Fertile Fields

Rarely will you find a more obvious-sounding investing tip than this: Those seeking growth opportunities should look to agriculture. One of farming's most vocal cheerleaders is Merrill Lynch analyst Donald Carson, who notes global agricultural markets are the strongest in decades. After a poor crop in 2003, global grain's stocks-to-use ratio fell to its lowest level in 25 years, and that dwindling

Rarely will you find a more obvious-sounding investing tip than this: Those seeking growth opportunities should look to agriculture.

One of farming's most vocal cheerleaders is Merrill Lynch analyst Donald Carson, who notes global agricultural markets are the strongest in decades.

After a poor crop in 2003, global grain's stocks-to-use ratio fell to its lowest level in 25 years, and that dwindling supply has pushed grain prices to their highest point since the mid-1990s. Carson claims it will take more than a year's worth of bumper crops to return inventories to normal.

This is good news to investors in this sector because high grain prices prompt farmers to increase acreage and shoot for higher yields, which boosts fertilizer demand. Notes Shawn McCambridge, a grain analyst at Prudential Securities: “With high prices you want to maximize production and you've got to put on some nutrient.”

CropLife, the industry journal, claims that with commodity prices on the rise, “2004 could be the kind of year for which fertilizer suppliers have hoped.”

One of the reasons fertilizers will be in high demand is because one of the most fertilizer-intensive crops — corn — is also likely to be popular with farmers. The cash margins for corn this spring are running 30 percent above year-ago levels, and that sends farmers one clear message: Plant me!

Another factor is rising farm incomes. Because net-cash farm income reached a record high in 2003, many farms are able to shoulder an added expense or two. This income cushion suggests higher nutrient prices will not slow consumption.

Offsetting these positives is a couple of negatives. One is the cost of energy, which counts as an input in the production of nitrate and phosphate fertilizers and hits manufacturers at the transport level as well. Another is that the USDA is forecasting a sizeable increase in soybean acreage, which typically calls for less fertilizer than the crops it replaces, like spring wheat.

Paul Schrimpf, editor at CropLife, notes that regardless of the fortunes of the fertilizer companies, farmers are in a great position.

“Farming is fun again,” he says. “As farmers sit down to calculate the better option, as between corn or beans, they can't lose either way.”

A Lot of Hooey

The basics of the fertilizer business revolve around this fact: All fertilizer contains nitrogen, phosphate and potash. Prices are now firming for all three nutrients.

Nitrogen prices are improving mainly because high bulk shipping rates are making nitrogen imports less competitive. True, robust gas prices forced some U.S. firms into bankruptcy (additional plant closures are expected in the second quarter), but that downcycle appears to have bottomed out.

In the words of RBC Dominion analyst Joseph Leinwand, “Nitrogen has gone from bad to better.”

Meanwhile, phosphates margins are at their highest levels in five years, mainly because the prices of component chemicals, such as ammonia, have eased dramatically. Further, prices for potassium, mined as potash, also have been “sticking” of late, in part because ex-Russian freight rates increased in early 2004 while ex-Canada rates remained flat.

Of the three, says Leinwand, “Potash, likely, has the best fundamentals.”

In general, he notes, the fertilizer market is only now recovering from the shock waves that the collapse of the Soviet Union sent though the fertilizer markets. In the wake of that political upheaval, 25 million to 30 million tons of capacity went onto the market, and that kept fertilizer prices artificially low for an extended period.

Now, things have settled into a more natural rhythm, with the former Soviet Union producing at capacity and global consumption growing 2 percent to 3 percent per year, according to Leinwand.

Fertile Ground

The fertilizer industry's structure is another positive. After undergoing considerable consolidation, the sector is led by three large-cap public companies, Agrium, IMC Global and Potash of Saskatchewan. Though each is a diversified producer, Agrium leads in nitrogen, IMC Global is the world's swing producer of phosphates and Potash accounts for over half the world's excess potash capacity.

Mutual fund investors seeking broad exposure to commodity stocks that include positions in fertilizer companies might take a look at T. Rowe Price New Era, a no-load fund geared to natural resources that includes Potash among its top 10 holdings. (It also holds Agrium.)

From 1979-81 — a span of time whose conditions mirror the current environment's — New Era averaged 40 percent per year. (Chart readers might note that earlier this year, the fund broke out of its five-year price range.)

For stock investors, there are other options. For instance, after losing money in 2003, Agrium reported first-quarter EPS of 7 cents, against break-even expectations. The company appears to have a lock on per-share earnings of a dollar for 2004 and $1.40 or so for 2005. Agrium's western Canada location affords it access to low-cost natural gas, better margin on ammonia per short ton (when compared to Gulf producers) and a geographical proximity to Saskatchewan and Manitoba acreage that yields over 70 percent of Canadian wheat. Though there are concerns over rising natural gas prices, these actually help an efficient producer like Agrium. Indeed, a big drop in natural gas would draw out more ammonia capacity and shrink Agrium's cost advantage.

Leinwand likes Agrium stock up to about $15 since, despite the stock's recent retreat, nitrogen prices “haven't really come down.”

A Refreshing Phosphate

After surviving a difficult 2003, when raw material costs rose for sulphur and ammonia, IMC Global now believes the phosphate cycle to be in the midst of a multiyear recovery. Perhaps more exciting for investors is IMC's prospective merger with Cargill's fertilizer assets. The resulting company would mark the first publicly traded venture for Cargill, the privately held global commodities giant. Cargill, with assets in Brazil and China, adds a global dimension to IMC's largely North American focus and would supplement the company's phosphate and potash assets with its nitrogen capacity.

Leinwand, who doesn't follow IMC, claims the merger should be viewed through the prism of overcapacity in phosphates.

“The industry in North America is oversupplied by 2 million tons or so,” he says. “The merger will help.”

Potash is sowing some productive investment seeds of its own, with first-quarter EPS of 94 cents — well ahead of Street expectations of 63 cents. Potash profits surged, and management has guided the company toward strong second-quarter demand at higher prices.

Leinwand sees Potash as the industry's one really good long-term investment, and he is “warming up” to the company, given the appreciating value of the company's potash reserves in a world strapped for the nutrient.

“Potash,” Leinwand notes, “is something you either have or you don't.”

Investors who attempt to follow Warren Buffett's counsel about investing for a lengthy holding period take note: Potash possesses over 100 years of its namesake material and 75 years of phosphate. Those are reserve lives that would make most oil companies green with envy.

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