Fertilizer stocks have been painful for investors to hold over the past year. They are down substantially from where they were a year ago, even as the overall market has had a nice rally. However, the big fertilizer stocks seem to have gone through a bottoming process over the last six months or so and could reward patient investors at these entry points. The sector has several secular trends that should bode well for these stocks over the long run.
- The emergence and expansion of the middle class in the developing world, particularly Asia, means a greater need for grains, meats and high-quality foodstuffs as more people have the means to pay for a better diet.
- Domestically, natural gas prices are at decade lows thanks to the massive new shale resources being brought on line. These low prices should hold for at least the near and medium term. Natural gas is one of the primary components and operating costs to the fertilizer sector. Low prices have a positive impact on their margins.
- There is only so much arable land in the world. As the demand for food increases, better yields need to be coaxed out of this limited resource. This means increased demand for fertilizer, as well as other modern agricultural tools and products (e.g., modified seeds).
Given these long-term trends and the compelling valuations of the sectors, here are two stocks in the sector that look like they will be solid long-term bargains.
Potash (POT) is based in Canada and is the world's largest fertilizer maker. Four reasons Potash is a great pick up under $43 a share:
- The stock is selling for about 11x forward earnings, a significant discount to its five-year average of 14.8.
- Despite slowing earnings growth, the company continues to throw off considerable cash flow. It increased operating cash flow by approximately 350% from 2009 to 2011. It also pays a dividend of 1.3%, which easily could be raised in the future given is large cash flow, "A"-rated balance sheet, and low payout ratio.
- The stock is selling quite a bit below analysts' price targets. The median price target of the 28 analysts that cover the stock is $56 a share, roughly 30% above current prices. Credit Suisse has an Outperform rating and $60 price target on POT.
- The stock has spent most of the last six months hovering in the $40 to $45 range after being much higher last summer (see chart below). Corn plantings are up 4% year over year and the company expects shipments to China to be up this year as well, which could mean a higher stock price by summer as sentiment improves.
Mosaic (MOS) is one of the world's largest producers of concentrated phosphate and potash for the agricultural industry.
Four reasons Mosaic has considerable upside from its current price of about $53 a share:
- It is more than 50% below analysts' price targets. The median price target of the 12 analysts that cover the stock is $85 a share.
- The stock is selling for less than 10X forward earnings, substantially under its five-year average of 14.3.
- The company averaged just under 12% growth in revenue annually between 2004 and 2011. At current prices, the market is giving Mosaic very little credit for any future growth. It also sells for around 8x operating cash flow.
- Like Potash, Mosaic has spent the past six months building a technical support base in the $47 to $50 range, after being much higher in the summer (see chart below).
More on Agriculture: