Potash Rides the Agricultural Bull Market posted on: October 10, 2007 | about stocks: POT
The agricultural sector has recently transitioned from a cyclical story to a secular story. Traditionally, agriculture stocks have gained momentum during various months of the year and in turn sold off a few months later. Now, we are seeing continued demand for agriculture products as commodities markets boom and wheat prices soar higher. Regardless of what various farms across the country are planting, the bottom line is they need fertilizer and Potash (POT) supplies that.
Potash is a Canadian company based in Saskatchewan that produces various fertilizer and feed products. As wheat continues to climb in price, Farmers are looking to crank out as much of it as they can to become more profitable. Wheat is seemingly overrunning corn on many farms as farmers look to take advantage of those high prices. In turn, you should then see a slight shortage of corn produced as numerous farms are now planting wheat in place of their usual corn crops. As corn becomes scarce, you will then see the cycle repeat inversely. Farmers will then start to plant even more corn. The main point to be taken away from this is that farmers simply cannot meet demand for all the various crops and the crop with the least supply then becomes the most expensive. As the agriculture commodities prices shift up and down between crops such as wheat and corn, there are clearly a couple beneficiaries. As farms harvest more crops, they will be using more fertilizer than ever. Potash is a direct beneficiary of higher crop commodity prices. Companies like Agrium and Monsanto will also benefit. While all three names should experience very profitable bottom lines for the next year, Potash is the pick of the litter due to its superior margins and market position.
Potash directly competes with Agrium (AGU), who also provide fertilizers and other feed products. And, when looking at fundamentals, it is key to examine the sector/sub-sector as a group to see which company is either undervalued or best positioned to make a large run in the future. First, let's look at market cap. Potash is huge compared to Agrium. Agrium has a market cap of merely $6.93 billion as compared to Potash's $32.3 billion. Now, being a larger company doesn't necessarily guarantee that Potash will quell competition altogether. But, at the same time, Potash has commanding market share and financial leverage over Agrium, which is a big plus. Next, looking at the PE ratios shows that Agrium has a PE of 43.95 while POT boasts a PE of 40.4. So, POT has a slight advantage in terms of valuation. Now, the PEG ratios for both of these companies are astronomical in terms of valuation and growth. Both numbers scream "short me," but, you have to realize that nearly all PEG's across the agriculture sector are sky high. This reflects the running momentum the sector has as it has exploded onto the scene as a secular growth story. The area where POT simply destroys AGU is where it matters most: margins and returns. AGU posts a meager 11% return on equity. POT, on the other hand, posts returns on equity of 22.9%, effectively doubling that of AGU. In terms of margins, AGU's operating margins are 7.5% while POT's are 28%. Potash's margins QUADRUPLE that of Agrium. These two numbers cannot be ignored; POT is simply posting much better numbers. Also, another notable fact is that POT's debt to equity ratio (0.3) is lower than that of AGU (0.5). Potash simply has larger margins and a better return on equity. This is why comparing fundamentals amongst members of the same sub-sector is so important.
Comparing Potash to Monsanto (MON) would not be a completely fair comparison, as they are in different sub-sectors of agriculture and sell different products. They are related entities, yet they are not direct competitors. Combine all the above information with the fact that CIBC World Markets downgraded Agrium just a few days ago and it is clear that in terms of fertilizer producers, Potash is the winner.
Now that we have the best of breed in this agriculture sub-sector picked out, let's take a deeper look at why we should be investing in the agriculture sector in the first place. As mentioned earlier, agriculture has now become a secular story and farmers simply demand more fertilizer and feed product everyday. Reuters reported that at a recent conference, Potash's Chief Financial Officer said, "Our customers right now are on allocation. We're having a hard time meeting demand in 2007. We expect that allocation process is going to continue in 2008, and even into 2009." Basically, this means that farmers are waiting up to 2 months to receive their fertilizer because there is such massive demand right now. And, the best part is, Potash expects this exuberant demand to last through 2008 and even into 2009. Think of Potash as the Nintendo of agriculture (silly, but bear with me). Nintendo Wiis are flying off the shelves the second they hit them. Potash is experiencing the same desire for their product; only instead of selling Wiis they are selling fertilizer. The CFO also commented on how he thinks that gross margins will effectively double as they expand the company and continue to see strong demand. POT already has operating margins of quadruple that of AGU, and they believe they can double gross margins? Wow, Agrium has an uphill battle ahead of them.
Another great reason to buy into POT at these levels is simply because it has sold-off recently. Last week, POT was down as much as 6% intra-day as the market saw some profit taking. This mini sell-off is likely to continue as the market is generally overbought at current levels. So, despite the strong move POT has already made recently, these dips provide excellent opportunities to build a long-term position in agriculture. As their CFO said, the demand is very strong and will continue to be very strong all throughout next year.
It's no secret that Potash is experiencing solid demand and solid growth. Pulling up a 1 year chart of POT reveals a very strong uptrend with both the 50 day moving average and the 200 day moving average acting as supports are clearly tracing the trend. Short term technical indicators such as the 20 day moving average vs price, the 20-50 day MACD Oscillator, and the 20 day Bollinger Band point to a consensus 80% buy. Medium term indicators signaled a 100% buy with positive signs from the 40 day Commodity Channel Index, the 50 day moving average vs price, and the 50 day Parabolic Time/Price. Lastly, long term indicators also point to 100% buy and this consensus is reflected by the 100 day moving average vs price and the 50-100 day MACD Oscillator. Clearly Potash is a long-term buy, as it should outperform the market with very little risk due to robust demand.
Taking a look at analyst coverage reveals a 4 star rating for POT by JP Morgan, CIBC World Markets, and Banc of America Securities. Also, POT is 78% institutionally owned with major shareholders including the likes of Janus Capital Management, Barclays, and Fidelity. Many of the big players on Wall Street are confident in Potash and are riding the agriculture train (or Tractor).
Lastly, looking at the put/call ratio to gauge the options market sentiment for Potash's future reveals more positive information. POT has a call volume of 13,314 and a put volume of 5,238, yielding a put/call ratio of 0.39. A ratio of less than 0.5 is a bullish sign as it signals there twice as many calls being bought than there are puts. Therefore, the options market reiterates the positive outlook on POT's future.
The scoop on agriculture and on Potash in particular boils down to simple Economics. These days there are fewer farmers, less farms, and more demand for their crops. The farmers use what land they have to grow quality crops quickly due to the high prices they are receiving for their crops. More turnover = more fertilizer needed. And, when there is not enough fertilizer to meet demand, prices go up. Potash simply wins all around. It is a great time to build a position in agriculture for the long-term as the high demand will remain constant for the foreseeable future.
