At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." Today, we'll show you whether those bigwigs actually know what they're talking about. To help, we've enlisted Motley Fool CAPS to track the long-term performance of Wall Street's best and worst.
Careful -- this Rose has thorns
According to the U.S. Department of Agriculture, 2012 is going to be a great year for corn. Thanks to favorable prices and the arrival of a mild and early spring, the USDA predicts farmers will plant some 95.9 million acres of corn this year -- the most acres planted since 1937. And that's horrible news for the fertilizer companies.
The problem with planting so much corn, you see, is that it's likely to result in a surplus of corn supply. As we all learned in economics 101, high supply combined with constant demand generally results in lower prices. It could also result in a double whammy for the fertilizer companies by putting less cash in farmers' pockets (with which to buy fertilizer) and giving less incentive to boost crop yields by applying fertilizer in the first place.
Fearing the whammy, analyst Dahlman Rose announced a series of downgrades in the industry yesterday, assigning "sell" ratings to both CF Industries (NYSE: CF ) and CVR Partners (NYSE: UAN ) , while downgrading fertilizer up-and-comer Rentech Nitrogen (NYSE: RNF ) to "hold." Worse, if Dahlman's opinion starts to gain backers on Wall Street, investors can expect similar downgrades to strike the two leading names in the industry, PotashCorp (NYSE: POT ) and Mosaic (NYSE: MOS ) , as well. With farmers plowing full speed ahead to accelerate soybean planting as well, it's probably only a matter of time.
How big is the problem?
Really big. Describing its worries, Dahlman called this year's likely corn crop "exceptional" in size and "very destructive for corn prices and, subsequently, fertilizer shares." Potentially, Dahlman sees corn prices dropping from the recent price of $6.20 a bushel to as low as $5 a bushel -- and perhaps even lower to $4 or less -- and this is on top of the 5% decline in futures prices already seen over the past month.
Scary news? Certainly. But does it justify the sell-off we're now seeing in fertilizer stocks? Let's find out:
5-Year Growth Rate
Free Cash Flow as a Percentage of Net Income
Sources: S&P Capital IQ; Yahoo! Finance. *According to S&P Capital IQ and Yahoo! Finance, no long-term growth projections are available for CVR.
Whether you prefer to value your investments on the GAAP earnings they report or the actual cash profits they produce, the picture here looks equally grim. Of the five fertilizer companies named above, only one still looks attractive: CF Industries. All the rest (with the possible exception of the enigmatic CVR) are selling for P/E ratios higher than their long-term growth estimates. And all the rest (CVR included) are generating less real cash than the earnings claimed on their income statements.
For the time being, only CF Industries is growing fast enough to justify its P/E and generating more cash than most people think it's making. And now Dahlman Rose says this may not last, and the growth estimates Wall Street has in place for CF (and the others) are overoptimistic and likely to decline. If it's right, then now might be a good time to harvest any profits you've made on the stock -- which is up 21% since I recommended it to you in December and up 30% over the past 12 months. As for the rest, Dahlman's advice seems sound. The bloom's come off the rosy outlook for fertilizer stakes. So if you've made any profits at all on these stocks, now's the time to take them.
I certainly am. Matching actions to words, I'm taking my virtual CAPS winnings off the table, declaring victory on my "outperform" CAPScall on Rentech, and closing out my recommendation today. I recommend you do the same. As for what to invest in next: Take a look at the Fool's new report and find out about "Stocks Only the Smartest Investors Are Buying." The report's free today, but it won't be for long -- so click quick.