Invest In Our Roots

Adam is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

In today’s post-industrial age of gadgets and gizmos, it’s hard to remember how our ancestors lived. 150 years ago, nearly 80% of the U.S. workforce was employed in the agriculture industry. Today, that number has shrunk to a miniscule 3%. And while the government believes that number will continue shrinking over the next decade, it doesn’t necessarily spell bad news for companies focused on the agriculture industry.

In fact, in 2012, despite a drought that plagued most of the Midwest, farmers saw near-record profits. With higher prices on their harvests and the federal crop insurance program pitching in, farmers are poised to reinvest their profits for another great year in 2013.

So how can an investor take advantage in the growing profits for farmers? Invest in the same companies farmers invest in!

Fertilizer

In order to grow big stalks of corn, and bountiful bushels of soybeans, farmers need a good fertilizer. What many non-farmers don’t know is there’s more than one kind of fertilizer. As a matter of fact, there are two major types of fertilizer – potash, nitrogen.

Potash

In the potash business you have companies like PotashCorp (NYSE: POT) and Mosaic (NYSE: MOS).

PotashCorp has been week this year, down 6% year-to-date, but nonetheless had a good year in my opinion, and 2013 ought to be better. It sells a great deal of fertilizer to farmers in China and India, and as those economies slumped in 2012, so did Potash’s stock price. However, in its most recent quarter, the company reported record sales in North America. As the economies in China and Brazil, which imports more than 90% of its potash, get back on track, potash producers, particularly exporters, will bounce back.

The same problems facing PotashCorp are those that have held back Mosaic in the last year. When choosing which to invest in, Potash has a couple of distinct advantages over Mosaic. First, it garners a higher profit margin than Mosaic – 28.7% compared to 17.4%. Second, it pays a higher dividend of 2.1% compared to Mosaic’s 1.8%. However, Mosaic is expected to grow faster and is trading at a lower P/E ratio to Potash – 13.2 vs 15.3. Mosaic looks like a better growth play, while PotashCorp may provide better value.

Nitrogen

If you had chosen to invest in fertilizer and focused specifically on the companies above for the last year, you wouldn’t have anything to show for it now. That’s not to say those companies are worse investments than others, but it shows the importance of diversification.

The nitrogen-based fertilizer business has been a boon to investors in the last year. Companies like CF Industries (NYSE: CF), its subsidiary Terra Nitrogen, and Rentech Nitrogen Partners (NYSE: RNF) have seen their stock prices go up 53%, 35%, and 112% respectively over the last 52 weeks. These companies benefited from the low price of natural gas in the United States, a key input for the production of nitrogen-based fertilizer. This gives them an advantage over European producers of nitrogen fertilizer, where natural gas prices are high.

Additionally, with the limited supply of nitrogen in the U.S., these companies hold a lot of pricing power. In fact, the gross margins for CF and Terra Nitrogen improved through the second half of 2012, and the margins for all nitrogen fertilizer producers ought to continue to improve through 2013 as demand rises in both the U.S. and abroad.

Out of the bunch, I believe CF industries provides the best investment opportunity at this time. Despite trading near record highs, the company is priced at just 7.9 times forward earnings compared to 12.4 forward P/E ratio for Rentech and a 13x trailing P/E for Terra Nitrogen (no analyst estimates provided). This is also a discount to its historical P/E of about 11, implying the company is still trading at a discount.

Diversified Fertilizer

Agrium (NYSE: AGU)has also been a high-flying stock this past year, up nearly 50% year-to-date. The company makes three major fertilizers – potash, nitrogen, and phosphate – and has an agribusiness side, selling seeds and crop protection directly to farmers. This diversification, allowed the company to climb higher, while others in the agriculture industry moved sideways.

Agrium represents the most complete, and well diversified of the agriculture companies mentioned here. With a forward P/E of 10.1, and a P/S ratio of just 0.9 the company is well priced compared to its historical ratios of 13.7 and 1.0.

An alternative to investing in a diversified company such as Agrium is an investment in a diversified ETF like the Global X Fertilizers/Potash ETF. The ETF holds about two dozen different companies related to the fertilizer industry, and provides investors with plenty of diversification.

2013: The Year of the Farmer

Agriculture analysts expect 2013 to produce record highs in income for farmers. For value investors, agriculture, particularly fertilizers, presents some great investing opportunities. As emerging markets like China, India, and Brazil begin to grow their economies again, there is great opportunity to feed the expanding middle classes in those countries. The high amount of income by U.S. farmers in 2012, likely means we’re in for a big investment in farming supplies in 2013. Invest with the farmers!


adamlevy has no positions in the stocks mentioned above. The Motley Fool owns shares of CF Industries Holdings. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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