Revisiting "Analysts Still Doubting the Fertilizer Stocks"

About 1 month ago, I wrote a piece entitled 'Analysts Still Doubting the Fertilizer Stocks'

At the time, one of my trio of fertilizer stocks, Mosaic (MOS) had just reported, with Potash (POT) set to report 2 days after the article, and then CF Industries (CF) shortly after. The theme of my article was, while these stocks had already had tremendous runs this year, analysts were still severely underestimating their future earnings potential.

However, Potash has a premium valuation for a reason; it has the most ability to expand mining production of potash - a large advantage. And with that said, after looking at how wrong the analysts have been on this sector, and how conservative they are on 2008 estimates, I think this is going to be like Apple (AAPL), where an expensive stock becomes a bit less so once we see new earnings and guidance.

Here is how far "off" the analysts were on each name (recall at the time Mosaic had reported, so analysts had pushed up their 2008 estimates significantly, whereas the other 2 names still had not reported)

Mosaic
$2.04 (90 days earlier) up to $2.94 (30 days earlier) up to $3.61 (at time of article post earnings), which is about where the estimate is now @ $3.64.

CF Industries
$3.27 (90 days earlier) up to $4.19 (30 days earlier) up to $4.93 (at time of article pre earnings), and now up to (get this) $6.66

Potash
$3.51 (90 days earlier) up to $4.02 (30 days earlier) up to $4.30 (at time of article pre earnings), and now up to $4.72

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With this pullback in the market, if you pull up a 1 month price chart you can see all 3 stocks trade at roughly the same price they did a month ago, despite a boatload more of earnings power coming down the pike. So all become 'cheaper' on price earnings multiple even though the stock prices are the same.

How much have 2008 estimates increased in the past 120 days?
Mosaic 78%
CF Industries 104%
Potash 35%

So while one can ask how can you continue to buy stocks that have run up so much, the data above shows the theme I keep coming back to - "pricing power" (which is another way to say "shortages"). It's a struggle for many companies now to maintain margins because they have a hard time passing along costs - ask Starbucks (SBUX). But here we have a relatively fixed cost industry, with pricing power to the extreme which means margins, margins, margins. Each incremental dollar of revenue begins to avalanche right down to the bottom line. And unlike some other industries which are a play on "global growth", I don't think there will be a huge hit to demand in this industry even if the world GDP slows significantly, especially in developing emerging markets because of the (a) urbanization trends in those countries - move 50-75M people worldwide every few years from farms to cities and you have a whole new demand dynamic (b) increased demand for more "western" foods with emphasis on "meat" which takes a lot more foodstuffs to feed and (c) global push for alternative energy sources incl. biofuels.

Now eventually new nitrogen and phosphate production will come online (most likely from, where else, China) so at "some point" in the future you will have a lot of supply online, but I keep coming back to the 1 nutrient of the bunch that a company like China cannot build 400 factories to produce, and that's potash. Much like gold or copper, you need to have a mine that has it - you can't just (over) build factories to produce it. While I am fully confidant that anything that 'can' be produced, will be 'overproduced' by the Chinese (driving down prices) in the coming years - think polysilicon in the solar space; certain things such as oil and "things that must be mined" just can't be put on the drawing board and overproduced within 2 years.

So we talk about a "wide moat" in business; what protects your competitive advantage. The 2 fertilizer producers that have emphasis on potash have the richest valuations... as they should; their moat is the strongest. As Potash just announced; it's going to take about $2 billion dollars simply to increase potash production by 15%... and they are one of the few companies in the world who actually has spare capacity. Why do they need to increase production? Well if the inventory trends are any indication... (current supply is 29% below the 5 year average). So while we hand wring as the stock prices gyrate on a daily or weekly basis, as one thinks out to what is going to survive and in fact thrive in a slower growth world economy full of new consumers with more middle class tastes - I keep coming back to this group. And this holds true if emerging markets GDP growth is 12%, 8%, 4% or 0%.

Long all 3 names in fund