Deep-Rooted Value in Fertilizer Stocks
Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The fertilizer business is usually quite volatile, prices and volume tend to fluctuate widely from quarter to quarter, and profit margins are hard to estimate due to the cyclicality of the business. However, many of these companies are trading now at historically low valuations, and they are fundamentally solid businesses with high levels of profitability and promising long term prospects. Over the long term, fertilizer stocks are well positioned for solid returns.
Companies in this sector have experienced some lackluster returns over the last months due to both general macroeconomic factors and industry related circumstances. Reduced appetite for risk is usually a bearish factor for commodity stocks, and the rise in the US dollar due to the Eurozone crisis has delivered a considerable headwind for fertilizer companies. Investors usually associate a stronger dollar with lower commodity prices, and hence lower demand for agriculture related firms.
However, prices of agro related commodities have remained quite strong, and demand from farmers has stayed elevated due to both profitable prices and a prosperous planting season. But fertilizer producers are not benefiting from this trend, because dealers have been reducing inventory levels due to uncertain economic prospects and the end of spring season. Earnings for most fertilizers have been uninspiring lately despite the strong demand from farmers, mostly due to inventory issues at the dealer level.
This kind of volatility is inherent to the industry from a quarter to quarter perspective, but over the long term prospects look quite interesting. Population growth coupled with declining arable land per person is a powerful combination which increases the need for more productivity over the long term. Besides, growing demand from emerging markets represents a sizable opportunity for the sector, both from a demand and production point of view.
Countries like China and India are rapidly changing their eating habits, grain, oilseed and meat consumption are expected to keep rising regardless of cyclical oscillations in economic growth. These countries are also still behind the curve when it comes to crop production efficiency and fertilizer utilization, as the population moves from rural areas to the cities, the need for more land productivity will increase even more.
When looking at valuation ratios for big fertilizer companies like Potash (NYSE: POT), Agrium (NYSE: AGU), Mosaic (NYSE: MOS), CF Industries (NYSE: CF) and Intrepid Potash (NYSE: IPI), they are trading at P/E ratios which are very low from a historical perspective, approaching levels last observed during the 2008/2009 recession.
The inventory situation should be resolved in the middle term, and secular trends are very favorable for these companies. Even if the macroeconomic situation gets worse and commodity prices see a considerable retreat, these companies have strong margins and profitability levels, which means they should be able to withstand any further complications if falling grain prices generate additional headwinds.
Fertilizer companies are trading at very attractive valuations, and they have sustained strong profitability in spite of inventory problems at the dealer level. This looks like a good time to start planting - and fertilizing - the seeds of strong returns in the following years.
acardenal has no positions in the stocks mentioned above. The Motley Fool owns shares of CF Industries Holdings. Motley Fool newsletter services recommend PotashCorp. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.