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Any Fertilizer Left To Fuel This Story?

Posted on: July 21, 2008 - Email Article - Printable Version

Darrell Reid

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Potash Corp. [POT: 82.62, +5.27 (+6.81%)], one of the most widely covered stocks of the past two years, has had a terrifying run up… rising 150% in the past twelve months. Many regard most of the “big names” like Potash, Mosaic [MOS: 37.67, +0.81 (+2.20%)] and Agrium [AGU: 37.40, +0.99 (+2.72%)] to be players in an overbought agricultural commodity bubble… but I don’t think so.

Agricultural chemicals, like any other commodity, are a long-term story with market fundamentals that are fully supported by emerging economies. Due to rattled investors unloading their shares fearful of a market top, it is a tremendous opportunity to add one of the most fundamentally sound stories out there today to your portfolio.

To quickly recap the Ag Commodity story, emerging nations’ incomes are rising as their GDP accelerates and their citizens’ appetites keep pace. Diets are the first things changed among previously poor citizens with higher incomes- who can blame them? A fundamental shift is being made away from starches to protein. In order to harvest the quantities of meat needed to support demand, more feedstock is required. More grains are planted to generate the increased amount of feedstock needed and more fertilizer is required to grow the grain.

This is where agriculture chemical companies fit in.

Their products are needed to generate the crops to feed nations with changing diets and tastes. Similar market conditions can be observed in India and Brazil. On the supply side, these fertilizers are needed to increase the yield on limited acres. For instance China has 20% of the world’s population within its borders, but only 7% of the world’s arable land. One quarter of China’s land is sand. Fertilizer is needed to crop yield in what little land they have. World grain stocks are at an all time low currently holding only 14% of what is in use. To add to the supply end of the story- the U.S floods of the Midwest have caused considerable damage to this year’s crop. The USDA has predicted the corn supply will drop 10% this year. Currently only 75% of the corn crop has emerged for this year compared to 92% last year.

These tight conditions make for a fantastic pricing environment for agricultural chemical companies as grain commodities skyrocket in price and Potash Corp. is set to be one of the key beneficiaries as farmers, retailers, and distributors feverishly plant crops in this profitable environment. For instance, did you know palm oil farmers receive $9 for every dollar spent planting? The price increases in fertilizers are negligible when talking about those returns.

A world leader in all facets of fertilizer production, Potash Corp. is in the best position to benefit from growing demand among emerging nations. Potash Corp. is the leading producer of potash by volume, the second largest producer of nitrogen products, and the third largest producer of phosphate products. Currently holding 75% of the world’s excess potash production capacity, no other company is able to increase their production capacity as quickly or as effectively. New long-term projects or “Greenfield” projects would currently cost over $2.5 billion to generate 2 million tons of capacity- a significant barrier to entry. Potash is already in the process of increasing their capacity by 2.7 million tons for $1.6 billion by 2012.

Potash Corp. is ahead of the curve in regards to capital expenditures and will be the first in line to service rising demand. Potash Corp. has already begun to take advantage of high demand while putting their excess potash capacity to use at higher rates. Canpotex, the international Saskatchewan sales entity just recently confirmed sale of potash over $1,000 per ton to spot markets in Asia for the fourth quarter- nearly twice the price in 2007. Elevated prices will apply to new sales of customers in Brazil and Latin America. Similar prices are expected for China and India when their contracts are renegotiated at the end of the year as well.

Now many agree that the agricultural chemical story is good, however many investors fear all the above has been priced in and there is no new market event to trigger any more share appreciation. The broader market tumbled 8.5% in June and has continued its trend in July. In the mean time, Potash Corp.’s share price has fallen 12.69% from it’s 52-week high in mid June.

Potash Corp. is a good buy from $205 to $225 per share with a 6-month target of $250 per share. UBS recently revised their price target to $320 after raising it to $285 just four weeks earlier. With institutional support from UBS, RBC Capital Markets, Credit Suisse, Goldman Sachs, and many more, along with an earnings call later this month, Potash Corp. will not remain in this range for much longer.

-Darrell Reid

Disclaimer: The author owns a long position in POT as a manager of the Nittany Lion Fund, LLC.

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