Agriculture Looks Poised to Rebound

After the credit crisis hammered farmers across the globe, it looked as if the agriculture boom had come to an end. Prices for key crop-boosting chemicals such as phosphate, nitrogen and potash, along with share prices of the companies that produced them, plunged sharply.

While that scenario has played out in a number of commodities, agriculture demand -- and pricing -- should be the first to rebound. Demand for industrial commodities and precious metals are highly correlated with construction. Besides a near-term stimulus plan out of Washington, there are few drivers for renewed construction right now. In contrast, human appetite for food is fairly constant.

The relatively bullish outlook for agricultural chemicals stems from several factors. First, the sharp drop in energy prices has put a lot more money in the hands of farmers and consumers. Second, the amount of crops sitting in silos remains near record-low levels, which implies strong crop planting in future years. And lastly, production of key chemicals is being throttled back to account for the recent crisis-induced slump in demand.

But it is the current slump that should serve as the primary catalyst for a rebound in demand and pricing. Right now, farmers are cutting back orders, choosing to apply far smaller amounts of chemicals to their current planting. However, farmers will need to compensate for that under-application this fall by applying greater amounts in the spring. If they fail to do so, crop yields will be subpar, creating dangerously low inventory levels of key crops. That would just set the stage for the next industry boom.

Let's look at nitrogen as an example. Prices have dropped from $350 a ton to just $125 a ton. At that price, a number of European producers cannot make a profit, and are ramping down production. In contrast, U.S. producers such as Terra Industries (TRA - commentary - Cramer's Take) and CF Industrial Holdings (CF - commentary - Cramer's Take) have lower-cost extraction processes and can take market share -- and turn a profit. Shares of both of those companies trade for less than 5 times projected 2009 profits (despite a sharp rally on Tuesday). And this is one of the few corners of the market where you could argue that 2009 forecasts are too conservative rather than too aggressive.

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David Sterman has been an equity analyst and financial journalist for 15 years, most recently serving as Director of Research at Jesup & Lamont Securities.