Five fertilizer stocks to watch in 2010

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The once stodgy fertilizer industry became white hot back in 2007 with the onset of what we now understand as a vast bubble in commodities (and, for that matter, nearly every asset class).

Corn futures reached $7.25 (U.S.) a bushel (the norm is around $4). The catchphrase in the farm belt became "beans in the teens," a reference to soybeans reaching heretofore unheard of prices above $11 a bushel. Accordingly, prices for crop nutrients rocketed along with everything else. Partly the bubble was driven by the overall boom-time flow of easy money; partly by extreme investor interest in any kind of commodity; and partly by a core Malthusian argument, advanced specifically by big agriculture: the very existence of civilization will require hyper-juiced, super-yielding, sci-fi crops in order to feed a global population that won't stop growing. Fertilizers like potash -- as marketed by the companies that produce it, at least -- promised to help increase those yields.

But the financial crisis and the Great Recession turned all that hothouse speculation into so much fallow acreage (at least for the moment). Crop prices promptly tanked. Farmers couldn't afford to pay for such high-priced nutrients. Nutrients prices promptly went to seed, taking fertilizer-company shares with them. Potash Corp.(POT Quote) stock at its peak in June 2008 was trading at nearly $240. It hit a low of about $63 in March.

Got a question on investing in agricultural commodities and fertilizers? Ask Ravi Sood, president of Lawrence Asset Management, at noon (ET) on Monday, January 11th. You can submit your question in advance here.

Fertilizer stocks fell so sharply that the now infamous fertilizer war commenced: CF Industries took a look at Terra Industries , thought it too cheap to resist, and made its hostile bid in January 2009. Agrium felt the same about CF and -- threatened by CF's move to expand into a perhaps more-dangerous rival -- made its hostile offer for CF several months later.

Then, fertilizer stocks started to rally -- once again, in the wake of a rise in commodities prices in general as the U.S. dollar weakened -- with investors stoked by increasing evidence that a macro-economic recovery had begun brewing. So sharply did crop shares advance that the three-way fertilizer war fizzled at the end of the year, as Agrium and CF found themselves bidding into the wind, so to speak.

Now, at the start of a fresh decade, a bears-vs.-bulls dispute has germinated alongside the rally in fertilizer shares.

The dispute is strongest when it comes to potash: Some market watchers believe a bottom has developed in the price of this potassium compound, taken out of the ground in places like Saskatchewan and the Perm region of west-central Russia. Some, such as Credit Suisse analyst Elaine Yip, see "robust" demand for nutrient in the coming months. The bulls have taken their cue, to some degree, from company executives themselves, who have since December publicly come forward with statements that demand of late has risen off historic lows.

The bears, on the other hand, point to the fact that potash prices just keep on falling. Indeed, the most recent contract settlement, struck by Russia's big potash producers with their buyers in China, went for $350 per metric ton, $50 below even what the bullish Ms. Yip had expected.

As for phosphate and nitrogen -- two of the three other major crop nutrients -- the market is far less volatile, but still under some pressure relative to the pre-crash years at least.

With that preamble out of the way, here are five fertilizer stocks to watch in 2010.

Potash Corp. of Saskatchewan , as it's known in full, is the favorite fertilizer stock of day traders, whether hedge-fund whales or home-office small fries. Like DryShips in the dry-bulk-shipping sector, Potash's highly liquid shares offer a way to make short-term bets on the vicissitudes of the global agricultural business in general and the pricing of the company's eponymous crop nutrient in particular.

The company, which controls anywhere from 17 per cent to 20 per cent of the global potash market, depending on who you talk to, does more business in that nutrient than any other (though it does have a substantial phosphate segment and a small nitrogen division). It has more production capacity -- 15 million metric tons annually -- than any of its North America competitors. As potash the product goes, therefore, so goes the company (which, along with 14 other companies worldwide, including brethren Mosaic, Agrium and others in North America, and several big producers in Russia, form an oligopoly that controls 70 per cent of the global potash market.)

Fertilizer gurus the world over have been attempting to divine the real story behind the direction of potash prices for the better part of a year. One thing is certain: they've gone nowhere but down since the middle of 2008, when they reached unprecedented heights of $1,000 a ton.

Much has been made of the recent deal between the big Russian producers and China, the world's largest potash importer, that set a price of $350 a ton. Some have called this a bottom. But, as Mark Gulley, an analyst at Soleil Associates noted, "You don't know you have a floor until you see the first increase. Wall Street's track record in calling a floor hasn't been very good."

Most analysts see average potash prices for 2010 hugging a fairly flat line, between $350 and $375 a ton, about where prices were nearly three years ago.

Potash Corp. reports its fourth-quarter results on Jan. 28, but the real event to watch for in the short term is the completion, expected this month, of contract negotiations between Chinese buyers and Canpotex, the consortium that represents North American potash producers in price talks with importers. Analysts believe that another $350-per-ton deal will strike many as an optimistic signal to buy potash stocks. It's open question whether that price will hold, not to mention how much China will want to buy.

Charlie Neivert, an analyst at Dahlman Rose who rates Potash shares at neutral, wonders about the disconnect between the northward direction of potash stocks relative to the underlying fundamentals of the business. Much of the buying action in these shares has been motivated by investors making macro bets on a global economic recovery, rather than anything potash-specific.

The bulls, on the other hand, argue that farmers, enjoying stable crop prices and "favorable economics" are ready to start buying again. Sales volumes will therefore increase from the historic lows of 2009, pushing investors to bid up potash stocks.

The bears counter that those favorable farmer economics have more to do with collapsed fertilizer prices than anything else, and that enough inventory already exists in warehouses as well as in the ground -- potash remains in the soil for two to three years, nourishing plants all the while -- and, thus, that farmers may be willing to skip on buying potash once again for the coming planting seasons (spring in our hemisphere, fall below the equator).

In the end, as Mr. Neivert suggested, the direction of Potash shares may depend less on fundamentals and more on investors' collective desire to broadly play a macro-economic recovery.

Mosaic, on an abnormal fiscal calendar, reported its second-quarter results on Tuesday, saying, in effect, "The worst is over" -- a familiar rallying cry on Wall Street these last few months. The Plymouth, Minn.-based company is something of a different species than Potash. Unlike its rival in Saskatchewan, Mosaic's business is fairly evenly divided between phosphates and potash, though this balance has been skewed of late as potash suffers its continuing price slide, reducing revenue in that business for Mosaic. (It promises to skew the other way within a few years, since the company has been developing other potash mines.)

Mosaic, two-thirds owned by the giant privately held ag and food conglomerate Cargill, which limits liquidity in the name, can perhaps find solace in the fact that the phosphate industry -- which crashed just as hard as potash -- appears to have stabilized, with sales volumes rebounding since the quarter before last.

For now, the phosphate market is quiet, but that will end when the planting season comes into full swing in March and April.

"We're confident that prices have bottomed out and that demand is picking up," says Edlain Rodriguez, an analyst at Broadpoint AmTech, who has a price target of $65 on the stock, though he says that's under review.

Agrium, based in Calgary, has made headlines with its as-yet (and probably ultimately) unsuccessful hostile bid to acquire CF Industries. But the real news appears to be that Agrium's stock, though its shot up some 134 per cent from its 52-week low, remains fairly cheap compared with its peers in the fertilizer sector.

Indeed, the stock has been a kind of favorite pick among analysts covering the industry, even though economic meltdown has decimated the company's financial results as much as any of its peers. Credit Suisse's Elaine Yip rates Agrium shares at outperform, based on valuation as well as the company's retail presence: throughout the farm belts of the U.S. and parts of Latin America, the company runs a chain of farm-product retail centers -- descendants of the country feed stores of yore.

According to Ms. Yip, this spring -- the first planting season coming out of the depths of the recession -- promises to be a strong one for Agrium's retail business. In a research note issued Tuesday, she set a price target on the stock of $74. The stock set a new 52-weeek high on Wednesday of $67.50.

Dahlman Rose's Mr. Neivert is also bullish on Agrium -- the only large-cap fertilizer name that he rates a buy -- though for a somewhat different reason: With its retail and wholesale businesses, with its phosphate, potash and nitrogen production segments, Agrium is, by far, the most diverse fertilizer concern in North America.

True, this would limit the stock's upside during moments of potash euphoria, such as the 2007-2008 bubble. But the company, which has a 4 per cent share of the potash market, would still participate in those booms. And its diversity of assets means that it's protected a bit from the downside if potash prices continue to sink and sales volumes remain lax.

CF Industries, the fulcrum of the three-way hostile takeover drama that has fascinated the fertilizer industry for a solid year, has had to simultaneously fend off Agrium's advances and pursue its interest in its smaller rival, Terra Industries. The love triangle has been all about nitrogen, the world's most popular form of fertilizer, accounting for 60 per cent to 65 per cent of the stuff that's applied to crops (though not soybeans, which obtain their nitrogen out of the air).

The nitrogen business, however, is far more fragmented than potash (with its OPEC-like cartel), or even phosphate. Thus the consolidation jones that has beset the nitrogen segment, where sales volumes and prices haven't crashed nearly as much as those of potash or phosphate. Volumes, for instance, only declined by 3 per cent to 5 per cent last year, according to Broadpoint analyst Mr. Rodriguez.

As investors bid up fertilizer stocks in the second half of 2009 -- CF's stock price has risen 130 per cent from its 52-week low, touching a new year high just on Wednesday, as did Agrium's shares -- the takeover bids have grown ever more inadequate. Seemingly, the last chance for one of the two proposed acquisitions to move toward consummation will come when CF convenes its annual shareholder meeting later this year. (CF hasn't yet scheduled a specific date, however. Can you say: "delay tactic?")

At the confab, Agrium will try to foist two dissident candidates onto CF's board through a shareholder vote, though it's far from certain that anything would happen even if the Agrium-backed nominees are elected. After CF successfully pushed three of its chosen dissidents onto Terra's board at a shareholder meeting in November, after all, those directors turned traitor and voted against accepting CF's bid.

The market appears to have given up hope. Agrium's self-described "final offer" is $45 in cash plus one Agrium share for each CF share -- a bid that amounts to $112.26 based Agrium's closing stock price Wednesday. That makes for a vast spread between the offer price and CF's current stock price of about $97; if the market felt a deal was likely, the arbs would surely close the gap.

A similar spread exists between CF's bid and the stock price of Terra (a little less than $40 vs. $36.50). Shares of the Sioux City, Iowa, company have backed off their 52-week high, set in mid December, when perhaps there existed more confident speculation in the market that a deal might get done. Even with the pullback, Terra shares have climbed more than 150 per cent from their year lows, outperforming the stock of every other fertilizer concern in this brief survey.

Terra is also the smallest of that group by market cap ($3.6 billion) and revenue ($1.9 billion, on a trailing 12-month basis) -- and the purest-play nitrogen concern. As such, it's in the most stable position, relative to its peers, given the nitrogen market's relative stability. (Though it's worth keeping in mind that "relative" is the key word here: In the third quarter, Terra's operating earnings tumbled by more than 70 per cent year-over-year.)

The reason for that (relative) stability? Farmers must apply nitrogen each and every season, because the plants use it up. In other words, if they're having trouble balancing their books, it isn't so easy for farmers to skip a year, foregoing a nitrogen purchase. Thus, while nitrogen prices have plunged during the recession, sales volumes have held up.

In the latter half of 2009, those prices have strengthened some and, analysts say, will likely climb higher in 2010. Indeed, in its effort to thwart the pursuit of CF, Terra has argued all along that the fundamentals of its business promise robust enough growth to warrant a much higher offer price.

The company has provided guidance in an attempt to back up this claim, saying that it expects 2010 earnings before interest, taxes, depreciation and amortization of about $694 million. Its trailing 12-month EBITDA totals about $476 million.

Some analysts have doubted the veracity of that projection, but the CF-backed directors elected to Terra's board in November evidently don't -- given the fact that they turned around and sided with Terra management in voting to reject CF's latest bid. Once the dissidents got a look at Terra's books, in other words, they seem to have been convinced that those growth forecasts were real enough to render CF's offer substandard.

And yet the companies have continued to spar as the Fertilizer Wars enter a new year. Investors are left to wonder two things: When will CF and Agrium give up the ghost, and how much higher can all three nitrogen stocks climb?