Trading Fertilizer After Earnings

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

Over the last few weeks, the world’s largest fertilizer companies have reported earnings with very mixed results. Where CF Industries (NYSE: CF), a nitrogen-based fertilizer company, reported very strong operating results, potash-based operations, like Agrium (NYSE: AGU), posted disappointing figures. Underlying the future prospects for both of these companies are the agricultural condition in play in the U.S. and globally. The combination of drought conditions, low per acre yields and forward-looking projections suggest that the industry is well positioned for the next several years.  Based on very strong fundamentals, these two stocks are strong buys for your core portfolio.

The Agricultural Backdrop

Dry weather during the current growing season has caused yield projections for corn to be slashed to estimates of 146 bushels per acre by the U.S. Department of Agriculture. Low yields have caused inventories to drop, prices to rise and projected planting for next year to swell to 96 million acres. Farmers have enjoyed a profitable year, freeing up the needed cash to invest in sufficient supplies of fertilizer to achieve better yields in both 2013 and 2014.

In general, there is a strong correlation between corn prices and fertilizer demand, just as there is a strong negative correlation between yields and fertilizer demand. When farmers are able to secure handsome profits, but yields are low, it creates a fundamentally strong market for fertilizer. Producing more corn can only be achieved by planting more acres or obtaining higher yields. While some farmers may opt for corn over other crops, the available acreage is limited; this leaves fertilizer as a primary source of more corn.

Supply issues have also had a significant impact on the performance of each of the above companies. Inputs to fertilizers – including nitrogen, natural gas and potash – have each played a role in driving the recent performance of those companies involved in the industry. While many of these factors are expected to persist, it is the global demand picture that serves as the catalyst for buying both stocks.

A Tale of Two Earnings Results

It was the best of times for CF, and it was the worst of times for Agrium. Nitrogen supplies have been tight, improving margins for CF and its subsidiary, Terra Nitrogen (NYSE: TNH). Simultaneously, low natural gas prices have helped the companies reduce productions costs, as gas is a critical element in the production of nitrogen-based fertilizers. The result has been higher margins that led to the solid operating results for CF that were recently released. The company reported earnings of $5.85 per share, beating the consensus estimate of $5.70.

On the other end of the spectrum, Agrium reported a 56% drop in quarterly profits during a quarter than was hurt by a shutdown of its potash mine; the idle time is projected to have cost the company as much as half of its sales. Earnings fell from $1.85 per share a year ago to $0.80 in the most recent quarter. The release drove the stock down nearly 10% on the news. Agrium was the latest potash company to guide lower for the fourth quarter as a both India and China, the world’s largest consumers of the nutrient, failed to sign new contracts. In recent earnings releases Potash Corp. of Saskatchewan (NYSE: POT) and Mosaic (NYSE: MOS) guided lower on the failure to get strong commitments from the two nations.

Despite the apparent weakening demand, all indications suggest that it is very temporary making potash an excellent investment on weakness for 2013 and beyond. Agrium CEO Mike Wilson believes the issue will be resolved by early 2013: "China and India will settle. And as soon as they settle, they're going to try to pull hard (on supplies). You combine that with Brazil, Southeast Asia, and we think it's going to be an excellent year for potash and phosphate and nitrogen in North America - you're going to see a real surge of demand."

The Trades

As farmers begin to prepare for the next growing season, fertilizer demand is expected to be very strong. Nitrogen-based fertilizers remain strong on structural advantages within the market – primarily tight nitrogen supplies and low natural gas prices. These factors create a strong environment for CF, making it a buy at current levels.

On the potash side of the industry, while Agrium’s operating results were not pretty, the company is well position for the next few years. The selloff looks like an overreaction in that context, giving you a nice buying opportunity at current levels. I would buy a portion of your desired position here and look for attractive entry points through 2012 to fill out the position.

Given the fundamental strength of the industry, CF Industries and Agrium are strong buys.

Mr. Ehrman 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.

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