While the Greek debt crisis, among other factors, continues to weigh down on the stock market, other areas are looking quite bullish. Poor weather in the Corn Belt delayed plantings far longer than usual and will likely result in a poor harvest, dashing hopes to rebuild dwindling supplies. This is bad news if you eat food, but it's pretty good news if you're a fertilizer company.
Credit Suisse recently raised its forecast for all three major types of fertilizer, bringing its estimates close to the record prices set in 2008. The need to rebuild supplies of many agricultural commodities, coupled with increasing demand for those commodities from emerging markets, will drive significant demand for fertilizer over the next few years. While the big three -- nitrogen, phosphate, and potash -- are all basically fungible commodities, not all producing companies are the same. To find the right investment, it helps to compare the companies and see where their strengths and weaknesses are.
From humble beginnings
Over the past 10 years, many of the big players in the fertilizer industry have grown to be massive players. PotashCorp (NYSE: POT ) has grown its market cap by almost 100-fold in 10 years. Even Mosaic (NYSE: MOS ) has grown more than four times in its six years.
Learning to differentiate
But interestingly, revenue growth has been fastest at the smaller companies. Since Intrepid Potash (NYSE: IPI ) came on the scene in late 2007, it has posted much higher revenue growth than PotashCorp or Mosaic, though less than Agrium (NYSE: AGU ) and about the same as CF Industries (NYSE: CF ) . This might suggest that there are some economies of scale but that they are less effective at larger sizes.
A closer investigation tells a different story, however. Agrium's wholesale segment deals with basic fertilizer chemicals, like Mosaic and PotashCorp, but unlike others, its retail segment also sells seeds, crop nutrients, and crop protection products directly to customers. Much of Agrium's sales growth has come from its retail segment, which has seen 41% annual growth for the past three years.
While this has provided explosive revenue growth for the company, it has come at a cost. The retail segment, which has grown steadily from less than half of total sales to about two-thirds, has much narrower margins than the wholesale segment, dragging down total company margins compared to its peers.
Agrium's narrow margins end up negating much of the revenue growth, leaving the contest between Intrepid, which focuses on potash, and CF, which deals primarily in nitrogen, with a little phosphate on the side. While Intrepid has been beating its peers, there are two advantages to CF's strategy. On the one hand, nitrogen and phosphate fertilizers need to be reapplied often, as they are more easily washed away in the rain. On the other hand, nitrogen is a much less capital-intensive business.
Whereas phosphates and potash need to be mined out of the earth after a costly exploration process, nitrogen is abundant and easily found -- 78% of the air we breathe is nitrogen. The main cost of nitrogen production is natural gas, which is used for energy and for its hydrogen component, which binds with nitrogen to create ammonia. While natural gas prices have rebounded this year, they are still very low and CF Industries uses certain hedging methods to take advantage of this fact.
By virtue of the low capital intensity, CF is able to produce much more free cash flow in the end.
Odd man out
There's one fertilizer company I haven't mentioned in these comparisons. Terra Nitrogen (NYSE: TNH ) is a master limited partnership that is majority-owned by CF Industries. Its business consists of one nitrogen production facility in Oklahoma that services a large part of North America. Its performance has been mostly unremarkable -- some strengths and weaknesses, but pretty in line with its parent. What makes Terra interesting is that, as a partnership, it is set up to pass its profits on to shareholders as cash distributions.
Terra's most recent distribution of $4.84 per share represented an annualized yield of 17%, but because distributions are dependent on earnings, that yield is likely to fluctuate greatly. However, over the past five years, Terra's average yield has been about 8%, while the stock itself has advanced more than 400%.
Quite the investment indeed.