By
Morningstar
:
By Jeffrey Stafford, CFA
As the world population continues its steady march higher and
arable land per person declines, farmers around the globe have
increasingly looked to fertilizers to boost crop yields and meet
the rising demand for food. Three primary crop nutrients, nitrogen,
phosphate, and potassium (commonly referred to by their chemical
symbols as N, P, and K), provide the essential base that helps
plants develop strong roots, retain water, transfer energy, and
synthesize amino acids. While each nutrient plays a crucial role in
plant growth, we don't think the commercial production of N, P, and
K stands on equal ground through the lens of industry
attractiveness. In our opinion, several factors give the potash
(potassium) industry structural advantages not shared by phosphate
and nitrogen, contributing to economic moats for a few producers.
In second place, we rank phosphate, with nitrogen bringing up the
rear. Although low-cost production is probably more important in
assigning moats for fertilizer producers, we also consider mix of
N, P, K production for the fertilizer names in our coverage
universe.
Potash
With potash deposits concentrated in only a handful of countries
(mainly Canada, Russia, and Belarus), potash production is also
highly concentrated. By our estimates, the top seven potash makers
control about 80% of global production capacity, led by Potash
Corporation of Saskatchewan. The oligopolistic nature of the
industry leads to more rational pricing and production decisions,
in our opinion. As such, we think future potash supply will be
brought on judiciously and we don't expect the handful of companies
that dominate the potash market to undercut each other on
pricing.
Further, we think the potash industry benefits from lower raw
material cost volatility when compared to phosphate and nitrogen.
While moves in energy and labor costs have an impact on cash costs
of production, the process to take ore out of the ground and make
potash fertilizer does not require major purchases of additional
feedstocks from third parties. Also, the potash industry benefits
from the least amount of government control, meaning decisions
affecting price and production are more likely to be made based on
pure economic soundness. We think barriers to entry are highest in
potash. Potash Corp estimates it takes seven years to fully develop
and ramp up a greenfield potash project, several years longer than
new projects for phosphate and nitrogen; giving a measure of
clarity for medium-term supply. The confluence of these factors
leads to an industry with moatworthy characteristics; benefiting
not only industry giants such as Potash Corp, but also much smaller
players such as Intrepid Potash (
IPI
).
Potash Heavy Producers
Potash Corporation of Saskatchewan (
POT
)
Potash Corp is the world's largest producer of potash. And while
the company is also a major producer of phosphate and nitrogen, the
majority of the firm's profits come from potash. The company's key
potash assets in Canada, in combination with its low-cost position,
form the basis of Potash Corp's wide economic moat. We believe the
strategic assets Potash Corp owns translate into a dominant and
difficult-to-replicate position in the fertilizer market.
Intrepid Potash (
IPI
)
Intrepid Potash is the only pure-play potash producer in North
America. Although the company lacks the scale of its much larger
Canadian rivals, Intrepid's strategically located assets reduce
freight costs, allowing the firm to extract higher realized sales
prices than its competitors. We think Intrepid's potash assets form
a narrow economic moat around the company.
Phosphate
Similar to potash, production of phosphate fertilizers begins
with mining ore; in this case phosphate rock. Rock deposits are
relatively scarce but not to the degree of potash ore. About 40
countries around the world produce phosphate fertilizers, compared
to only 12 for potash. With production less concentrated,
irrational pricing and supply decisions are more likely, in our
opinion. Unlike potash, the process to make phosphate fertilizers
requires not only mined rock, but also ammonia and sulfur - two
feedstocks that can fluctuate wildly in price. As such, we think
cost volatility is higher for integrated producers of phosphate
compared to integrated potash producers. Further, barriers to entry
are lower for phosphate. The time to ramp up a new phosphate
greenfield project is about half that of potash, at three to four
years. Also, about half of the phosphate industry is under some
type of state or subsidy control, versus about 20% of the potash
industry. In our view, the key to success in the phosphate industry
is access to low-cost phosphate rock, as high-cost nonintegrated
producers typically serve to set a price floor for phosphate
fertilizers.
Phosphate Heavy Producers
Mosaic (
MOS
)
Mosaic is the world's number one producer of phosphate, with
about a 13% share of global production. The firm benefits greatly
from the vertical integration of its phosphate assets, as the
company's five mines in central Florida churn out close to a tenth
of the global production of phosphate rock. Mosaic is also a
top-three producer of potash. With lower-cost phosphate assets and
a solid position in potash, we give Mosaic a positive moat trend
but do not award the firm a narrow economic moat.
Nitrogen
In our view, nitrogen sits at the bottom of the fertilizer food
chain. Production is less concentrated than both potash and
phosphate, with about 60 producing countries. The production
process for nitrogen fertilizers helps to explain this
disadvantage. Nitrogen fertilizers can be made anywhere there is a
reliable source of natural gas, the main feedstock. Companies that
churn out nitrogen fertilizers should be viewed as natural gas
processors, whereas integrated potash and phosphate producers are
typically miners. Natural gas prices, thus, have an enormous impact
on costs of production. While gas prices in North America have
trended lower, we view natural gas as a volatile input, especially
when compared to mining costs for potash and phosphate. Nitrogen
barriers to entry are relatively low, with about three years to
ramp up a greenfield project. Further, government intervention is
high, with about 50% of production under state or subsidy control.
Similar to potash and phosphate, access to low-cost inputs, in this
case natural gas, is key to success in the nitrogen industry. In
nitrogen, producers with high gas costs (currently European
producers) generally provide a price floor to the market.
Nitrogen Heavy Producers
CF Industries (
CF
)
CF Industries is the largest nitrogen fertilizer producer in
North America. Despite its substantial scale in nitrogen
fertilizers, the firm is not a low-cost producer, in our opinion.
CF purchases the vast majority of its natural gas in North America
at higher costs than companies in other parts of the world. In
addition to nitrogen, CF Industries is also a major producer of
phosphate fertilizers. Operating its own phosphate rock mine in
Florida, CF is a vertically integrated producer.
Agrium (
AGU
)
In addition to its extensive retail assets, Agrium produces all
three primary crop nutrients. By production volume and sales,
nitrogen is the company's leading fertilizer product. The firm has
access to relatively low-cost natural gas in Canada, but gas is
cheaper still in the Middle East. We don't believe the firm has an
economic moat.
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