3 Ag Stocks Neatly Aligned for Upside
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The agricultural market may suffer from low margins, but I believe farmers are keeping inventories low for an expected increase in demand. While some argue that volatility and competition will keep upside low, bulls, like myself, appreciate the overly discounted operational strategies of several top producers and recommend buying now. Below, I weigh the pros and cons of several stocks targeting the market.
Potash (NYSE: POT): Value At An Affordable Price
This agricultural producer is selling cheap at under 12x past earnings. Part of this is due to the expectations for a slight decline of 1% next year and the single-digit returns over the next few years thereafter. Low multiples also stem from the fact that margins have fallen from rising supply. But, as the global leader in fertilizer with 20% of production under its wing, Potash has good control over the market's inventories and therefore is more of a price marker than is recognized.
Net farm income has also been at record levels, and planted acreage across the world is likely to rise. After some time of cautious customer buying (notably seen during 4Q11), revenue is likely to take off this second half of 2012. Demand is rising for fertilizers, which will boost potash, phosphate, and nitrogen prices. While the phosphate market is quite concentrated among more foreign producers than the potash market is, the firm is the biggest North American producer of phosphoric acid. At the same time, six projects will hike up annual potash capacity to 17.1 million tonnes by 2015. Sales have already grown by a CAGR of 18.3% over the past decade, so the momentum is in the right direction.
Great Complements: Mosaic & Archer Daniels Midland
Mosaic (NYSE: MOS) and ADM (NYSE: ADM) are two other ag producers to be optimistic about. Phosphate and potash fertilizer will provide excellent returns given larger farmer interest in boosting yields. For Mosaic, however, the main catalyst comes surprisingly in potash - this despite the fact that it has a pole position in phosphate, and potash is forecast surpluses. Ultimately, potash promises the strongest returns due to its oligopolistic and high barrier to entry. In addition, Mosaic benefits from low cost phosphate rock assets that reduce volatility and uncertainty in sulfur and ammonia inputs.
Early this year, Mosaic announced that it was, in essence, following Potash's suit of decreasing potash production. The financial position of farmers is still strong and, given how low domestic corn stocks have been against historical levels, activity for 2H12 is likely to be robust. The cuts in supply will thus make prices "sticky" at abnormally high levels. With a 13% stake in the phosphate market and vertical integration, Mosaic also has a great ability to dilute fixed costs over its operations.
A bet in Mosaic is ultimately well balanced with one in ADM. In case Mosaic does not close its value gap, ADM can provide the growth to offset. At just around 10x forward earnings, ADM is forecast 26.2% EPS growth in 2012 and 22.3% and 11.2% in the following two years. Management is committed to returning free cash flow to shareholders, which reduces the uncertainty that guidance is not met.
Equipped with a healthy balance sheet and 450 bps less leverage as a percent of market cap compared to competitor Bunge Limited, the company can increase takeover activity to improve pricing power. Renewed access to Black Sea exports also enables the company to better meet demand. Accordingly, I recommend buying shares now.
TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool owns shares of Archer Daniels Midland 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.If you have questions about this post or the Fool’s blog network, click here for information.