can trim further, beyond input costs, in comparison to their peers.

The company at 9.15x forward earnings and 2.1x book value look attractive today, but the stock has experienced a consider run up over the last three months. A continuation in the decline of natural gas prices may allow this trend to continue, but an ongoing stagnation in prices will move Agrium back to a more normal growth rate. Nonetheless, we believe that Agrium is a good value relative to other agriculture plays today, and also has the additional benefit of being an attractive firm to hold if natural gas continues to stagnate.

Agrium is traded on both the TSX and NYSE.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.