Buy Agrium: Fed Shovels Fertilizer Into Your Portfolio
Douglas is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
In recent months there have been two main, yet totally unrelated, drivers of fertilizer prices that make the industry a critical one for inclusion in your portfolio.
The first of these is the obvious impact that this summer’s drought has had on crop yields. Farmers are predicting the worst yield since 1995 and for crop prices to continue to soar. This should result in farmers clamoring for fertilizer to augment next year’s output.
The other major catalyst has been U.S. monetary policy. As the Federal Reserve continues quantitative easing at unprecedented levels, inflation fears will drive commodity prices higher. While this most directly impacts hard commodities like gold and silver, the impact will be felt in grain prices as well. To this end, companies like Agrium (NYSE: AGU) and CF Industry Holdings (NYSE: CF) are ideally positioned to put up big numbers.
Drought Favors Fertilizer
As this summer’s dry conditions continue to hamper yields, farmers and investors are already looking toward next year. Low yields have not only left farmers scrambling to ensure better results next season, they have driven commodity prices higher – particularly for corn and soybeans. As rational capitalists, farmers have a tendency to favor those crops commanding the best prices in the prevailing market. Nitrogen-based fertilizer is a critical component in growing corn, leaving nitrogen-heavy companies in particularly strong positions. Agrium is the third largest global nitrogen producer, and CF, which is also the majority owner of Terra Nitrogen (NYSE: TNH), is particularly strong in nitrogen.
An additional benefit that has been enjoyed by the nitrogen-based companies is the low cost of natural gas. Shale gas has kept prices for natural gas quite low, which has been very favorable for these companies; natural gas is a critical component in the manufacturing of nitrogen fertilizers. This is one of the reasons that both Agrium and CF have outperformed phosphate-based companies including Mosaic (NYSE: MOS) and Potash Corp. of Saskatchewan (NYSE: POT).
A Fed Play
As difficult as it is to resist the urge to make a fertilizer reference about the Fed’s recent policy initiative, quantitative easing is actually favorable for fertilizer companies. While commodities benefit most directly from the increased inflation expectation driven by QE, fertilizers should be seen as a secondary play. The companies that are directly responsible for increasing supply of those hotly demanded commodities should benefit nearly as much as the commodities themselves. Long-term projections estimate that the demand for fertilizer should double by 2016. This means that in addition to high current demand, the long-term prospect for these companies is very favorable as well. Investments that offer immediate upside and long-term stability make the basis of some of the best choices for your core portfolio.
For anyone not sufficiently convinced by the above arguments, the timing for a fertilizer allocation is quite favorable now courtesy of Brazil. This South American agricultural leader is on the cusp of its peak growing season, and many U.S. based fertilizers companies, including Agrium and CF, are expecting significant demand increases. The continuing emergence of Brazil as a top agricultural market, third after the U.S. and Europe, make it a critical market to watch. Thus far, signs point toward important growth this year.
Based on their exposure to nitrogen, solid year-to-date performance and impressive relative metrics, Agrium and CF Industries are the two stocks to own in this sector. Agrium’s ability to participate in every level of the value chain make it a top pick because it will be able to capture any shifts in market structure. CF has the lowest P/E in the industry, at 8.5, and still boasts one of the most robust operating margins at 48%. Each of these stocks has excellent long-term potential without sacrificing near-term outlook. Both stocks should be in your core portfolio.
dsewrites 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.If you have questions about this post or the Fool’s blog network, click here for information.