More Headwinds For Fertilizer Stocks

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

Each year, the population of Earth grows by 75 million people. It will grow by 2 billion by 2050. All those people need to be fed somehow. In the meantime, the quantity of land available for agriculture diminishes every year. Land turns into desert or just wears out due to bad farming practices. You could imagine these two facts must be super-bullish for agricultural stocks. If you have less land and at the same time need to feed more people, you need more fertilizers and better crops, right? Not so easy.

Hurt by lower prices

The recent quarterly report by Mosaic (NYSE: MOS) has shown that there are significant headwinds to profitability in the industry. The operating income was down 7.5% from a year ago. Record potash and phosphate sales were offset by lower prices. This fact should worry shareholders of other agricultural stocks such as Agrium (NYSE: AGU) and Potash (NYSE: POT).

Lower prices were a result of a combination of factors. India continued to show low demand levels, as problems with agricultural subsidies continued to pressure farmers in the region. A weak rupee contributed too, as it has made imported fertilizers harder to afford. Mosaic has stated it thinks that India will ultimately rebound, as the nation is growing by 18 million people each year. At the same time, the company does not provide an exact time frame when it would happen.

Excess supply

Another contributor to the pressure on prices was the growth of supply. Additional phosphate supply came from China & Saudi Arabia, while extra potash supply came from Russia and Canada. Mosaic states that production volumes historically increase before prices, and expects pricing to rebound somewhere in the future. It is important to notice that in the near-term prices would likely remain under pressure.

Here’s another drop of paint to the picture of excess supply. Stocks of potash at Canadian mines owned by Mosaic, Potash and Agrium were collectively 20% larger in May than the five-year average. In response to that, Potash declared that it was going to temporarily shut down its six Canadian potash mines for summer maintenance. Mosaic moves in the same direction and plans to run its Canadian mines at less than 75% of capacity this quarter.

Valuation

Agricultural stocks have been underperformers this year. Mosaic is down 4%, Agrium is down 9% and Potash is down 3%. I believe the long-term picture is bullish for fertilizer producers, but is it the right time to pull the trigger?

Mosaic is selling for 11 times its future earnings, and analysts’ mean target price is $84.46, implying an astonishing 56% upside. The stock has not been there since 2011, and currently there are no catalysts to pave the road to these highs. Mosaic stated that it was going to issue debt in the second half of this year, taking advantage of favorable debt market conditions. The company’s debt load is low, and it can surely afford it. Mosaic pays a dividend that yields 1.85%.

Agrium is cheaper than Mosaic if judged by forward P/E. It trades at a 9.39 forward P/E. Cheaper valuation could be partly explained by a higher debt load. Early in June, Agrium suspended plans for a fertilizer plant in the U.S. Midwest and expansion plans for a plant in Alberta. Given the current situation, the company does not need excess capacity. Analysts are optimistic with a $109.80 mean price target, but the stock will have difficulties to meet because of the current fertilizer price trends. Agrium’s dividend yields 2.23%.

Potash trades at a forward P/E of 12 and pays the biggest dividend, which yields 3.64%. The company has been trading in a $36 - $44 range for a long time now. Given the dividend, the stock is interesting from a long-term point of view. At the same time, Potash shares the same downside risks as the other stocks. Analysts’ mean target price is $45.98, implying a 19% upside. In my opinion, this is optimistic for the short term.

Bottom line

Despite the fact that the long-term big picture is bullish for fertilizer producers, the current environment poses downside risks. Supply is growing and puts pressure on prices. The situation in India is unclear. Mosaic stated that Chinese farmers demanded low prices and would go if the company were to lift the prices up a little bit. All in all, short term risks prevail. 

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Vladimir Zernov has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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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