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.
Every Rose has its thorns
My, how time flies when analysts are having their fun. Remember how in May we were discussing Dahlman Rose's decision to downgrade the fertilizer companies? Remember how in June we were talking about Dahlman again -- as it did a complete 180 and began upgrading fertilizer companies helter-skelter?
Well, it's August now, and you know what that means: It's time for another change of heart from the ever-fickle folks at Dahlman Rose.
Give this analyst credit, though. Dahlman Rose didn't try to justify its decision to downgrade Agrium, PotashCorp (NYSE: POT ) , and Rentech Nitrogen (NYSE: RNF ) with some song and dance about how belated rains in the Midwest lifted the prospects for a good corn crop. Nor did it try to divine the direction of potash prices in China and India. No, Dahlman made its reason for the downgrade clear: The trade worked.
Shares of fertilizer producers like PotashCorp, Mosaic, Rentech, and CF Industries (NYSE: CF ) are all up since Dahlman began recommending them. Accordingly, Dahlman says: "We are closing our bullish near-term call on fertilizer shares and turning cautious on the industry. The upside in the 2013/2014 crop has largely played out."
That leaves downside risk as the only factor left in these stocks, so Dahlman is choosing discretion over valor, and downgrading everyone -- or, at least, Agrium, PotashCorp, and Rentech -- to hold. You should give serious thought to doing the same. Here's why:
Free Cash Flow as a % of Net Income
As you can see, little has changed in the valuation picture for these companies since Dahlman last recommended them in June -- or since CIBC did in July, for that matter. If anything, these stocks, which looked expensive last month, look a bit more so this month.
On the other hand, the factor that's supporting these stock prices -- farmers' ability to sell corn for high prices, permitting them to buy more fertilizer for next year -- is coming into doubt as more and more corn withers on the stalk. This week, the U.S. Department of Agriculture cut its estimate for the year's corn crop by another 15% to just 124.3 bushels per acre (a total of 11 billion bushels nationwide). Even high corn prices don't bring in much cash when you have no corn to sell, hence the downside risk that Dahlman mentions.
Foolish final thought
Fertilizer stocks are cyclical, and as we all know, cycles go up and they go down. For this reason, Dahlman's decision to quit while it's ahead seems smart. After all, a new chance to get in when the stocks are cheap is just around the corner.
It's also worth remembering that fertilizer stocks are commodities. As such, they don't sell just locally in the U.S. market, but all around the globe. For example, here in Indiana, our corn cobs are looking like they came to us pre-grilled. The USDA says more than half the Hoosier harvest is in "poor" condition or worse. But just a few hundred miles to the northeast, Minnesota is seeing a bumper crop of corn. More than half the crop is in "good" or "excellent" condition -- and Minnesota grows 40% more corn than Indiana does. And even if the U.S. corn harvest turns out to be weak overall, China's expecting a good crop this year -- bigger than our own. Meanwhile, south of the equator, Argentina and Brazil are both entering planting season with plans to produce record-size harvests.
In short, there are plenty of places to sell fertilizer in the world and lots of moving parts to consider. It's not enough just to say, "Gee, it's hot outside today. I guess fertilizer stocks are going to be a good investment forever." You have to look at the big picture. You have to focus on the valuations. And with fertilizer stocks as expensive as they are today, the valuations don't look good enough to buy.
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