The Ultimate Guide to Buying Fertilizer Stocks

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

Sometimes it pays to just pay attention to the boring things in life. Think health food. Think farming. Or think of stuff that’s behind those corn fritters and tortillas on your plate. Unexciting as they may sound, but if it weren't  for fertilizers, you would hardly get to eat anything!

So as a prudent investor, you should start weighing fertilizer stocks as well if you still haven’t. With the U.S. spring planting season around the corner and the recent bashing the fertilizer industry has taken, time is ripe to get your hands on some stocks.

Two charts, one story

The top three nutrients farmers apply include nitrogen, potash, and phosphate. Among these, nitrogen is most critical for essential crops like corn and alone accounts for more than half the total nutrients consumed in the U.S. Prices of nitrogen firmed up over the past few years while those of potash and phosphate hardly moved. Not surprisingly, nitrogen-centric companies have consistently outperformed peers that focus on the other nutrients. I’ve hand-picked two graphs for you that sum up the story. Take a look.

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This graph, presented by Michigan State University Extension, depicts the price trend of key nutrients from November 2010 to September 2012. Anhydrous ammonia, urea, and liquid nitrogen are compounds of nitrogen. DAP and MAP are phosphate products. The trend lines explain the rest.

Here’s the second, and more important graph for you as an investor. 

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RNF Total Return Price data by YCharts

That’s some riot of color! Take a deep breath and look closely – You’ll see how of the seven stocks mentioned, the top five revolve around nitrogen, and each has returned above 10% returns over the past year.

Rentech Nitrogen (NYSE: RNF), CF Industries (NYSE: CF), Terra Nitrogen, Agrium (NYSE: AGU), and CVR Partners (NYSE: UAN) get a major portion of their revenue from nitrogen. Mosaic and PotashCorp (NYSE: POT) are the outliers above. Why? While the former gets 70% revenue from phosphate and the rest from potash, PotashCorp is 70% potash and phosphate combined and 30% nitrogen. So you can also guess why PotashCorp generated better returns than Mosaic.

Nitrogen rules the fertilizer industry, and I don’t see it losing the crown for years to come, going by the long-term trend of the nutrient’s usage and prices. Just one statistic sums up the bullish story for nitrogen – As per the U.S. Department of Agriculture’s recent report, 97% of the corn acres planted in 2010 received some form of nitrogen fertilizer. Naturally, nitrogen is one nutrient that should never see a dry day.

That means if an investor wants to have a piece of the fertilizer growth story, nitrogen looks like the best bet. The $64,000 question is -- which stock should you go for? This is how my personal ranking goes.

Rank # 5

PotashCorp excites me the least, simply because it gets less than a third of sales from nitrogen. Worse, when most peers are counting advantages of low prices of key input natural gas, PotashCorp is battling gas supply disruptions from Trinidad resulting in steep gas costs. Pros: PotashCorp has a solid global presence, is generating high free cash flow, shoulders low debt, and increased dividend by a staggering 700% since 2011. Cons: Demand for potash and phosphate is low, and at 17 times P/E and 11 times price-to-cash flow, PotashCorp commands higher valuation than peers.

Rank # 4

CVR Partners is the only company that uses pet coke instead of natural gas as its key input, and is one of the few producers of diesel exhaust fluid. DEF reduces toxic emissions, has already found several takers, and presents one of the biggest opportunities for CVR in the years to come. CVR primarily deals in urea ammonium nitrate solution, which is touted as the most lucrative of all nitrogen products. It is on track to upgrade its UAN capacity by 50% apart from increasing DEF capacity by nearly 10%. Top draws: Easing pet coke prices and 7.2% dividend yield. Downside: Its bottom line dipped 15% last year on flat sales as UAN prices remained soft, and the stock looks relatively expensive at 16 times P/E and 14 times P/CF.

Rank #3

Rentech is the other player to dip its fingers in the DEF opportunity. In its first full financial year (since listing) that ended Dec. 31, 2012, Rentech’s net income more than trebled to $107 million on the back of 31% rise in revenue. Its dividend yield stands at a handsome 10% riding on a payout of $3.30 per share last year. But it has also lowered dividend guidance for 2013 to $2.60 per share. As the youngest among all, Rentech doesn’t have much history either. Nevertheless, Rentech is significantly expanding ammonia, urea, and DEF capacity. Growth potential means the stock’s recent plunge calls for attention.

Rank # 2

Agrium can be a top beneficiary of an agriculture boom because its portfolio includes seeds and crop protection products as well apart from all three essential nutrients. Agrium reported around 8% improvement in both top and bottom lines last year. It is chalking out plans for a greenfield nitrogen plant in the corn belt while increasing potash capacity by 50%. Recently acquired Canada-based Viterra’s agriculture business should add significant value. At a P/E of just 10 times and P/CF of only 7 times, Agrium is a solid buy at the current price.

Rank # 1

Though Terra Nitrogen yields a handsome 7%, it is controlled by CF Industries. So Terra’s performance and growth depend largely on the parent. So let’s talk about CF. Boy, CF scores an easy slam dunk in this game. It is the largest nitrogen producer in North America, sports the best margins, boasts solid financials, reported record sales and net income last year, is set to own the biggest nitrogen facility in Canada, and is pumping $3.8 billion in expansions. For all this, CF’s stock is currently trading at a ridiculously low P/E of 7 times and P/CF of just 5 times. Such opportunities don’t knock on your door every day, seriously.

There’s more to come

So if it’s fertilizers, it will be nitrogen and CF for me. Though that doesn’t mean investors holding stocks of companies that don’t live by nitrogen are sitting on misfires. These stocks might have lagged their nitrogen counterparts, but each has its own catalysts, some that could mean better returns this year. I’ll soon present my take on some of these companies. Stay tuned. 

Neha Chamaria has no position in any stocks mentioned. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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