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Jill: Every trader and market participant tends to gravitate to their favorite sector to trade. Whether you understand the fundamentals of the group or have a handle on how the stocks trade based on price action, we all have an area that we "get" the most. My favorite happens to be the agricultural space because I get "stuff". The ags are one of the areas of the market that trade on true fundmental supply and demand which you can see in the equity action and the underlying commodities. We have recommended many successful strategies to trade the volatility in the group and you can get more on my thesis in the webinars I presented with Bob Lang of Real Money Pro located in the Education tab on Options Profits.
I expected choppiness in 2012 with a strong finish at the end of the year and believe that momentum will continue through Q1 and into Q2 which is a seasonally strong time of year for the group. Overall, the combination of drought conditions (weather being the biggest variable), low per acre yields and forward-looking projections suggest that the industry is well positioned for the next several years. This is what needs to happen to keep the story back on the bullish track: 1) signed contracts with China and India will not necessarily translate into upward earnings in 2013, but they may lead to a sharper decline in inventory drawdowns which could limit further price declines; in addition, the contracts could be viewed as a sign that the bottom has been reached; and 2) farmers opting to fully maximize potash applications despite soil tests that might indicate otherwise.
At Options Profits, we have the ability to go directly to the source where the commodity trading takes place to get a true measure of market sentiment, Check out my latest video from the corn pit on the CMEGroup's trading floor with Gary Sandlund of Futures International, an OTCGH subsidiary. We review the underlying trends and what we expect for the group as 2013 kicks off:
Potash Corporation of Saskatachewan (POT) produces and sells fertilizers and related industrial and feed products primarily in the United States and Canada. It operates in a need-based business with high barriers to entry. It typically takes five to seven years and billions of dollars to get a facility online. Longer term, robust population growth will require a a massive increase in food production by 2050, which, in turn, will necessitate an intensive use of fertilizers to increase crop yields. POT also sports impressive dividend growth, averaging 33% annually over the past five years. It currently pays a yield of 2% on a low payout ratio of 20%.
Turning to some balance sheet metrics, POT did not perform as well relative to peer in 2012, but I think it is set up well for 2013. Potash CEO sees potash shipments rising about 12.0% in 2013 from the year earlier on strong demand in India and China. The risk/reward is increasingly attractive on a multi-year basis, trading at nearly 18% discount to the five-year average of forward P/E. I also think the market is not giving POT credit for significant capacity expansions set to come online beginning in 2H2013 that should drive 20-25% potash volume growth in 2014-15. Let's turn it over to Skip for the technical take and trade setup.
Skip: POT is used extensively around the world by farmers as potash is a key ingredient in fertilizers. Suffice to say that without potash farmers would have a serious problem. Thus companies that make potash are in an excellent position to prosper from selling it. POT is one of those well-managed corporations in this fertilizer business.
POT will soon report fourth quarter earnings performance lagged that of the same quarter as 2011. That is not news for the stock or the market because even we know about it. Thus, that report is discounted in the current price of POT.
This current quarter things are looking much better for POT as earnings per share are expected to show a 23% increase over that of the first quarter of 2012 (69c vs. 56c). For this fiscal year, ending in December 2013, POT should show an increase in earnings performance over that of 2012 of 11%+.
The technicals is what I really like about POT. What I see in POT's pattern--short, intermediate or longer in timeframe is a technical improvement with potential for more. The $38 level held twice in 2012, $46 being resistance. Perhaps the mid to high $40s will once again get a test.
POT options markets currently show that the out-of-the-money options are bid well enough to set up a bullish vertical call spread with a good risk/reward ratio. The time to expiry that I prefer is June.
Trades: Buy to open 3 POT June 42 calls for $2.40 points and sell to open 3 POT June 47 calls at $0.70.
The total risk for the spread is $1.70 points per spread.
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