Analysts at UBS, in a recent report, said that they believe fertilizer markets are bottoming on the back of improved agriculture market fundamentals and the recent "run-up" in crop prices.
The firm's view is based on the data provided by Agrium AGU - one of the major fertilizer makers - at the company's investor day last week. UBS noted that Agrium's data could be seen as a proxy for the state of the broader fertilizer industry given that the company is a top player in nitrogen, phosphate and potash markets. The firm added that improved crop prices could augur well for growers' income and willingness to spend on nutrients moving forward.
While UBS's view paints an optimistic picture, the question is whether the industry will rebound or there will be further pain ahead. Let's dig into some of the key issues that are still weighing on the stocks in the fertilizer space.
Supply Glut Hurting Nutrient Prices
Fertilizer makers remain exposed to a difficult pricing environment for nutrients they sale. Potash prices, which are already at their lowest levels since 2007, remain under pressure due to elevated supply. The potash market is expected to remain oversupplied in the near future, thereby hurting prices. Moreover, depressed global energy prices and higher supply have also contributed to a softer nitrogen pricing environment.
Global capacity expansion continues to exert pressure on urea and other nitrogen fertilizer prices. Elevated supply in the global nitrogen market is hurting prices, causing farmers to delay buying activities. Urea prices are expected to remain under pressure in the near term, partly due to high levels of Chinese export supplies.
Weak nutrient prices dragged down profits of major fertilizer makers such as Potash Corp. POT , Agrium, Mosaic MOS , CF Industries CF and CVR Partners UAN in the first quarter of 2016 and are expected to remain a major headwind in the near to medium term. As such, margins of these producers will remain squeezed given a weak fertilizer pricing environment.
Low Farm Income: A Drag on Buying Decision
The agriculture market is not out of the woods yet and there is a continuous negative sentiment among agriculture investors that can create uncertainty in the near term. According to the U.S. Department of Agriculture ("USDA"), U.S. farm income is expected to slip 3% to $54.8 billion in 2016 to the lowest level since 2002. This would also mark the third straight year of decline.
The outlook reflects depressed prices resulting from excess supply of crops and livestock. While prices of major crops (such as corn and soybeans) have recovered of late, they remain at their multi-year lows. CHS Inc., the nation's largest farmer-owned cooperative, also said earlier this year that net farm income is falling faster than cash receipts and the U.S. farm economy is not at the bottom yet. Lower farm income unfavorably impacts grower's nutrient purchasing decisions.
Uncertainty in Key Consumer Markets
The general outlook for the fertilizer industry remains cloudy due to insipid economic growth in certain developing markets. A challenging currency environment coupled with economic weakness has contributed to a sluggish demand environment for potash across certain emerging markets.
Moreover, the crop protection market remains under pressure, in part, due to a slowdown in Brazil. Agricultural market conditions remain weak in Brazil impacted by cautious buying by farmers and the uncertain political and economic situation in that country. Tighter profit margins and credit are making growers in Brazil more cautious in their spending. Lower insect pressure and reduced seed volumes are also contributing to a weakening demand for crop protection products.
China (the world's biggest potash importer) is also yet to sign potash supply agreements for 2016, leading to uncertainty in the global potash market and downward pressure on potash prices. This has also led to cautious buying patterns in other major consumer markets including India.
Moreover, lower government subsidies coupled with local currency devaluation may lead to depressed demand for potash from farmers in India which has been in the grip of severe drought this year. Drought conditions will hurt demand in India which in turn would put pressure on prices. High inventory levels in India and cautious buying in Brazil have also contributed to a depressed market environment for phosphate.
Based on the above-mentioned factors, it could be surmised that the broader fertilizer industry is still in a rut and remains buffeted by a slew of headwinds that could continue to weigh on the performance of the companies in the space moving ahead. Nevertheless, long-term fundamental for the fertilizer industry remains intact given the continued growth of global population and concurrent rise in food consumption.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.