3 Stocks to Benefit From Rising Food Demand

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

As the demand for crops and meat increases worldwide, especially in BRIC countries, grain prices should remain strong, leading to a greater use of fertilizers and chemicals in order to increase yields, revenues, and margins. In this context, crop nutrient suppliers seem poised to benefit.

In this segment, as in many others, big, international companies offer the best prospects for the long-term. Consequently, I will look at three huge firms within the industry, PotashCorp (NYSE: POT), Mosaic (NYSE: MOS), and Agrium (NYSE: AGU), that enjoy scale benefits and, therefore, appear to be in an advantageous position to outperform its peers.

PotashCorp: Wide range of crop nutrients 

PotashCorp is the world's largest potash provider, second-largest nitrogen producer, and third-largest phosphate company. Offering a wide array of crop nutrients, it largely benefits from scale and diversification advantages. Moreover, by owning several potash mines in Canada, including rights to the world’s largest potash reserve, the company has considerably cut input costs. Going forward, PotashCorp is not only going to benefit from expansion projects in its potash production segment, but also from rising demand for nitrogen, a more resilient and profitable nutrient than potash and phosphate.

“Given the oligopolistic nature of the industry, (…) [analysts expect that] potash prices will stay above marginal costs of production, but think [that] potash supply growth outstripping demand growth will put some pressure on long-term prices relative to current levels.” (Morningstar)

Despite these concerns, its nitrogen segment, which accounted for that 30% of its revenue in Q1, provides plenty of growth opportunities. Furthermore, after India and China returned to buying potash after weak demand in 2012, the gap between a fast growing offer and a slower-growing demand will narrow considerably; analysts expects demand to rise in low teens during 2013.

PotashCorp’s substantially low input costs protect its margins and provide a good moat to the company. Even if demand of potash were to drop, this stock is still a buy for long-term investors, especially trading at 17.1 times its earnings, slightly below the industry average while holding lower business risks than many of its peers. As mentioned above, its cost advantages have provided the firm with a 38.1% operating margin and a 25.9% net margin, versus the 27.1% and 18.3% respective industry averages.

Further reasons to feel bullish about PotashCorp can be found in its strong international presence -- international markets account for over 70% of its revenue -- a strong balance sheet, robust cash flow generation capabilities, and a history of rising dividends, currently at a 2% yield.

Mosaic: The main phosphate producer

Mosaic is another phosphate, potash, and nitrogen crop nutrients company. Although its market capitalization of $26.3 billion is 28% smaller than PotashCorp’s, its valuation in relation to its earnings is also 20% lower. Offering compelling growth prospects while trading at 13.6 times earnings, I’d recommend buying this stock as well. As the largest producer of phosphate in the world, its fixed costs can be distributed among a large customer base, providing the firm with fair margins.

However, its main advantage might stem from its vertical integration, especially within its phosphate assets. This provides an edge over smaller, non-integrated producers that are more susceptible to high rock prices (Morningstar). Nevertheless, just like PotashCorp, Mosaic is not immune to other input cost variations, particularly in the prices of products used to process phosphate fertilizers.

Its strong international presence and growing demand of phosphate and potash nutrients in fast-developing markets such as Brazil, India, and China, where Mosaic holds a robust position, will drive growth going forward. In addition, the Ma´aden joint venture provides growth opportunities in other important Asian countries. Furthermore, the company has recently declared that it intends to increase its financial leverage and put a stop to its expansion plans for now in order to achieve a more efficient balance sheet and resilient long-term profitability, while returning value to shareholders through stock repurchases.

Although some concerns arise around this decision, overall, the outlook seems promising. After reporting a strong Q3 that beat analysts' estimates and a sturdy guidance, this stock seems to offer an attractive entry point for investors.

Agrium: Operates in North America, Argentina, and Australia

Agrium is the third and the smallest firm in terms of market capitalization that I will take a look at. Producing mainly nitrogen, phosphate, potash, and sulfur fertilizers and operating in three very big agricultural markets, North America, Argentina, and Australia, it's in a position to benefit from expanding demand.

Valued the cheapest among the three companies reviewed here, at 9.5 times its earnings, 2 times its book value, and 0.9 times its sales, this stock is still not a buy for the long-term, although it might deliver some upside for those short on the company.Analysts expect Agrium to widely underperform the market and its industry, particularly in terms of EPS growth. The main reasons behind this pessimism are its volatility in pricing and demand for crop nutrients and its susceptibility to natural gas price variations.

Nevertheless, there are several reasons to keep an eye on this firm as certain events might unfold and portray a more encouraging outlook. One of the main factors that could boost growth is the demand for crop nutrients, which has been sluggish lately, but promises to recover as arable lands need to be increasingly efficient to supply the world’s fast-growing demand (particularly within BRIC countries).

Moreover, being the largest agricultural retail operator in the United States, with more than 750 farm stores across the country, its recent acquisition of the Landmark operations of AWB in Australia added roughly 400 farm stores to its portfolio. The company should benefit largely from this purchase as the country is one of the main food exporters for the rapidly growing Chinese market. Moreover, “the retail agriculture market is very fragmented, leaving Agrium room to steadily snap up smaller competitors and increase its share lead and bargaining power with suppliers.” (Morningstar)

Bottom line

Although Mosaic and PotashCorp compete in some areas, both seem poised to grow independently. In terms of valuation, they both look pretty attractive and offer, in my opinion, very good entry points for investors. I'd recommend not missing out on them, as upside potential is much and risks are not that high. Agrium, on the other hand, although alluring for its valuation, still offers an unclear future. I'd advocate on holding for now, but not losing track of the company as it might become an attractive investment.

With less and less arable land available around the world, increasing yields from existing plots could become vitally important to keeping up with expected population growth. Cheap and effective fertilizers could be the key to achieving this goal. As the global leader in potash production, PotashCorp has established several barriers to entry that make it nearly impossible for competition to break through. Click here now to access The Motley Fool's premium research report that covers precisely what these barriers to entry are and details several other key reasons why PotashCorp presents such a compelling investment opportunity today.

Damian Illia has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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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