Down more than 40% today alone and now just a quarter of the top a mere three months ago.. Is this a bank? No. Its a fertiliser company called Mosaic (MOT).
Even with all the financial mayhem, one would expect suppliers to agriculture to be relatively stable. People have to eat, even in a recession. What’s more, the recession will be mostly confined in those areas of the world where not too many people live, the developed economies.
Emerging market economies are still growing, and what’s more, their populations are growing. And growing wealth means more people eating (more) meat, which needs 8 times the acreage to feed animals compared to the direct production of grains for human consumption.
On top of that, more and more agricultural land is turned to growing crops not for food production at all, but for producing biofuels.
So we feel pretty confident to say that we’re hitting on a favourable long-term trend, one that will not be overly disturbed by the fallout of the financial crisis and in fact, some of the effects are already priced in as commodities, even agricultural ones, have come back quite a bit recently (in the same good three months that cut MOT’s price in half, and then again in half).
However, a prime variable for determining the success of this fertilizer company is agricultural acreage in use, and unless we return to the times of the burbonic plague of the 14th century, we cannot see that happening any time soon.
Then, there are the prices for inputs and outputs, and here it gets a bit more tricky, as these are commodities with low supply and demand elasticities, and hence prone to rather wild price swings.
Those of it’s main end products have come down quite a bit:
- “With phosphate prices falling, nitrogen prices peaking and potash prices rising less than expected, there is considerable uncertainty surrounding the near-term earnings outlook as underscored by Mosaic’s earnings miss and downward guidance,” Merrill Lynch & Co. analyst Don Carson said today in a note to clients. [Bloomberg]
And phosphate happens to be more than 50% of sales. By the way, the earnings miss was very moderate:
- Excluding mark-to-market derivative losses, Mosaic’s per- share profit was $2.83 in the three months ended Aug. 31, the company said yesterday in a statement released after the close of regular trading. Nine analysts surveyed by Bloomberg expected profit excluding one-time items of $2.94 a share, on average. [Bloomberg]
Near term prospects:
Agriculture: remains strong, even continuing the present production trend doesn’t seem to be enough to meet growing demand, let alone restoration of some very low inventory levels
- The record crop this year has calmed agricultural commodity markets following the near-panic attack earlier this summer when heavy rains and flooding delayed planning and damaged crops in many parts of the U.S. Corn Belt. However, our analysis indicates that another bumper crop is required next year to meet the demands for food and fuel, as well as to build stocks to more secure levels. That means farmers will need to plant more area and intensify cropping processes in order to increase yields. [MOS earnings cc]
- Mosaic also said it will reduce planned phosphate production by 500,000 to 1 million tons in “the next several months” in response to increasing phosphate inventories. As a result, phosphate sales volume is expected to be 8 million to 9 million tons in fiscal 2009, which ends on March 31, Mosaic said. [Bloomberg]
- In the case of phosphate, fundamental drivers continue to look positive, but as Jim noted, a number of factors have combined to slow new sales, increase producer stocks, and cause us to reduce planned production during the next few months.
Just to give a perspective, phosphate prices were like $400 per tonne a year ago and although they are stabilizing now, they’re still above $1000 and MOS estimates for the coming quarter is between $1020 and $1080 per tonne. What’s more, the reduction in production is likely to be temporary, as inventories are run down. Fundamentally, the phosphate business is still very sound:
- Managing through swings in pipeline inventories is part of this business and is not unique to phosphates. As I noted at the start, phosphate fundamentals still look positive to us.
- We continue to advise our customers to monitor three fundamental factors. Grain and oilseed prices, raw material costs, and Chinese export policies for a cue on the direction on the phosphate market. As I noted earlier, our crystal ball is clouded a bit, but at this point it looks to us like each of these drivers points in a positive direction in the medium term.
- Swings in pipeline stocks should not be confused with changes in use. The fundamentals of our core businesses, beginning with the basic need to plant more acres and grow higher yielding crops, remain positive. Record demand continues to fuel both the potash and phosphate markets, but we are taking the decisive steps necessary to work through the temporary slowdown in the movement of phosphates through the distribution pipeline.
- And though volume may be weaker this year than we first thought, margins remain excellent. [MOS earnings cc]
These are still rising, a year ago they were $164 per tonne, last quarter they averaged $335 per tonne and this quarter they will be $488 per tonne, and they are still expected to rise significantly in the next quarter. Although the phosphate business is 2.5 times as big, this should at least provide some buffer to the lowering of production of phosphate
- Record demand continues to fuel the potash markets. Slide 17 shows that after surging 16% last year, world import demand is projected to increase modestly this year and then increase another 6% in 2009. The small increase this year is especially impressive, given that imports by China likely will drop more than 35% due to the delays in settling 2008 contracts.
- Slide 18 shows that shipments to China dropped significantly during the first half of this year but large increases in almost every other market more than made up for this decline. The resumption of more normal shipments to China during the second half of this year, the expectation of more timely settlements of the 2009 Chinese contracts, and strong demand prospects in other major importing markets, are expected to keep potash moving at a break-neck pace, not only for the rest of this year, but throughout 2009.
- Potash sales volume guidance for fiscal 2009 remains unchanged at 8.2 million to 8.6 million tonnes. We are producing all we can, as fast as we can, and we wish we had more inventories at hand to satisfy customer demand. [MOS earnings cc]
In fact, they are producing so flat out that they could not even take advantage of the problems of a major competitor:
- one of the major producers is, with their supply problems, some industrial accounts have had force majeure declared on them and they have called us. We have not been able to find the extra production or the inventory to serve them. So that’s not something we can step in and fill. Our industrial potash production is fully committed. [MOS earnings cc]
MOS also made some comments as to the why of the relative price movements of phosphate and potash:
- I think what has occurred this last couple of quarters is that we have seen the rise in phosphate prices precede the increase in potash. And so over the last couple of quarters, with rapidly escalating phosphate prices, dealers, distributors, retailers, have been eager and motivated to get the phosphate product into the warehouses before they saw further price increases. So what we see now is this bulge in the pipeline. They filled up, anticipating just for their price increases.
- Potash was later to start seeing escalating prices. We had a reduction in China last year of potash demand. So it was just a little later that potash started facing growing, strong global demand. Phosphate space and dealers and warehouses are full, they can’t really take much more. There is view now, and I think a correct view that I subscribe to, that potash demand is going to come back, particularly with the Chinese having to restock their pipeline, which is contrary to what we’re seeing in North America, very low, particularly in potash. [MOS earnings cc]
Input prices, sulfur and ammonia
- Many customers have stepped out of the market in order to assess how the recent decline in sulfur prices and an expected decline in ammonia prices will impact phosphate prices.
- A $450 per tonne decline in sulfur prices lowers DAP production costs approximately $180 per tonne. Lower sulfur and other raw material costs provide price relief for customers as well as cost relief for phosphate producers. [MOS earnings cc].
So there is another buffer in the making to soften the impact of lower phosphate production (which, it should be kept in mind, is a temporary measure) in the form of cheaper input prices. Indeed, when asked how sure they were about phosphate prices, this was the response they gave:
- What I would suggest is the focus needs to be on margins, not on sales price. And that’s what’s driving our bottom line, is the very strong margins we’re seeing. So although we may miss, and could possibly be wrong, with what our sales forecast is, we’re comfortable and confident in our margins, that we see input costs go down, the drives that reduce sales price, we still see good margins in this business.
This effect will arrive with a lag, due to MOS running down on their inventories first though:
- The margins that we are currently generating, that we generated in this past quarter, are at historically high levels, at very attractive levels. As we indicated earlier, because of the lagging effect of rising sulfur and ammonia costs before we start to see the downturn we think that that margin will likely decline in the second quarter. We do believe, however, we will see very healthy margins and recovering margins in the second half of the year and I would emphasize again that the margins that we are currently seeing, that we expect to see, are high by any historic measure for the phosphate industry. [MOS earnings cc]
And they’re even paying some dividend:
- We implemented a modest regular dividend just last quarter, far sooner than we originally expected. We know that some of you are looking for more and we are evaluating more meaningful distributions of cash in the future and the appropriate means for doing so. [MOS earnings cc]
In short, it’s certainly good value here, the fundamentals are much better than a year ago and the stock price is significantly below it, but it’s also certainly not without risk:
- The risk of a major further lurch downward in the markets
- The risk of further reductions in commodity prices
- The risk of the sheer momentum of the downturn in this stock, which has a lot to do with it being the darling of the markets until just a couple of months ago, and the associated unwinding of overly leveraged positions. You might have heard what they’re saying about falling knives…
The latter risk seems most acute to us, to be honest. If you can stomach it, you could start with a small position here. We do note this though:
- The RSI is 23, that’s indicating way oversold
- We might get a little help from the general markets on the bail-out vote
- There does seem to be at least some support at $40 (and if not, in the mid 30s) as that was some resistance level in the summer of 2007, but we’re not sure investors have that long a memory, especially in today’s market environment of women and children first..: