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The growing season for fertilizer stocks

While farmers buy fertilizer, says this Canadian analyst, fertilizer firms are trying to buy each other, which could grow profits for investors.

The calendar says its spring, although this will come as news on the East Coast, where the snow is as deep as ever.

Still, things will start growing soon in many parts of Canada. And that includes agricultural stocks.

The time has come for farmers to stock up on fertilizer. But the story today is not so much what farmers are growing for people to eat.

It’s about fertilizer stocks eating each other.

For the full story, we turn to Ms. Jennifer Dowty in Investor's Digest of Canada. Ms. Dowty, who is an Assistant VP and portfolio manager at MFC Global Investment Management, has a keen eye for the numbers that tell the true story of a stock’s progress.

In this case, the numbers are mixed in with a flurry of mergers and acquisitions that are on the table.

Beef and corn

Before we see who’s eating whom, let’s see what the prognosis is for fertilizer stocks in general.

“In the near term, fertilizer demand should accelerate as spring planting season approaches, and longer-term trends remain solid,” says Ms. Dowty.

And emerging markets with growing middle class populations are still crying out for higher protein diets, global slowdown notwithstanding.

For the most part, that means beef. “Producing beef requires a large amount of grain, and therefore, fertilizer,” adds the analyst. Corn also requires a heavy application of fertilizer, and as long as greenhouse gas standards call for more biofuels, corn-derived ethanol will be in demand.

And of course, whatever the crop, farmers use fertilizer to increase both production and quality. “While demand for fertilizer is rising, supply is limited, and few new projects are planned in the near term,” says Ms. Dowty. “The positive fundamentals for fertilizer suggest that prices will remain above historical levels for years to come.”

The urge to acquire

It helps to be big in the fertilizer business, and several firms are trying to get bigger overnight. Here’s the sequence.

Late in January, CF Industries (NYSE-CF) made an offer to acquire Terra Industries Inc. (NYSE-TRA).

A month later, Canada’s Agrium Inc. (TSX-AGU) made a bid to acquire CF Industries. Terra is trying to fight off CF and CF is trying to fight off Agrium, but the acquisition battle is definitely on.

What’s more, a month ago rumours flew that privately owned Cargill of Minneapolis would make a bid for U.S. giant Mosaic Inc. (NYSE-MOS) — in which it already has a sizeable stake — and Mosaic’s shares shot up more than 8 per cent.

Ms. Dowty is confident that this urge to acquire will continue “as these companies are seeking growth, and they have the financial capacity to achieve it through acquisitions.”

Management is also well aware “that we are in an earnings trough and it makes financial sense to acquire companies at the current attractive multiples,” she adds.

So let’s follow the food chain to see which of these fightin’ fertilizer firms is the best buy.

An attractive target

“Farmers have been delaying their purchases of fertilizer, waiting for prices to fall,” Ms. Dowty informs us. “But, by April, they will have to purchase fertilizer for the upcoming planting season.”

Terra Industries should be one of the leading beneficiaries. A producer of nitrogen fertilizer, it has six manufacturing plants across North America.

The company issued stellar fourth quarter results in February, beating the Street’s expectations. It has plenty of cash flow and a quarterly dividend that yields 1.5 per cent.

Terra also has more than $8 per share, which allows it to buy back its own shares. As planting season arrives, volumes will go up. And costs will go down, thanks to the contraction in its biggest expense, natural gas.

CF offered 0.425 of its shares for every one of Terra’s, a five per cent discount. Even if Terra successfully rejects the CF bid, Ms. Dowty reckons, “it remains an attractive takeover target for others to consider.”

Prey and predator

CF produces both phosphate and nitrogen fertilizer. In fact, it’s 10th largest in the world among nitrogen producers.

On the balance sheet, CF closely resembles its takeover prey. It, too, beat the Street with its fourth-quarter results. It also has strong cash flow and a sizeable share buy-back program (and its dividend yields a slightly more modest 0.6 per cent).

And its predator also made an offer that values its shares at a five per cent discount — one Agrium share plus US$31.70 of cash.

“The two acquisition targets both delivered similar returns prior to the takeover offers: both peaked last summer and then bottomed at the end of November,” the analyst reports.

Toting up general support among analysts, Ms. Dowty finds that it is stronger for Terra, with five buys to two.

Terra’s shares have been trending upward for some time now, while CF had been going sideways before a recent turn for the better. Terra is trading at $28.63, CF at $72.40.

Ms. Dowty concludes with “the bottom line” for her Investor's Digest of Canada readers. “If you believe the market is going higher, both stocks offer upside momentum. However, I favor Terra Industries, based on its strong quantitative, fundamental and technical qualities.”

In short, if you think your portfolio should start growing this spring, it may be time to spread a little fertilizer in your portfolio.