Fertilizer Getting Hit via Barron's Article

Looks like much of today's fuss is about a Barron's article entitled 'Fertilizer Stocks Could Start to Wilt' I don't have a subscription but the body of the article was posted on a msg board so here is the text - excuse me while I yawn. As always, these stocks are prone to severe pullbacks because so much hot money has entered the space. It was much easier to invest in them a year ago when no one cared. Now the risks become much higher as any line item in an earnings report that does not please the momentum lemmings will cause them to flee. So eventually a day will come when an earnings report comes out and growth is only 45% instead of the expected 46.7% and for that 1.7% "miss" the stocks will drop 35% within seconds. That is the world of stock investing nowadays. But I don't think we are near that point yet. However, as more people jump on the bandwagon I will be a lot more defensive around earnings reports - there used to be almost no risk in holding these stocks through earnings as analysts estimates were shockingly wrong, but as with all high growth secular stories eventually the analysts overcompensate and create unreachable targets. When those targets are "missed", even if they represent massive growth, the herd panics.

But the specific reasoning below is not anything I'd lose a wink of sleep over - but there is a reason I focus on potash specifically (which I've outlined ad nauseum in the blog), even though the whole group has ramped together... but this piece has pushed both Mosaic (MOS) and Potash (POT) to their 50 day moving averages. I'd still like to see even more weakness to add more, although I added a small dash of Mosaic (can't help myself). I am awaiting lower prices (somewhat impatiently) as I outlined a few weeks ago [Thoughts on Fertilizer] - again the fund will suffer in price in the near term since we already have some good exposure to these hard hit commodity areas but these continue to be among my favorite bull secular markets so these coming purchases will be the basis for the next round of outperformance in my opinion. But for now, I am hoping for 10-20% type of corrections even from here, as the momentum chasers and hedge fund computers abandon ship.

By NAUREEN S. MALIK

THE RISING GLOBAL DEMAND for corn, wheat, soybeans and other cash crops is providing a boon for shares of fertilizer companies such as Potash Corp. of Saskatchewan and Mosaic. Over the past year, shares of Potash Corp., the world's largest fertilizer company, have tripled and shares of its rival Mosaic have risen almost threefold, thanks to soaring prices of crop nutrients such as potash, phosphates and nitrogen.

Farmers are absorbing rising fertilizer prices to produce higher yielding, better quality crops. These agricultural commodities are fetching hefty profits due to global demand for food, feedstock and biofuels such as ethanol. Demand for grains from the expanding middle classes in places like India and China are expected to double and triple earnings this year at Potash Corp. and Mosaic, respectively. But challenges loom ahead for these much-loved stocks due to global economic uncertainty.

This could cause speculators investing in Potash Corp., Mosaic and agricultural commodities, to bank profits. A commodity correction could curb farmers' profits and pressure fertilizer prices. "There are a lot of speculators in [agricultural] commodities and there's not a lot of ways to speculate [in related stocks]," says John Buckingham, the chief investment officer of Al Frank Asset Management. With this eager money concentrating on a few equities, the "Monsanto, Mosaic, Potash Corp. names got bid up dramatically." Shareholder turnover in both companies has at least doubled since the end of 2007.

The market now values Potash Corp., the No. 1 producer of potash and a leader in making phosphates and nitrogen, and Mosaic, the leading producer of phosphates and second-largest provider of potash, each at roughly $50 billion. Potash Corp. was valued at just $13 billion when Barron's wrote positively about the company 17 months ago. (See Barron' s, "On Fertile Ground," Nov. 6, 2006.)

Potash, phosphate and nitrogen are the three crop nutrients coveted by farmers to improve crop yield. Nitrogen, found naturally in the earth's atmosphere and soil, is a nutrient needed for basic growth; potash -- a form of potassium carbonate left behind after sea water evaporates -- boosts quality; and phosphates improve the plant size, says Goldman Sachs analyst Edlain Rodriguez.

The price-to-book value on both stocks has risen to more than eight times versus their historical averages of three to four times book. The Standard & Poor's 500 stock index is trading at 2.4 times -- in line with its five-year average. Frank Holmes, chief executive officer of U.S. Global Investors, recently pared back stakes in Mosaic and Potash Corp.. He uses fundamentals to pick stocks and quantitative metrics to sell. (See Electronic Q&A, "The Picks of a Natural Resources Whiz," March 17, 2008.) "When they spike exponentially over 60-day periods, then we sell 10% or 20% or even 30% of the position," he says.

Agriculture has been a relatively safe haven in the current market climate. Citi Investment Research analyst Brian Yu is bullish on both companies, but he says the biggest uncertainty threatening the industry is not whether the U.S. is in a recession but "if the slowdown in the U.S. were to go to global markets."

Of the basic fertilizer varieties, potash has the strongest industry fundamentals and prices have catapulted in some markets to over $500 a metric ton. China, currently in negotiations for 2008 supply, is paying $250 per metric ton and is playing hardball about any price increases. Still, China is self-sufficient in phosphate and nitrogen while its inventories for potash are running low. Potash Corp. Chief Executive Officer William Doyle says, "I think the prices are sustainable and I actually think they are going to be going up," quite possibly by over $100 per metric ton with the Chinese negotiations.

The top five potash producers control 65% of the capacity and there is a five-to-seven-year lead time to bring new tons to the market. Two-thirds of Potash Corp.'s revenues come from potash and the remaining from phosphates and nitrogen. It has 22% of the global potash market and has the ability to control supply with 75% of the extra tonnage out there. The company is restarting two potash mines to increase its volume from 11 million metric tons to 15.7 million by 2012 and has investments in potash producers in Jordan, Israel and China. Citi's Yu expects Potash Corp. to generate $203 of Ebitda (earnings before interest, taxes, depreciation and amortization) per tons versus $96 at the end of 2007 and $69 in 2006.

Mosaic is the second-largest potash producer with 13% of global capacity while phosphates make up the lion's share of its business. There is a four-year lead time to build out new phosphate capacity. Looking at the potash market, "last year was a volume story and I think this year is going to be more of a pricing story," says Goldman's Rodriguez. He notes both companies have a competitive advantage in the industry as low-cost producers with strong management teams, but that their fortunes are tied to commodity prices.

Commodity speculators are "one reason prices have gotten as high as they have, and you wonder how long people are going to keep feeding them," says Jack Scoville, vice president of brokerage firm Price Futures Group. The weak dollar is supporting foreign demand for cheaper U.S. crops. Scoville expects a correction due to macroeconomic concerns and the potential for "a significant increase in supply" of wheat, soybeans and maybe even corn due to favorable weather conditions, he adds. (Ed. note: if this guy can predict weather global patterns I will glady ask him for the Lotto numbers as well) Last year, U.S., Australian and European supplies were hurt by droughts and hot weather, he notes. Wheat prices have gone from $3.50 to $4 a bushel two years ago to $12, with a brief spike to $25 in Minnesota a few weeks ago, Scoville says. Soybeans have doubled to $12 and corn prices have tripled to more than $5 a bushel.

Weakness would likely begin with easily produced nitrogen, which Potash Corp. produces. Increased production by lower-cost producers of "commodity chemicals" will squeeze margins at North American and European companies, says Theresa Gusman, a portfolio manager of DWS Global Commodities Stock Fund.

Although bullish about growth at Potash Corp. and Mosaic, J.P. Morgan Securities analyst David Silver says the speculative interest in their stocks "may peak toward the end of April or early May which would coincide with the spring planting season." That means that these stocks, rather than continuing to blossom, could wilt on the vine.

Long Mosaic, Potash in fund; long Mosaic in personal account