Mosaic (MOS): Fertilizer producers have pricing power ~ market folly

Saturday, April 19, 2008

Mosaic (MOS): Fertilizer producers have pricing power

Buy: MOS, Target Price: $167, Time Frame: 6 months

All the fertilizer names continue to rock and thus its time to re-evaluate them. Just like my last analyses of the fertilizer plays, this analysis is a part of a 3 part agriculture series in which I'll be covering Agrium, Potash, and Mosaic. These three companies specialize in fertilizer and currently there is a fertilizer shortage in supply and thus these companies are ripe for success through 2008. All three of these companies are compelling because they are in the agriculture sector and more importantly the fertilizer sub-sector, but they are all appealing investments for different reasons (valuation, growth, dominance). Instead of just picking one of these names to own, pick all three and spread the money you would have spent on 1 across all 3 names. Fertilizer is seeing a secular bull market due to the pricing power that these companies have.

Potash, Agrium, Mosaic and the like are gaining pricing power due to supply issues of fertilizer. Additionally, they are seeing very strong demand. So, not only were their prices high due to short supply, but when you add in big demand, prices exponentially increase. Not to mention, agricultural commodity prices are sky high (and so are the futures prices) and there looks to be no end in sight. This is mainly due to an issue I've touched on in a few analyses over the months. And, that issue is the reality that there is simply not enough crop supply to meet crop demand. There are not enough farmers, there is not enough farmland, and there's simply too much demand. When a scenario like this plays out, the suppliers to the farmers simply cannot lose. The makers of fertilizers and seeds are seeing huge demand from farmers who are struggling to meet the robust crop demand. So, the producers of these products, who are facing this robust demand, then see a shortage of their supply of fertilizer and the like. And, that's exactly what we're seeing right now. POT, AGU, and MOS all have pricing power because there is insane demand for their product and their product is in very short supply. This issue will not be solved for some time either because demand for crops (especially corn) is not going anywhere and thus the producers have to find a way to step up their supply of fertilizer. But, any outcome is a victory for companies like Potash, Agrium, and Mosaic simply because they're raking in cash. This analysis focuses on Mosaic (MOS) but I will be doing a series of 3 analyses on the 3 main fertilizer companies out there that all are attractive as buys each for a different reason.

MOS produces phosphate and potash and animal feed ingredients. Basically, they are involved in the agricultural sector in terms of providing nutrients so that various crops can grow. And, as I've just detailed above, there's a lot of demand for crops. When looking into an industry you'll typically see a value play, a growth play, and a best of breed play. In the agriculture sector, the fertilizer plays are where you want to be right now just due to their supply situation. Within this sub-sector, AGU is the value play, POT is the best of breed, and MOS is the growth play. Now, why is MOS a growth play if it has a market cap of 58 billion? Well, I'll tell you why. MOS is seeing faster growth than that of POT (who is best in breed in this space). MOS is seeing quarterly revenue growth of 67% which is greater than POT's 42%. Also, MOS is seeing big gains in terms of quarterly earnings growth. They are seeing a 1134% growth year over year. POT, on the other hand, is only seeing year over year quarterly earnings growth of 102%. So, even though POT and MOS are similar in terms of market cap, MOS seems to be growing at a faster rate than POT and based on their last year's performance, this growth is pretty sustainable. And, the best part is, MOS isn't even trading at a premium to its peers for this growth. POT is the richest in valuation and yet it is growing slower than MOS. You are paying for MOS' great growth, and even then you are hardly paying a premium for it. As long as MOS continues to grow at around this pace (as they have), then these valuations would be worth paying for and would be warranted. But, there is a caveat with this pick. If MOS' growth slows for any reason, then their rich valuations will no longer be warranted and thus the shares would see a pretty good sized sell-off, seeing as they are trading at a premium currently. So, that's the only cautionary measure with this pick. Make sure to monitor their quarterly earnings with care to ensure that growth is being sustained or increasing. So, from this we see that MOS is the growth play of the sector based on consistent earnings growth that outpaces their competitors and at the same time is sustainable. Also, keep a watch on analyst estimates for this name. I have a feeling that their estimates are extremely weak and that MOS is being underestimated by analysts. Then, in reality, based on forward earnings, MOS would be trading at an even lower multiple, making it a screaming buy. Plus, strong operating margins of 24.8% and a return on equity of 30% just add to an already great fundamental picture.

Additionally, MOS recently had a big positive development that provides yet another reason to own this name. MOS is going to be prepaying $150 million of their long-term debt (principal amount). The ability for the company to pay ahead of schedule like this is a positive sign in that it shows they are pro-actively servicing their debt, as well as making an active effort to increase shareholder value. Debt is obviously never really a good thing, and the fact that MOS can shed $150 million of debt way ahead of schedule is very encouraging. Also, they have already prepaid $1 billion worth of long-term debt over the course of the past year. MOS has clearly seen a big increase in their amount of cash from the high crop prices and thus high fertilizer prices. This cashflow perfectly illustrates just how real the problem in the agriculture sector is. Demand is out of control and thus supply companies like MOS are raking in cash trying to meet all the demand. MOS has then used the excess cash they've received to constructively payoff their debt. This company and its management are definitely taking big steps in the right direction and this is a very encouraging sign for investors. Management's effort to strengthen their balance sheet and improve their credit ratings should provide investors with yet another good reason to invest in MOS. Lastly, as if we needed another reason to own MOS, it should just briefly be pointed out that MOS was one of the top performers of 2007 in terms of % gainers, locking in a 289% gain for the year, which is 8th out of all non-penny stocks. So, MOS has performed extremely well and will continue to perform well given the advantageous environment they are working in currently. Again, the story in their industry is real and they have pricing power. Easy money.

Agriculture will be a big story for all of 2008 and into early 2009. AGU, POT, and MOS are the 3 main players within the fertilizer sub-sector and each is compelling as a buy for a different reason. MOS, for instance, has seen the largest, most consistent, and sustainable growth when directly compared to its competitors and is thus the growth play of the group. Play the increasing demand for crops, play the increasing demand for fertilizer, and play the pricing power fertilizer producers have gained by playing AGU, POT, or MOS. In this case, play MOS because it is seeing high, sustainable growth and because management is actively enhancing shareholder value by paying off debt and cleaning up the company's balance sheet. And, keep an eye on estimates as I believe analysts are underestimating MOS growth and thus it should be trading at a lower multiple and becomes even more of a bargain. One last thing I wanted to point out is to wait for a slight pullback because they are overextended and due for consolidation before their next leg higher. After they all report earnings, look for continued strength in the names and get in on any weakness that you can. I'm simply writing this analysis before any pullback occurs because I wanted to get the information out there beforehand. If I wait to write this all up right when these names start to dip it will be too late. As you can see from the chart, they take massive violent downswings that only last a few days and then are right back to their winning ways. Watch the chart and the moving averages/Bollinger bands that act as support lines. Buy on any weakness and continue to watch the fertilizer story play out. MOS has the momentum to compete right up there with the best (POT) and so watch out as their growth continues to accelerate. This whole sector is booming and MOS is doing all they can to trump the competition.

Buy: MOS, Target Price: $167, Time Frame: 6 months