An Allocation to Fertilizer

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

When building a solid core investment portfolio, it is important to consider a wide variety of factors to ensure that one obtains exposure to an array of critical areas. Over the past five years, few allocations have performed with the consistency or the absolute returns offered by commodities and commodity companies. Within that context, a prudent investor looks for the best-in-class company to provide that exposure, particularly in the absence of the ability to be broadly diversified. Based on factors of population growth, quality fundamentals and long-term investment potential, an allocation to fertilizer is advisable and CF Industries Holdings Inc. (NYSE: CF) is the name in which to invest.

What’s That Smell?

While fertilizer may epitomize the opposite of a sexy investment, the growth expectations in this industry are what returns are made of. The International Fertilizer Industry Association predicts that fertilizer consumption will experience double-digit growth by 2016. Furthermore, population projections place the global population in the realm of nine billion by 2040. With the bulk of high-quality land already in use, this presents the world with a significant problem. The land available must produce more on a per-acre basis if the world is to be able to feed itself, and lower quality land must be made a viable option.

The implication of this reality is that the need for quality fertilizer will not only grow, it will grow at a sustained and highly attractive rate from an investment perspective. While the population figures are projections, the explosive growth in the population is an inevitability. There are very few industries that can all but guarantee a growing demand for its product for several decades.

The Economic Landscape

It seems foolish to investigate the potential of any investment without properly locating it against the backdrop of the overall economy. In this case, this requires a look at how the next round of quantitative easing by “Helicopter Ben” Bernanke and the Federal Reserve may impact commodity prices.

Should the money supply lurch larger once again, it is likely that the price of cash-based commodities will also swell. Commodity critics will point out that with the exception of gold – a universal safe haven against inflation, political unrest and government intervention – there are limited pure play options available. While this is true, it does not mean that those companies with significant commodity exposure like CF Industries and its competitors will not reap some of the rewards. Given the global macroeconomic factors that seem to be driving the Fed’s policies of late, QE3 seems like more a question of “when” rather than “if.”

Best in Class

Amongst its peers, CF Industries is the best option due to both strong fundamental metrics and as a result of structural advantages that are not necessarily as readily apparent. Beginning with the valuation of the peer group, CF Industries has a P/E of 8.3 relative to 10.6 for Agrium Inc. (NYSE: AGU), 15.3 for PotashCorp (NYSE: POT) and 13.5 for The Mosaic Company (NYSE: MOS). As a value play, CF Industries has a solid advantage at current levels.

When one considers the growth numbers for each of these companies, the case becomes even more compelling. CF Industries has a 5-year annual expected growth rate of 14.9% relative to 13.8% for Potash, 7.9% for Agrium and 8% for Mosaic. Combining these metrics and looking at the PEG ratio for each company gives the clearest picture: CF Industries has a PEG of 0.55 relative to 0.93 for Potash, 1.23 for Agrium and 1.31 for Mosaic. On a growth-adjusted basis, CF Industries is the best-in-class play.

In addition to the above, there are a variety of structural advantages that CF Industries has that help to illustrate why it is the best name in its space. The company has built strategic alliances with several partners on a global basis that will help it remain diversified and dominant. Some of these include:

-          An alliance with KEYTRADE AG in Switzerland

-          An alliance with GrowHow UK Ltd. in the U.K

-          A 66% economic interest in Canadian Fertilizers Ltd. in Canada

-          An alliance with Point Lisas Nitrogen Ltd. in Trinidad and Tobago

-          A 75.3% ownership interest in Terra Nitrogen Company L.P. (NYSE: TNH) in the U.S.

By diversifying its interest and remaining globally plugged into the nitrogen trade, the company is extremely well positioned to face any hurdles that may arise as global issues play out.

Overview

With an exploding population and an unquestionable need for growth in the fertilizer industry, maintaining exposure to this area is critical to proper diversification. Based on fundamental metrics, structural planning and solid management, CF Industries is the most attractive name in the space. While a more diversified exposure may be preferable, this is the right choice if one is limited to a single company.


Mr. Ehrman 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.

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