Not All Fertilizer Stocks Are Created Equal

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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.

See also 10 Large Caps With Bullish Options Sentiment and Short Trends on seekingalpha.com



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Stocks

Referenced Stocks: AGU , CF , IPI , MOS , POT

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