Mixed Signals For Fertilizer Companies

Key Points:

* Urea prices fell by more than $70 in late September
* A strike is helping to support potash prices
* Some analysts are raising 2009 earnings forecasts
* Highlighted stocks include AGU, CF, MOS, POT and TRA
Fears that fertilizer companies could be losing pricing power sent their shares tumbling late last week.

The primary cause was a sharp drop in urea prices. A report published last Thursday on Farm Futures revealed a $70 decline in Black Sea prices over the previous 2 weeks. (Ammonia prices were weaker as well.)

Urea is a key ingredient used in fertilizer. Traders are concerned that the recent drop is an early signal of slipping demand for fertilizer. Any weakness would call into question fourth-quarter and 2009 profit forecasts for Agrium (AGU), CF Industries (CF), Mosaic (MOS), Potash of Saskatchewan (POT) and Terra Industries (TRA).
It is possible that some farmers are choosing to work through current supplies, rather than pay elevated prices. Certainly, the ongoing credit crunch is affecting spending. However, there is a difference between purchases being delayed and a trend of reduced demand.

Keep in mind that both global economic growth and increased use of ethanol played material roles in higher aggregate demand for agricultural products. People in developing nations continue to eat better, as their incomes enable them to enjoy meals that are beyond a subsistence diet, and ethanol is still being looked at as an alternative fuel source.

Potash Strike

A discernable trend in potash prices would provide more clarity. However, there is an ongoing strike at 3 of POT's mines. The mines account for approximately 30% of the company's potash production.

The strike is providing some artificial support to potash prices.

Adding to the uncertainty is the fact that supplies of potash are abnormally low.

Profit Forecasts

Nearly all of the covering brokerage analysts are keeping their 2008 profit forecasts for fertilizer companies unchanged heading into third-quarter earnings season. (One analyst did cut his forecast on AGU last week, but the consensus earnings estimate of $9.43 is still 7 cents above the average forecast of a month ago.)

Looking ahead to 2009, a couple of brokerage analysts have raised their profit projections over the past few weeks. There is currently no expectation that demand destruction will occur next year.

Brace for Further Volatility

Though nearly all of the fertilizer stocks continue to trade at discounts relative to their projected earnings growth, they are very volatile. Investors should expect more large price swings in the future.

Depending on the resolution to the Potash of Saskatchewan strike, other work stoppages could occur. On the other hand, if the company holds its stance firm, the current strike could continue for an extended period of time. Either occurrence would cause sustained supply disruptions.

On the demand side, farmers are likely to continue maximizing crop yields. This said, farming communities are not immune from the ongoing credit crunch. Furthermore, a global economic slump could adversely impact emerging countries, such as China, which would cause some drop in demand.

However, given the food shortages that occurred earlier this year, it would seem a significant global recession would have to occur for demand to drop significantly.

AGU, POT and TRA are Zacks #1 Rank ("strong buy") stocks. CF is a Zacks #2 Rank ("buy") stock. MOS is a Zacks #3 Rank ("hold") stock. All five are classified in Fertilizers.

Related ETFs

No ETF focuses solely on the fertilizer stocks.

Market Vectors Agribusiness (MOO) may be the best option, since it holds shares in companies such as MOS and POT. The fund, however, also has exposure to farm equipment makers like Deere (DE) and CNH Global (CNH).