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Who's hot, who's not -- in fertilizer stocks
Wading back into the fertilizer sector Friday, analysts at Dahlman Rose announced a series of three new upgrades -- and at least one commentator believes we could see a few more in short order. Rentech Nitrogen (NYSE: RNF ) , CF Industries (NYSE: CF ) , and Agrium (NYSE: AGU ) -- all three of these fertilizer names scored upgrades to buy courtesy of Dahlman last week. But why?
Rentech Nitrogen Partners
Let's start with Rentech. The company doesn't even report earnings until March 19, which might lead you to believe the analyst is jumping the gun on this one. Then again, with a 17.4 P/E ratio and a 6.5% dividend yield, it might not pay to wait.
Already, analysts on Wall Street have Rentech pegged for an average 12% earnings growth rate over the next five years. But StreetInsider.com says it sees "a number" of upcoming USDA forecasts that could bode well for Rentech, and boost earnings estimates going forward. These include "(1) the annual USDA Long-Term Agricultural Outlook on February 11th, (2) the USDA Prospective Plantings Report on March 28th, and (3) upcoming USDA WASDE releases on February 8th and March 8th."
Dahlman thinks that if "preliminary acreage estimates for 2013/2014 ... exceed 96.5 MM acres for corn [then this] should support fundamentals for the nitrogen participants" such as Rentech. Given that the company's dividend yield and expected growth rate numbers are already high enough to justify the stock's price, any good news at all should prove Dahlman right, and transform Rentech into a "buy."
Dahlman is similarly upbeat on CF's prospects, and for similar reasons. But here, the prospects for outperformance may be magnified by the ultra-low expectations investors have for CF stock. Right now, the company's carrying a below-average P/E of only 8.2, and it's almost certainly being held back by the belief that earnings will grow at less than 3% going forward. (CF's dividend yield, at just 0.7%, also doesn't really do a lot to make the stock look attractive.)
But CF does have a few things to recommend it. For example, it's more diversified than Rentech, distributing both nitrogen and phosphate fertilizers. For another, it's in a much better situation than Rentech, cash-wise, generating positive free cash flow of $1.7 billion annually -- or nearly 96% of reported net income. In contrast, Rentech is currently burning cash.
If by this point you're starting to think that CF Industries might be the better way to play the upcoming USDA ag reports -- well, hold up a sec. Dahlman still has one more recommendation to pitch you: Agrium.
Priced at just 13.6 times earnings, and growing at 6.9% according to consensus estimates, Agrium sits in a happy middle ground between Rentech and CF, cheaper than the one, but growing faster than the other. It's similarly neither hot nor cold on the cash-flow front, generating a bit over $1 billion in cash profit annually -- enough to back up about 79% of reported profit.
But here's the best part: Agrium is already starting to prove Dahlman's thesis right. Last week, Agrium announced that its Q4 earnings will come in north of $2 a share, beating both the low and the high end of its previous guidance range ($1.50 to $1.90), and positively crushing the $1.73 number that the Street had been expecting it to produce. Agrium says its retail business posted a "record year" in 2012, while its wholesale fertilizer business "also continued to generate better-than-expected results."
Wait! There's more.
As if all that wasn't enough news to consider, StreetInsider.com predicts that the improving prospects for fertilizer producers will extend beyond the three names Dahlman has recommended. According to the ratings aggregator, peer producers PotashCorp (NYSE: POT ) and Mosaic (NYSE: MOS ) are also "on watch" for upgrade, based largely on the "on improved outlook" from Agrium.
Should we be excited by this prospect? I'm not so sure.
Priced at 16.3 and 14.5 times earnings, respectively, neither Potash nor Mosaic looks particularly "cheap" to me based on consensus growth rates of 4% and 8% (again, respectively). In fact, when you get right down to it, I'm not all that enthused about buying any of these companies based on mere hopes of what the USDA might or might not say in its upcoming forecasts.
Even if you think the P/E numbers do look cheap today (and really, given the weak growth estimates, the only stock that looks attractive here from a P/E perspective is Rentech), the fact remains that none of these companies is currently generating real free cash flow at anywhere near the rate they claim to be "earning" GAAP profits.
My advice: Don't trust to Dahlman's optimism, or USDA's forecasts, to rescue you from buying overvalued stocks. The fundamentals just don't justify investing in any of these companies today. The valuation argument simply isn't there.
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