The Drive For Higher Yields
Hussain is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The year 2012 saw high growth in commodity prices, with some commodities surpassing the highs achieved in the 1970's. This price hike was due to a number of factors, including high input cost, rapid demand growth, slow growth in production and the drought in the US and certain areas of Europe. As per OECD-FAO Agricultural Outlook, the growth in agricultural production is expected to slowdown in the upcoming decade. Given the high growth in demand, the prices of almost all the agricultural commodities are expected to remain at high levels. This will attract more investment in the agriculture sector and in technologies and products that will help in enhancing the crop production.
In the light of these expectations, the future outlook of the fertilizer industry looks very promising. Fertilizers can provide a lot of improvements in crop yields, especially in the developing countries. In the fertilizer sector, Potash of Saskatchewan (NYSE: POT), Mosaic (NYSE: MOS) and Agrium (NYSE: AGU) are the three major competitors, offering almost similar products.
The drought of 2012
There was a shortfall in the agricultural output in 2012, mainly due to the drought in the US and some parts of Europe. The shortfall was seen in almost all the major crops, including corn and rice. This shortfall negatively affected the results of fertilizer companies, especially those operating in the US and CIS markets.
Potash is the leading producer of fertilizer, in terms of capacity, with specific expertise in the production of potash. The company primarily operates in North America and thus, experienced a decline in revenues by more than 9% in 2012, as compared to an average annual growth of more than 48% over the preceding 2 years.
The drop in sales led to a decline in the company’s net margin to 27% in 2012, as compared to 35% in 2011. The decline in the earnings of the company was primarily due to the sharp decline in the sales of potash during the year, which is the company’s higher margin yielding product.
Mosaic is the largest producer of phosphate and fourth largest producer of potash in the world. Phosphate contributes around 65% to the company’s net sales, but has a lower share in the company’s operating earnings. Potash contributed 62% to the company’s operating earnings for fiscal year 2013.
In 2013, the company’s revenue decreased by 10.2%, while its net income only dropped by slightly more than 2%. Sales declined due to the fall in the selling price of both potash and phosphate, while the improvement in net margin can be attributed to greater sales volume of potash.
Although Agrium is also involved in the production and sale of other products through its retail channel, the sale of fertilizers made up to 71% of the company’s total revenue in 2012. Unlike its peers, the company primarily produces and sells nitrogen, followed by potash and phosphate. Nitrogen sales accounted for almost 42% of the company’s wholesale revenues in fiscal year 2012.
Along with other fertilizer producers, Agrium also experienced a decline in the demand for potash and phosphate and an increase in the demand for nitrogen. The higher sale of nitrogen more than offset the decline in sales of potash and phosphate. Revenue increased by around 7.8%, while the company’s margins saw a slight increase of 9 basis points, due to the lower sales of potash and an increase in nitrogen prices.
The global demand is expected to accelerate
As per the USDA’s estimates, the total production in 2013 could increase by as much as 8.3% due to the added pressure to meet the growing demand. Despite the expected rebound in agricultural production, the US spring season saw a delay due to the wet/cool conditions. This resulted in lower corn plantation.
This means that although production in the US market is expected to improve from last year, the actual growth in production will fall short of estimates. This will result in lower than expected fertilizer consumption in the first half of this year. However, the expected growth in plantation and fertilizer consumption is still positive for the second half of the current year. Thus, I still expect all the companies to perform better as compared to the previous year.
In the future, demand for potash is expected to grow at the fastest pace (3.5%), followed by phosphate (2.7%) and nitrogen (1.3%). Due to the higher margins for potash, the companies are shifting their focus towards potash.
Out of the three companies discussed, Potash has the largest percentage of revenue coming from this fertilizer, followed by Mosaic and Agrium. The long term growth in the demand for potash and other fertilizers is expected to come from India and China. In this regard, Agrium falls behind its peers as its major market outside of North America is Europe. As for the remaining two companies, it is Latin America and Asia.
Thus, based on my analysis and the companies’ respective market presence in various continents, I would give a buy recommendation for Potash and Mosaic. Among these two companies, I believe Potash to be a better choice for investment, as its product mix and the end markets targeted provide a higher potential for gains.
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