Global population growth
and escalating food demand underpins long-term upside for potash, phosphate
and nitrogen producers, but fertilizer oligopolies may have jumped the gun
last year with aggressive rates that priced farmers out of the market. As
farmers expand acreage rather than boost yields in now-tired fields, grain
prices have backed off recent highs. That's why Robert Winslow, agriculture
research analyst and director at National Bank Financial, is picking his
stocks with care. In this interview with The Energy Report, he shares where he
sees strengths and weaknesses in the industry and names some interesting
contrarian plays.
Companies Mentioned : Agrium Inc. : Allana Potash Corp. : BHP Billiton
Ltd. : CF Industries Holdings Inc. : d'Arianne Resources Inc. : Elemental
Minerals Ltd. : IC Potash Corp. : K+S Potash Canada : MBAC Fertilizer Corp. :
PotashCorp. : Stonegate Agricom Ltd. : The Mosaic Co.
The Energy
Report: Your last interview took
place in April of 2011. What have been the major developments on the
agricultural front impacting the fertilizer markets since then?
Robert
Winslow: Increased weather volatility, like
last summer's drought in the U.S., which led to modern-era highs in corn,
wheat and soybean prices, have had a significant impact on the market.
Although grain prices have softened of late, I believe you're likely to see somewhat
higher-than-usual grain prices through at least the first half of 2013, given
the persistent dryness in the U.S. corn belt and wheat-growing regions. Grain
prices drive farmer sentiment and buying, and therefore the price and the
demand for fertilizer.
We've seen
some disconnects when it comes to potash, such as in India: Because the rupee
was devalued about 20% through 2012, Indian farmers can't afford to pay the
prices that the potash companies would charge, and this resulted in subdued
demand. Chinese demand has been somewhat subdued as well. Globally, we've had
this really interesting dichotomy with high grain prices buoying larger
demand in places like North America and even Brazil, but softening demand in
yet other parts of the world with country-specific issues. In total, we
haven't seen the demand strength in potash that you might have otherwise
expected with this high grain-price environment.
Some would
say it's partly because grain prices are not sustainable at these high
levels. We are actually of that view. Like any commodity, when the price gets
too high, two very simple things play out: demand destruction and supply
response. You've seen demand destruction over the last 3–6 months. For
example, high-cost ethanol plants have been shuttering production. High-cost
producers of cattle, pigs and chickens have been culling their herds because
they can't afford the feed costs unless meat prices rise in conjunction,
which they have not.
Then
there's supply response. Farmers are expanding acreage by moving into
marginal land. You may not get robust yield on that land, but you can still
increase production, which we're seeing play out now. Brazil is expected to
increase soybean acreage by 8–10% this year. With these dynamics
playing out, the grain prices are beginning to come down. We expect that by
the second half of 2013 you should start to see lower fertilizer demand
reflected in pricing, even in the U.S. and Brazil. That is why we maintain a
fairly cautious view on the fertilizer sector at this stage.
TER: How might
continuing climate change and severe weather affect grain prices and
fertilizer demand?
RW: Nobody
really knows the answer. I don't pretend to, but I will say that the
stocks-to-use ratio for grains right now, globally, is about 68–69 days
of supply. It's relatively tight compared to the last 30 years or so, and it
doesn't take much to tip over and get a real spike—or falloff—in
grain prices. When you do get these supply shocks through floods or droughts,
the relatively tight supply situation can move prices quite dramatically,
which we saw just this past year.
Many
investors don't believe such price spikes are sustainable and they aren't
going to pay for them. We're probably at least two years away from where we
have a bit more of a buffer in the stocks-use ratio to get us away from this
tightness that is causing more volatility in the grain price. In the
meantime, we can expect continued volatility in both grains and fertilizer
equities.
TER: How have
the various segments of the fertilizer industry performed in the last year
and a half?
RW: Potash
has been the commodity with the most interest. We've been a bit of an outlier
in the investment community, with a rather bearish view on both the commodity
itself and on some of the senior potash producer equities. We are of the view
that the potash oligopolies (and we all know who they are) have been rather
aggressive with their pricing. In a perfect world, you might be able to raise
your prices every year, but we don't live in a perfect world. Places like
India just couldn't afford the higher prices, so they bought less. The
oligopolies and agronomists are right in saying that parts of the world, like
India and China, need more potash in the soil, but ultimately, demand is
price dependent.
In 2012,
global potash demand looked to be in the neighborhood of 50 million tonnes
(50 Mmt), which is below the levels we saw back in 2004. Thus, the commodity
usage has been basically flat to down over the last 7–8 years—not
a compelling investment theme. But the potash price more than tripled over
that period. This aggressive pricing has since come back to bite the
oligopolies. I expect a demand recovery in 2013 because India has been
under-applying fertilizer, and it will need to make up for that at some
point. I doubt India would purchase its full allocation, which would be 6–7
Mmt, unless it can buy potash near or below $400/Mmt. And if it does buy the
6-7 Mmt, then there's a good chance India might buy less again in 2014, with
Indian farmers trying to mine the soil. Of course, if the rupee comes back
with vigor, India would have more buying power.
On the
supply side, there's tremendous brownfield supply expected over the next
three to four years. Most of it is coming from the oligopolies themselves. It
looks like the global supply will be growing about 4% per year, on average, over
the next four years. So if your demand is flat and supply is up 4% per year,
it doesn't bode well for potash prices. That doesn't include the greenfield
supply that could come on from BHP Billiton
Ltd. (BHP:NYSE; BHPLF:OTCPK), K+S Potash Canada (SDFG:FSE) or any of
the juniors that are working to build mines. So the supply/demand dynamics
are not, in our view, compelling for potash over the next two years,
particularly if we get less volatile global weather patterns and grain prices
trend down.
TER: How do
the prospects look in the other fertilizer segments?
RW: Phosphate
is looking rather interesting here. Not unlike potash, there's a bit of an
oligopoly situation, with Morocco controlling half or so of the global
phosphate rock market. It appears that Moroccans really want to move more
into the higher-margin business. Instead of just selling rock to the world, they
figure they can make monoammonium phosphate and diammonium phosphate, which
are finished fertilizer products. This will make it rather challenging for
the non-integrated phosphate producers and/or companies that still rely on
imported rock. U.S. phosphate producers like The Mosaic
Co. (MOS:NYSE) and Agrium Inc.
(AGU:NYSE; AGU:TSX), for example, rely or expect
to rely to some extent on Moroccan rock.
On the
other hand, that should provide some interesting opportunities for the
greenfield phosphate companies, certainly in North America, that are
developing phosphate deposits. There are a couple of companies in particular
that you might want to keep an eye on. One is d'Arianne
Resources Inc. (DAN:TSX.V; DRRSF:OTCBB; JE9N:FSE) and the
other is Stonegate Agricom Ltd. (ST:TSX,
SNRCF:OTCPK). Both are working on projects here in
North America. The next few years could be interesting for them.
TER: Then how
about the nitrogen products?
RW: Unlike
potash and phosphate, nitrogen isn't reliant on ore bodies. It's produced all
over the world, so you don't get the sort of concentration you get in potash
and phosphate. If you're investing in that sector, you have to be a little
careful, because we believe that nitrogen producers in North America, in
particular, are near peak margins due to the low price of natural gas, which
is a big input component. In our view, you shouldn't generally buy equities
that are about to post peak earnings and peak margins, especially when the
market already expects those peak results.
Two
companies in particular, Agrium Inc. (AGU:NYSE; AGU:TSX) and CF Industries Holdings Inc.
(CF:NYSE), have share prices near their
all-time highs, and the market's already valuing some pretty robust results
for them. We would be very cautious, and, in fact, we have an Underperform
rating on Agrium. That stock's trading a little over $102 today, and we have
an $87.50 target on it.
TER: How are
current commodity and financial market conditions affecting plans for junior
mining companies in the project development stage?
RW: It's a
challenging time. Finance risk is the key challenge for a lot of these junior
companies, whether it's potash or phosphate. That means that if you have an
ore body or an asset, it needs to have some competitive advantages, for
example by being a low-cost operation either at the mine level or through low
distribution costs. We look at projects like Allana
Potash Corp. (AAA:TSX; ALLRF:OTCQX) in
Ethiopia, for example, which looks to be well positioned as a low-cost
operation at the mine gate and could be one of the lowest-cost delivered
potash suppliers into India, which has no domestic potash. Companies are
better off when they have these types of strategic advantages, but at the end
of the day, the finance risk is still an overwhelming one today.
There is
one development stage fertilizer company that we're most intrigued by, and that's
MBAC Fertilizer Corp. (MBC:TSX;
MBCFFOTCQX), because its finance risk is now
largely behind it—it is about to move into production in the next few
months or so. It has a phase one phosphate project in Brazil called Itafos,
right in the Cerrado, which is the breadbasket of Brazil. It also has another
phosphate asset to the north of the Cerrado. This company has a logistic
advantage because half of the phosphate fertilizer manufactured in Brazil
uses imported rock from Africa. We are extremely interested in this stock and
it has our Top Pick rating in the sector. We have a $5.25 target on the stock
with an Outperform rating. Frankly, the company is a potential acquisition
target because there are parties that appear to be aiming to consolidate the
phosphate fertilizer sector in Brazil. We believe MBAC Fertilizer is one to
own for 2013.
TER: It's nice
to see some blue sky on the horizon.
RW: I'm not a
complete bear on the sector. There are some bright spots in my coverage list.
TER: Do you
expect any other interesting M&A activity in this industry due to current
market conditions?
RW: I don't
see much particularly different about 2013 versus 2012 as far as the macro
call goes. There's been expectation for some time that the Indians and/or
Chinese would come in and buy up more of the junior fertilizer companies to
help secure supply, particularly in the potash sector. That just hasn't
happened yet. One thing that's different about 2013 is that there should be a
number of bankable feasibility studies completed this year, which will help
derisk a number of the early-stage projects. It looks like Allana Potash is
expecting its bankable feasibility any day now and d'Arianne Resources is expecting
a bankable feasibility mid-year. Elemental
Minerals Ltd. (ELM:TSX; ELM:ASX; EMINF:OTCPK) has a bankable study expected in the second half of 2013 on its
potash project in the Republic of the Congo. Even IC Potash Corp. (ICP:TSX;
ICPTF:OTCQX), which is a company looking to develop
a sulfate of potash fertilizer project in the U.S., expects a bankable study
in mid- to late 2013 as well.
There are
number of bankable feasibility studies coming, which will help derisk these
projects and could spur some investment by the likes of the Indians, the
Chinese and even the Brazilians as they look to secure fertilizer, but time
will tell. Because finance risk is quite significant for these companies,
they ultimately need strategic partnerships and/or offtake agreements to help
mitigate that risk. So as these studies come out in the next 6–12
months, that could change the equation for many of them. We'll have to wait
and see how that plays out.
TER: You
talked about MBAC, which you like. What's the situation with PotashCorp. (POT:TSX; POT:NYSE)?
RW: We're
bearish on that one. I believe we have the only Sell rating for that stock on
Bay Street and Wall Street. So if you like contrarian views, that's us. The
potash commodity supply/demand situation is not particularly compelling. In
terms of valuation, we look at that company as having mid-cycle earnings
around $3.05 a share in our 2014 estimate. A typical multiple on mid-cycle
earnings tells us this stock is overvalued at $41–42. The Street and
most analysts seem to love it. They believe it's worth $50+. Considering the
cyclical downside potential for grain, we're not of that view. We had a sell
on it for most of 2012 and it's been the right call. We'll have to see how
2013 plays out.
TER: What do
you see ahead for fertilizer producers and how can investors position
themselves in this industry, if they like the future prospects?
RW: It's as
simple as this: The correlation between grain prices and agricultural
equities, particularly the fertilizers, is quite high. Grain prices have
retreated of late but still appear to have more downside risk than upside and
we would argue over the next year or so, barring unforeseen supply shocks,
the trend for grain prices is for further downside. If you're of that view,
then the bias for the agricultural equities would be down as well. So we're
pretty cautious here. We'd be inclined to sell into strength, if these
agricultural equities rally, and focus more on the supply/demand fundamentals
for grains. With that view, we have only a select few buys and we're more
cautious with a number of sells in our universe.
TER: And
there's a little bit of news on the horizon for mid-year with some of the
smaller companies if they can get their act together.
RW: That's
correct, on the bankable feasibility studies coming out.
TER: We
greatly appreciate your time and input today, Robert.
RW: Thank you
very much.
Robert
Winslow is an agriculture research analyst
and director at National Bank Financial (NBF). Prior to joining NBF, Robert
was an analyst, managing director, and the head of research at Wellington
West Capital Markets Inc. (WWCM). Prior to WWCM, Winslow was a special
situations analyst at Orion Securities. Winslow began his career at Solar
Turbines Inc. (a Caterpillar company) in Dallas, TX, where he was a senior
product engineer. He has a Bachelor of Science in mechanical engineering from
Queen's University, a Master of Science in mechanical engineering from Texas
A&M University, and a Master of Business Administration from Cornell
University. He also holds the Chartered Financial Analyst (CFA) designation.
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DISCLOSURE:
1) Zig Lambo of The Energy Report conducted this interview. He
personally and/or his family own shares of the following companies mentioned
in this interview: None.
2) The following companies mentioned in the interview are sponsors of The
Energy Report: None. Interviews are edited for clarity.
3) Robert Winslow: I personally and/or my family own shares of the following
companies mentioned in this interview: None. I personally and/or my family am
paid by the following companies mentioned in this interview: None. I was not
paid by Streetwise Reports for participating in this interview.
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