Just two years ago, telling investors that fertilizer would become a Wall Street darling might have prompted a less savory, if synonymous, reply.
Not so today. Last year's unprecedented surge in share prices of the world's biggest seed and fertilizer makers mean any company able to help farmers get the most out of increasingly valuable acres is worth serious consideration.
Despite some recent selling along with the rest of the market, agriculture remains one of just a few bright spots enjoying solid fundamental growth and some defensive characteristics.
Witness the explosion in shares of some big names in seeds and fertilizer, where triple-digit 52-week gains are the rule. Some examples, as of January 23:
- Potash Corp. of Saskatchewan, up 145 percent.
- Mosaic, up a whopping 280 percent.
- Monsanto, up 87 percent.
Those, along with Agrium, Terra Industries, CF Industries, and others, make seeds and fertilizers used on farms worldwide.
The Market Vectors Agribusiness exchange-traded fund, which tracks the DAXglobal Agribusiness Index and includes machinery, fertilizer, livestock, and seed shares, is up more than 27 percent since its September launch.
Two continuing trends underpin this stunning performance: surging grain prices and increasing use of ethanol. Sustained economic growth in emerging markets like India, China, and Brazil is raising living standards and letting millions of people add meat to their diets. That spurs demand for grains used in animal feed, driving up prices for all sorts of agricultural commodities.
As demand for soybeans, wheat, and especially corn climbs, farmers hike fertilizer use to raise crop yields. As a result, between 2001 and 2006 demand for the three most common nutrients—potash, phosphate, and nitrogen—climbed 19 percent, 13 percent, and 14 percent respectively, according to the Fertilizer Institute, an industry organization. Growth normally averages just 1 percent a year.
Then, in 2007, a second shift sent shares into the stratosphere: America's new affinity for biofuels. "The match that lit the bonfire was corn ethanol," says Charles Rentschler, an analyst with Wall Street Access.
To meet growing ethanol demand, U.S. farmers planted 91.9 million acres of fertilizer-loving corn last year, up from 78.3 million in 2006, according to the Department of Agriculture. Government estimates see almost a quarter of that crop going to feed ethanol plants that now dot the Midwest, and that number could nearly double over the next five years.
With U.S. energy policy favoring ethanol, sustained crop prices at higher levels appear likely to last, and that's what matters most to fertilizer firms. "The big picture is really grain prices. That sets the opportunity for these producers," says Brian Yu, a Citigroup analyst.
Corn, wheat, and soybean prices have remained resilient.
Inventories of grain and fertilizer are still relatively low, analysts say. Demand continues to be healthy, and most fertilizer makers still have plenty of room to raise prices, thanks to farmers' willingness to pay up while profit margins are highest.
Mike Wilson, the CEO of Agrium, a nitrogen producer with a growing retail fertilizer operation, says despite some market jitters lately, "all those fundamentals—pricing, demand, farmers [abroad] wanting to plant more acres—are all positive. Our customer is happy because he's making some of the best money he's ever made." Wilson also says that the sector is drawing investors trying to find safe spots to put their money as market woes mount.
Still, even in agriculture, recent volatility is keeping shareholders on their toes. Also, while 2008 is expected to be a good one overall, analysts at Bank of America and elsewhere have expressed concern that record soybean prices will prompt some farmers to shift back into beans from more fertilizer-intensive corn.
Then there's valuation. Analysts continue to raise price and earnings targets for several of the industries' largest players, but they're starting to get a bit more finicky. Citigroup's Yu, for example, likes CF Industries today not based on its market position compared with rivals but because its price-earnings ratio is in the 20s rather than the 30s or 40s like Agrium or Potash. Not that CF is a slouch. Its shares are up more than 200 percent from a year ago, too.
Seed leader Monsanto, another analyst favorite, is leveraging its monster pipeline of bioengineered seeds at a time when demand is soaring, and it could benefit if European regulators decide to loosen bans on some varieties of its genetically modified seed, analyst Rentschler says.
In all, the massive run-up in agriculture shares last year is unlikely to be repeated, but if grain prices hold up, there's little reason to turn bearish on better (or simply better priced) names in agriculture.