As corn goes, so goes fertilizer, 9.9.11
Contributing to this article:
Robb Parlanti, CFA, Senior Portfolio Manager/Global Security Analyst, Principal
Don Smith, CFA, Portfolio Manager/Global Equity Analyst, Principal
Marc Bianchi, CFA, Portfolio Manager/Global Security Analyst, Principal
Scott Swickard, CFA, Portfolio Manager, Principal
Joshua Kohn, CFA, Portfolio Manager/Global Equity Analyst, Principal
Although a farmer’s field might seem an unlikely place for an economics lesson, today a noteworthy example of the law of supply and demand in action is being played out between rows of corn stalks. Prices of corn and other agricultural commodities are near record highs this year.
According to Bloomberg News, in the past year corn prices are up about 77%; soybeans, 42%; and wheat, 13%. Many agricultural economists are drawing comparisons between today’s rising prices and those of the 1970s, when crop prices soared to a series of new highs.
We think the prices of corn and other crops are likely to stay at the high end of their historical ranges for some time for several reasons, including unfavorable weather conditions this year, a low inventory from previous harvests, a rising world population that’s consuming more food, growing demand from emerging nations, and the relatively high price of oil (which boosts demand for corn-based ethanol).
Corn: a $2-trillion market
As long as agricultural-commodity prices remain high, farmers will grow more crops and apply more fertilizer to help them grow. Corn is a $2-trillion global market -- and the biggest agricultural-commodity market in the United States by far, with production yields more than three times greater than those of the next-biggest crop, soybeans. As a result we’ve concluded that in the U.S., as corn goes, so goes fertilizer.
As for the prospects of this year’s crop of corn and other commodities in the U.S., they have been diminished by the weather. The Midwest and much of Texas have endured a troublesome combination of flooding in the spring, followed by a drought in the summer. The result: the worst U.S. crop conditions since the Dust Bowl era of the 1930s, according to Bloomberg News. In July the U.S. Department of Agriculture (USDA) cut its forecast for this year’s harvest of corn, sorghum, wheat, and other crops. The USDA’s estimate for corn alone was cut by 4%, from 13.5 billion bushels to 12.9 billion. (We think these harvest estimates could be pared further.)
Meanwhile, the global demand for increased quantities of food remains as relentless as the drought in Texas. As living standards improve in emerging nations, meat and dairy consumption increases. And all of the livestock that’s the source of meat and dairy products needs to eat, too. Also, the United Nations estimates that the world’s agricultural output must expand by 70% over the next four decades -- a tall order, since the amount of land available for farming is shrinking due to the continuing encroachment of cities and towns.
China: the hungry dragon
Much of the increased demand for food comes from China, which has been called "the hungry dragon." The U.S. Grains Council reports that China could purchase as much as 15 million tons of corn from other countries by 2015. Indeed, Chinese demand for grains is increasing 3-5% annually, partly because the country is the world’s largest hog producer. To help feed its animal and human populations, China ordered 21 million bushels of U.S. corn in July alone -- its biggest purchase in 15 years and a larger order than the USDA expected for the entire year, according to The Wall Street Journal.
Ethanol is another plank supporting the floor of demand for corn. For example, under the Renewable Fuel Standard in the U.S., petroleum refiners must use 12.6 billion gallons of corn ethanol this year and 13.2 billion next year in making gasoline, with the goal of reaching 36 billion gallons by 2022. This alone would be enough to boost ethanol demand, but the rising price of crude oil also helps, since fuel producers blend ethanol with distilled petroleum in gasoline to cut costs. What’s more, ethanol is profitable for farmers: the profit for turning one bushel of corn into 2.75 gallons of ethanol -- the "crush margin," as it’s known -- was 19 cents in late August, no paltry sum when multiplied over millions of bushels. Overall, ethanol demand is up 6% year over year, says The Des Moines Register. The U.S. even exports ethanol to Brazil, a leading producer in its own right. (In contrast to the U.S., Brazil makes most of its ethanol from domestic sugar cane.)
What does all of this mean for fertilizer? While all agriculture commodities need fertilizer, corn receives the most fertilizer of all row crops. For instance, the USDA reports that in 2009 corn accounted for 4.8 million nutrient tons of nitrogen-fertilizer use, compared with 1.3 million tons for wheat and 101,000 tons for soybeans.
Fertilizer market expanding
So, as farmers benefit from increasing demand for corn and other crops, they’re looking to use more fertilizer to help meet that demand. The USDA estimates the fertilizer market will reach about $26 billion this year, and the International Fertilizer Industry Association predicts an annual growth rate of 2.5% through 2015. But we think some segments of the fertilizer market are likely to grow faster than that.
Most fertilizer used in commercial farming contains three basic ingredients: nitrogen, phosphates, and potash. Nitrogen is derived from natural gas and is the most widely used type of fertilizer by volume. Phosphorus is obtained through surface mining and must be applied to soil periodically to replenish the phosphorus that plants absorb as they grow. Potash, which is also mined, yields potassium, used to improve the health of crops. (Fertilizers consume 95% of the global supply of potassium, our research shows.)
We think six companies specializing in those fertilizer ingredients -- CF Industries, Intrepid Potash, Mosaic, Phosagro, PotashCorp, and Sociedad Química y Minera de Chile -- should benefit from sustained high prices of, and global demand for, corn and other crops. We think all six companies may consequently have a considerable measure of pricing power and generate a superior rate of earnings growth over the next two years at least:
* CF Industries (headquarters: Deerfield, Illinois; market capitalization: about $13 billion) produces nitrogen and phosphate-based fertilizer. Last year, the company expanded its production capacity with the acquisition of competitor Terra Industries. And CF Industries announced a plan to invest $1.5 billion in its production and distribution network over the next four years. In its most recent quarterly earnings announcement, the company described the North American nitrogen-fertilizer industry as profiting from "an extended period of strong cash flow, characterized by higher cyclical highs and higher cyclical lows."
Intrepid plans mine
* Intrepid Potash (headquarters: Denver, market capitalization: about $2 billion) is the largest U.S.-based producer of potash, with two mines in Utah and one in New Mexico. In the second quarter Intrepid sold 225,000 tons of potash, an increase of 60,000 tons from a year earlier. The company plans to develop an innovative "solar-solution mine" in Carlsbad, New Mexico, to obtain potash ore that was inaccessible previously. In this underground mine, salt-saturated brine would be injected to dissolve the potash, which would then be pumped to the surface and recovered after the brine solution is evaporated by the sun. Intrepid expects the mine to yield at least 150,000 tons of potash annually, beginning in the middle of the decade.
* Mosaic (headquarters: Plymouth, Minnesota; market capitalization: about $32 billion) mines and produces phosphate and potash. The company, the world’s largest producer of phosphates, is profiting especially from increased fertilizer use in emerging markets. About 67% of Mosaic’s sales originate overseas, mainly from Latin America, China, India, and other emerging nations, according to StreetInsider.com. The company’s sales were $9.9 billion in fiscal 2011, a 46% increase from the previous year. Mosaic estimates it will sell 1.7 million to 1.9 million tons of potash in the first quarter of fiscal 2012.
* Phosagro (headquarters: Moscow, market capitalization: about $5 billion) is the world’s third-largest producer of phosphate fertilizer. Phosagro’s geographic nearness to the prime European Union market gives it an advantage over its five competitors on this list, who are all headquartered in the Americas. Also, demand for fertilizer within Russia’s own borders is robust. According to the investment firm Sovlink, production levels of phosphate fertilizer in Russia last year were at their highest levels since the fall of the U.S.S.R. in 1991. Phosagro holds more than a 60% market share of phosphate fertilizer in Russia. Phosagro’s production has grown at an accelerating rate: it took the company 25 years to produce its first 30 million tons of fertilizer, but only 10 years to make another 20 million tons.
Potash to double production
* PotashCorp (headquarters: Saskatoon, Canada; market capitalization: about $50 billion), as its corporate name suggests, is the world’s largest independent potash producer, responsible for 20% of the world’s production. The company also produces phosphate and nitrogen. We aren’t the only ones to recognize this company’s strengths; last August PotashCorp was the target of a hostile takeover bid by BHP Billiton, a move that was subsequently quashed by the Canadian government. Since then the company has planned to invest roughly $7 billion to double its potash production by 2015. PotashCorp achieved record production of 2.6 million metric tons last quarter, compared with 2.2 million metric tons a year ago.
* Sociedad Química y Minera de Chile, known as SQM, (headquarters: Santiago, Chile; market capitalization: about $16 billion) is a chemical and fertilizer producer -- and the world’s largest producer of lithium, used in batteries. SQM draws nitrates, potassium, and other minerals from Chile’s Atacama Salt Desert, where moisture is blocked by the Andes Mountains. The company completed construction of a new potassium-nitrate plant in Coya Sur, near the Peruvian border, late last year. In 2010 SQM produced about 1.3 million metric tons of minerals, including potassium, up 84% from the previous year. The company expects global demand for potassium alone to reach 55 million tons this year.
In sum, the law of supply and demand is now fostering a growing global appetite for corn and other agriculture commodities. If it’s true, as we believe, that as corn goes, so goes fertilizer, then CF Industries, Intrepid Potash, Mosaic, Phosagro, PotashCorp, and Sociedad Química y Minera de Chile should be in good financial stead for years to come.
The views expressed represent the opinions of Turner Investments as of the date indicated and may change. They are not intended as a forecast, a guarantee of future results, investment recommendations, or an offer to buy or sell any securities. Opinions about individual securities mentioned may change, and there can be no guarantee that Turner will select and hold any particular security for its client portfolios. Earnings growth may not result in an increase in share price. Past performance is no guarantee of future results.
Turner Investments, founded in 1990 and based in Berwyn, Pennsylvania, is an investment firm with more than $17 billion in assets under management in stocks, as of June 30, 2011. Turner manages growth, global/international, core, value, quantitative, and alternative separately managed accounts and mutual funds for institutions and individuals.
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International investments entail risks not ordinarily associated with U.S. investments, including fluctuation in currency values, differences in accounting principles, and economic or political instability in emerging nations. Investing in emerging markets can be riskier than investing in established foreign markets due to increased volatility and lower trading volume.
As of August 31, 2011, Turner held in client accounts 6,600 shares of BHP Billiton, 466,380 shares of CF Industries, 96,730 shares of Intrepid Potash, 943,530 shares of Mosaic, 7,150 shares of Phosagro, 75,140 shares of PotashCorp, and 150 shares of Sociedad Química y Minera de Chile.