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.
All fertilizer, all the time
Friday is looking to be a miserable day to own a fertilizer stock -- any fertilizer stock -- as ace agriculture stock analyst Dahlman Rose issues its latest round of prognostications on the sector. Across the length and breadth of the industry, Dahlman rained down pessimistic ratings this morning:
- Agrium (NYSE:AGU) -- Sell
- CF Industries (NYSE:CF) -- Sell
- Potash (NYSE:POT) -- Sell
- And, of course, Rentech Nitrogen (NYSE:RNF) -- Sell!
Fact is, the only fertilizer stock that escaped the analyst's ire even just a little bit was Mosaic (NYSE:MOS), which somehow got off with only a downgrade to hold.
Why all the pessimism? StreetInsider.com, which reported the ratings this morning, quoted Dahlman to explain its moves thusly: "We believe that the best market conditions for [Nitrogen, Phosphorus, and Potassium fertilizers] are behind them as new capacity moves forcefully ahead." With India having just placed a couple big potash orders at prices ($427 a ton) a bit higher than expected ($416 a ton), prospects look "good" for the first half of this year, but "the industry maybe just one crop away from a significant earnings downdraft driven by crop and capacity issues."
After all, even $427 is a steep discount from the $530 a ton that Canpotex (which represents Potash, Agrium, and Mosaic on potash deals) was able to negotiate with India a couple years ago. Plus, with corn prices on the decline, and record acreage being planted this year in the U.S., it's possible farmers will have less cash to spend on fertilizer this year, than investors might like.
Should we be worried?
How worried should you be about all of the above? In a word: very. First, the analyst making these predictions for potash, nitrogen, and potassium fertilizers is no babe in the woods, or even in the cornfields. While overall, Dahlman Rose is a pretty useless investment banker, sporting a long-term average record for accuracy of less than 40%, and ranking in the bottom 20% of investors we track on CAPS, there is one area in which Dahlman positively shines: fertilizer stocks.
Within this small niche of the market, classified as "chemicals" on CAPS, Dahlman boasts a sterling record of 75% accuracy on its picks and a combined record of 232 percentage points worth of outperformance of the S&P 500 over the past four years.
Quite simply, Dahlman's performance in this field has earned it some respect, and the right to be listened to when it warns investors not to buy shares of Potash and Agrium, Rentech, and CF -- and to be careful about Mosaic as well.
Dahlman's opinion is also (largely) supported by the numbers. Across the industry, most fertilizer stocks sell for valuations ranging from 16.5 (Potash) to 12.1 (Agrium). Mosaic, the only stock Dahlman is even remotely optimistic about, sits in the middle of the pack at 13.2.
By themselves, these valuations don't look too awfully bad. But remember that projected growth rates for the fertilizer producers are anything but robust. Agrium and Mosaic "boast" projected growth rates of just 7% and 8%, respectively. Potash, only 5%. (Rentech breaks the curve with a 12% profit growth rate, but seeing as it currently has no free cash flow, it's hard to say what that "growth" is really worth.)
Remember, too, that most of these stocks fall far short of the goal of generating free cash flow in line with their reported GAAP income. Rentech is worst in this regard -- actually burning cash even as it claims to be earning $110 million a year on its income statement -- but Potash, Mosaic, and Agrium all generate a whole lot less profit than they let on.
Honestly, I agree with most of what Dahlman is saying about these stocks today. For the most part, they're not as good as they look. If I've got one quibble, though, it's that the analyst is too easy on Mosaic (whose numbers are just as bad as most of the rest) and too hard on the only stock on the list that presents a bargain: CF Industries.
Priced at a P/E ratio of just 7.2, CF is easily the cheapest stock on the list. Meanwhile, with a projected long-term growth rate of 12%, it's tied with Rentech as the group's speediest grower. Best of all, with $1.85 billion in trailing free cash flow, CF Industries is the only fertilizer company out there -- literally, the only one -- currently making more cash profit than it's claiming to have earned under GAAP.
To my Foolish eye, it's the only one of the five you should even consider buying.
Fool contributor Rich Smith has no positions in the stocks mentioned above. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 319 out of more than 180,000 members.
The Motley Fool owns shares of CF Industries Holdings. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.