Looking for Green in Fertilizer Stocks

CALGARY, Alberta ( TheStreet) -- Agrium ( AGU) shares pushed higher Wednesday, adding to a strong rally in fertilizer stocks over the last month, after the company reported better-than-expected second-quarter results and made some buoyant remarks about the second half of the year.

The agricultural business has proved a good place to plant one's money ever since the end of June, when the USDA came out with a crop report that indicated that the number of acres under cultivation in the U.S. would be less this year than many ag pros and other Farmers' Almanac devotees were expecting.

Agrium shares, for example, were trading at $48.94 on June 30, a year-to-date low point, before spiking 30% in the space of a month. Shares of rivals Potash ( POT) and CF Industries ( CF) and have traced similar trajectories, gaining 28% and 40%, respectively, since June 30.

Before the USDA released its projections, a set of worries had afflicted agriculture-related stocks. For one thing, when the euro-zone debt crisis bloomed this spring, the spiking dollar made many people concerned about the ding those currency fluctuations might take on the profits of fertilizer producers. For another thing, a bumper harvest this year in North America, long predicted by farm-belt prognosticators, had everyone worrying that a market flooded with product would hurt crop prices and, thus, the bank accounts of growers across the country. Poorer farmers make for lousy fertilizer customers, of course.

But the USDA report appeared to allay some of those bumper-harvest fears. "We started to see crop maybe wasn't going to be enormously large, or off the charts big, and some of the acreage numbers weren't quite as big," said Charles Neivert, a long-time stock analyst in the agriculture and chemical sectors, now with Dahlman Rose in New York. In response, Crop prices, especially corn, the most important vegetable to the North American farm business, moved sharply higher and have remained elevated.

Also helping matters has been a lower-than expected acreage under cultivation in Canada and a drought in Eastern Europe and Russia, which has driven wheat prices higher worldwide. As crop prices go, so go fertilizer stocks, and as they rocket, fewer and fewer bears (and other scarecrows) have stuck around.

Charles Neivert, for instance, turned from bear to bull on the fertilizer producers around about the end of June. Good timing, needless to say. He saw the improving fundamentals in the farm belt, and advised his firms' traders and clients to buy up. "Basically it was a very significant shift in the momentum on these stocks; the news flow started to turn more positive," he says of his shift.

Still, Neivert has some longer-term concerns. In a research note analyzing Potash's earnings last week, Neivert again raised those red flags once again. Although he agrees with many pundits that the autumn planting season in North America will be a strong one when it comes to fertilizer demand, given the strength in crop prices here, he believes that by the time next spring rolls around, demand for crop nutrients could be weaker than some expect.

Additionally, potash (both the product itself and the eponymous Saskatchewan corporation) could be hurt more than phosphate or nitrogen products and producers (like CF Industries, for example) simply because of capacity issues: potash volumes are on the rise, which could lead to oversupply.

Another agriculture stock specialist, the trader and research analyst Chris Damas, is more bullish on the fertilizer group -- with the exception of Mosaic ( MOS), which faces its own set of difficulties in Florida, where it mines most of its phosphate. Based on pollution concerns, a Florida judge recently ruled that Mosaic can't expand its Fort Meade mine in the central part of the state, pending further study. Because the present mine is tapped out of phosphate, Mosaic must find alternate sources.

Damas especially likes CF Industries, which has yet to report is latest quarterly results.

As for Agrium, the company surpassed analysts' expectations on both the bottom and top lines. Per share earnings of $2.90, which excludes 30-cents worth of one-time gains, easily beat the consensus target of $2.77, according to Thomson Reuters. Likewise, revenue of $4.37 billion compares to the forecast of $4.17 billion.

The beat appear to have been driven by Agrium's retail business, which accounts for some three quarters of its revenue. The Calgary, Alberta, company runs a chain of huge farm-supply depots around North America. Together, the retail segment has grown by 32% even from the corresponding period of pre-bust 2008, which was an all-time record moment for the agricultural sector as a whole.

Still, as Damas points out, Agrium's retail segment has suffered from some profit-margin compression, 18% in the most recent quarter, which is down from 26% in 2008. Wholesale prices for phosphate and nitrogen fertilizers have risen along with crop prices -- and Agrium has "little pricing power," Damas said in an email.

Of course, rising wholesale prices is a good thing for the industry at large, and the stocks in the sector. But the question is raised: How much life does the rally have left in it?

Though wary of pinning a timeframe on the upside momentum in crop shares, Neivert said that it could last until September, with the North American harvest coming in and the fall planting-season seeds going into the earth. But investors, he said, ought to keep their eyes on the news feeds, especially when it comes to the international players: how much fertilizer will India and China buy? How much product will the Southern Hemisphere growing giants (read: Brazil) require?

If demand from overseas is strong, the fertilizer rally could last into the winter months (in the Northern Hemisphere, that is), warming investors with their green light.

-- Written by Scott Eden in New York


Disclosure: TheStreet's editorial policy prohibits staff editors and reporters from holding positions in any individual stocks.

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