Why This Dip Presents a Great Opportunity

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

Markets don’t take time to punish stocks that stumble on earnings or outlook estimates. Agrium’s (NYSE: AGU) was a perfect case: Its stock tanked 10% right after it released third-quarter numbers as it whiffed on earnings and outlined a fourth-quarter outlook that fell pretty short of analyst estimates. 

What now -- is it time to get out of Agrium as it wades through its fourth quarter, or is the pull back an opportunity to buy? Don’t let one or two weak quarters rule your judgement.  Here’s where I see Agrium headed.

Shared Pain

In its third quarter, Agrium’s earnings slipped to $0.80 per share from $1.85 a year ago. Now that’s a huge fall. When the top line shed (only) 6%, what triggered the fall? One-time expenses ate away around $0.55 from earnings, and low nutrient prices and low production due to plant turnaround blew away the rest. I can’t really blame the company, for the latter at least.  

Solid demand and record appreciation in prices of nutrients that so characterized 2011 turned their course this time around as the worst-ever drought ravaged the U.S. and economic uncertainties hurt demand from important markets like India and China. Inventories remain high for nutrients, compelling companies to hold back production.

PotashCorp (NYSE: POT), Mosaic (NYSE: MOS) and Agrium put their plants to rest at regular intervals over the past twelve months, and the challenge isn’t over yet. PotashCorp will shut down two mines for eight weeks between December and February on weak demand. Its last-quarter potash production was down 18% from the year-ago period. Mosaic slashed its next-quarter potash sales volumes guidance significantly to 1.3 to 1.4 million tonnes from 1.6 to 1.9 million tonnes provided earlier. Its potash plants operated at 65% capacity in this past quarter. Mosaic also cut guidance for phosphates. Turnaround at Agrium’s plant meant 59% lower potash production in its third quarter, and it will run its facility at 10% lower capacity year-on-year in the forthcoming quarter.

Agrium’s fourth-quarter earnings per share guidance range of $1.50 to $1.90 sounds bad, because that accumulates to lower full-year earnings compared to 2011. So is it time to raise a yellow flag? Well, Agrium might have a tough time proving itself in the immediate term, but the long-term outlook remains upbeat.

1 Fight, Many Gains

Hedge fund Jana Partners has pushed Agrium back into the spotlight. As a large shareholder, Jana feels Agrium is not unlocking its true potential through its existing business model. An interesting part of Jana’s discussion includes comparing Agrium with CF Industries (NYSE: CF). CF poses as a direct competitor for Agrium’s wholesale division (which deals in fertilizers). While CF is a hard-core nitrogen player, Agrium derived 40% of its wholesale segment sales from nitrogen last financial year. That touched up to 20% of total sales.

Nitrogen was also the only bright spot for Agrium in the last quarter – sales climbed 35% and gross profits surged 53% to hit a record quarterly high. Not surprisingly, nitrogen-centric CF has had an awesome run so far this year in terms of both earnings and stock price gains. Its revenue and net profits hit record highs for the first nine months of the year, and its stock is up 27% year-to-date. Jana’s contention is that CF has outperformed because it runs a pure-fertilizer business – something it feels Agrium can achieve too if it separates its retail and wholesale businesses.

I’m not going to go any deep into this company-shareholder fight as of now, but what I do understand is this: Having a shareholder who seems hell-bent on getting the company drive its value up only makes Agrium the kind of company (or stock) worth watching. The hotter the confrontations get, the harder will be the company’s efforts to maximize returns from the existing business model to prove Jana wrong, which of course, should be a blessing in disguise for investors. Agrium’s dividend has already increased nine-fold since December last year, it has recently completed a share buyback worth $900 million, and its stock is up a solid 37% year-to-date. See the point I am trying to drive home?

Reaping Hopes

Macro factors seem in favor too. Farm receipts are expected to be high as crop insurance saved farmers’ coffers after the drought, and low yields mean crop prices remain steadfast. Naturally, the air is filled with hopes of solid 2013 spring plantatings in the U.S. Dealing in nitrogen particularly helps as it is the most important nutrient farmers apply. Meanwhile, India and China, who cut back purchases drastically this year, are likely to bounce back in 2013 as their domestic stockpiles decline. These are some great catalysts for the stock. 

Eyeing Greener Pastures

Agrium’s retail division (seed and crop protection products) should fare well too. Both Agrium and seed giant Monsanto (NYSE: MON) are looking at U.S. corn acreage of about 96-million acres in 2013. For soybeans, Monsanto feels it could even surpass this year’s. Favorable industry situations have thus encouraged Monsanto to outline 2013 EPS growth to be between 13% and 17%. Agrium should benefit too.

Its retail business will anyway get bigger once Agrium acquires Viterra’s agri-business from Glencore, giving it huge headway in the Canadian and Australian markets. Agrium is already the largest direct-to-grower retailer in the Americas, and has rightly set its eyes on other potential markets. Only, the deal might take time to come through as approval is getting delayed. Agrium expects a breakthrough in early 2013 – a development that could just fuel its shares.

On a Roll

Agrium has already set the ball rolling for a greenfield nitrogen plant in the corn belt while expanding potash capacity by 50%– great steps towards a secure future. I see any weakness in Agrium’s shares as a good opportunity. It even looks cheap when compared to most peers, trading at enterprise value of around 16 times free cash flow. Mosaic’s enterprise value is 23 times FCF while PotashCorp’s is at 34 times FCF. Only CF trades cheaper at 7 times free cash flow.

I give a green thumbs up to Agrium. What about you? If you agree, add Agrium to your free stock watchlist to stay updated on all its news and analysis. 

Neha Chamaria has no positions in the stocks mentioned above. The Motley Fool owns shares of CF Industries Holdings. Motley Fool newsletter services recommend Monsanto Company. 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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