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The
recent tumultuous downturn in stocks has created deeper values and new
opportunity in the agricultural space. Dahlman Rose & Co. Managing
Director Charles Neivert is a near-term bull on fertilizer companies, but the
window could close and diminish prospects in the not too distant future. In
this exclusive interview with The Energy Report, Charles talks about
the complex dynamics that affect the farming and fertilizer industries, and
reveals his best pick for a core holding.
Companies Mentioned: Agrium Inc. - BHP Billiton Ltd. - CF
Industries Holdings Inc. - CVR Partners, LP - Intrepid Potash, Inc. -
PotashCorp - The Mosaic Company
The Energy Report: Charles, I was looking at an
un-weighted basket of fertilizer stocks, and they were down about 23-24% for
the last week of July through the first six trading days of August. Has this
opened up some tremendous value for investors? Or is this downturn signaling
a commensurate slowdown in agriculture along with the general economy?
Charles Neivert: I think that as a group this is probably more of a
signal of a very strong value for investors over the next three to six
months—possibly longer than that depending on the company. We don't see
a great change in the agricultural landscape due to the changing economy. It
is certainly part of the things going on, but it may have less bearing on the
fertilizer names than some other material spaces. That's simply because food
is involved and the grain crop out there that may have been damaged in some
ways—though possibly not quite as definitive as we might see in other
products. As a result, we think there is a lot of value in the fertilizers.
TER: The key difference is that it's food?
CN: Yes. The demand for food is less elastic. Certain amounts of food
are needed to keep going and global inventory is limited. This year, a number
of grain crops were not exceptionally large. As a result, we don't see a big
rebuilding of inventories. The potential is that the price of some of these
grains could continue to go up if the harvest does not come up. So, you could
see things going up even though the economy is backing off simply because
supply is being cut away.
TER: It sounds like you are near-term bullish on some fertilizer
names, but that you have longer-term fundamental concerns.
CN: Yes, that is the case. Company prospects really depend on which
nutrient is involved during which timeframe. The near-term is very good, I
think, for any nutrient given the food and grain situation. However, as you
mentioned, fundamentals for some of these products could potentially
deteriorate over time while others are likely to be stronger for a little bit
longer.
Again, given the nature of the agriculture business, it is really difficult
to have a very long-term outlook within the context of a potentially
extremely volatile production range, meaning grains. That is because the
grains can go anywhere from very, very large harvest years to rather
challenged times without any real rhyme or reason. There are no traditional
business cycles. The agricultural cycles are all based on weather. If weather
is extremely cooperative across a broad range of geographies, you could have
an enormously large crop at a time when you don't really want an
enormously large crop. You may already have inventories, but there is not
much you can do about it.
You might also get a small crop on top of small inventories, or something
in-between. You don't have the same control, particularly on the supply side,
as you do with a manufacturing operation that can back off production when
inventories are long. For the most part, the rules that governments have put
into place to enforce land set-asides to help control production, have
largely been abandoned. Those policies are no longer
used, particularly in the U.S. and even in some other areas. So, you can get
large or small crops completely opposite of what you might want or need at
that time.
TER: Let me just flip here to the macro-economy for a moment. In a
detailed statement following a meeting of the Federal Open Market Committee
on August 9, the Fed signaled a prolonged period of slow growth and, in an
extraordinary comment, said that interest rates are expected to remain low
until mid-2013. How does this affect the agricultural universe?
CN: Well, those rates are pretty much focused on the United States.
So, I don't think it really has that much of an impact on the Ag space. In
fact, it may have none. Low interest rates, to the extent that they affect
the dollar could present some potential challenges because the dollar is weak
or because the dollar is strong. That does have a
lot to do with corn or soybean costs to potential importers of U.S. products
versus some competitors. But, it will have nothing or little to do with what
the farmer is going to plant in any given year.
TER: Charles, what are your institutional investor clients telling you
now during this selloff? Are they holding off on buying stocks for fear of
needing cash for redemptions at this point?
CN: Each portfolio manager may take a different tack, so really this
one is a little hard to answer. My guess is that now people are moving and
seem to like the Ag space for the time being. We are seeing good activity. A
lot of it is to the buy side where activity levels are good.
TER: Can a case be made that some of these plant nutrient producers
are defensive stocks?
CN: In the current environment, you can make that argument. They are
not typically defensive in the way you think of a
food stock in a recession. In a recession, these
guys get hit. When grain production is being challenged, they become
defensive opportunities.
TER: Potash is traded in a negotiated market, not a globally efficient
and tight market. But we have seen some transactions of $490/ton in India.
Could this represent an upward trend?
CN: Well, the price of this product has been coming up for over a year
now as demand has come back from the trough of 2009. I won't say it's
impinging on capacity, but it starts to be a snug market because we have run
through a fair amount of inventory over the last year to a year-and-a-half.
That is what ultimately justifies the fertilizer price. For the sake of
argument, if this year's crop turned out to be extremely large and we rebuilt
inventories substantially, fertilizer pricing would have a very tough time
going up from here. By the same token, if the crop comes in short, and the
way it's looking, it would increase the price of grains and therefore be a
bit supportive of a price increase in potash. What we found in 2008 was that
crop price is a very important determinant in what the fertilizer price can
ultimately do.
TER: Are you currently bullish on potash as a commodity?
CN: No. Near term I like all the names and products, but on a
longer-term basis, I'm not as bullish. I see an awful lot of capacity on the
horizon. Some has begun to come up and more is coming over the next few
years. It will be a pretty steady stream from a very
wide variety of potential producers and some new entrants.
TER: At what price-per-ton would you be bullish on potash equities
generally?
CN: I don't look at the price of the product
as a sign at all. I look at the price and prospect for the grains and
consider what needs to happen from that point. So, when grains are at low
prices and the crop is looking strong, I'm not going to be bullish.
TER: Is the extraordinary heat wave in the U.S. affecting crops?
CN: It's definitely affecting crops. The timing of the heat wave is
also an issue. If you get periodic rain, it reduces that impact. But, there
are times where heat can be extremely damaging and other times when it's less
damaging. If heat hits at certain points of the growth cycle, plants can be
far more damaged than at other stages of their growth. The heat that came
through the Midwest earlier in the year hit around a time when certain plants
were going through a key stage maturation, and that can be a problem.
TER: Is there a play for investors on drought-resistant crops?
CN: Seeds haven't yet gotten there. There is no seed out with the
label of drought-tolerant. It's hard to say resistant. It's really a matter
of degrees. If you get no water, nothing will help you. But, if you get
smaller amounts than normal, some seeds under development will still produce
near- or full-yields under less-than-ideal conditions, but they are not in
the market yet. They are within a few years, so the claim goes, and we will
see when they make it. All the major seed players are working on that
particular trait. You can get into the companies that would provide that
pipeline by looking at the typical seed names of the world—du Pont de
Nemours & Company (NYSE:DD) and Monsanto Company (NYSE:MON).
TER: Low equity prices have left a lot of companies with cash on their
balance sheets. What does this bode for M&A activity?
CN: It's a tough call. It depends on the product because some of the
markets may be so consolidated already that it will be difficult to get
anything by the antitrust people. Cheap prices may or may not allow for
acquisition because people will look at the price from six weeks ago for
comparison. A perfect example is what PotashCorp
(TSX:POT; NYSE:POT) went through when BHP Billiton
Ltd. (NYSE:BHP; OTCPK:BHPLF) took a run at them. The stock was down in
the high '80s to low '90s for a long time. BHP was thinking it could get the
company for $130, but just before the offer, PotashCorp's share price went up
to $106 because the wheat market in Russia started to give way. Russia was
experiencing a serious drought. The prices started to move up, and even
though the $130 offer was actually still a pretty substantial premium, it was
not accepted. Not only was it not accepted by the company, but, as conditions
in the grain marketplace worsened with stress from the U.S. corn crop, that
price got even higher. So, it easily surpassed the offer number. Either
people were expecting a much higher bid, or something is going on that makes
the stock just worth more—like getting another bid. When the BHP bid
was pulled, the stock didn't drop.
TER: What are you telling your clients right now Charles? Where are
the value and the growth stories?
CN: The name we like the most in the group is CF
Industries Holdings Inc. (NYSE:CF) because we see the pressure on the
corn crop in particular leading to a very positive, constructive situation
for corn into 2012. The biggest beneficiary of a corn crop that needs to have
a very large planting is more likely to be a name that is heavy in nitrogen,
as opposed to one heavy in potash and phosphate.
We think there is going to be a fairly significant increase in corn acres planted
next year, and if you need acres in corn, the U.S. doesn't have a lot of new,
unplanted acres to go after and would have to probably use acres currently in
another crop. Often that tradeoff is in soybeans, which would result in an
increase in the application of nitrogen.
TER: Even in this downturn, CF Industries is still up 82% over the
past 12 months and it's flat over the past month. So, it's held up pretty
well under this pressure.
CN: CF Industries is our only straight-out buy. We've been recommending
this stock for a long time. Even when I was less constructive on the
industry, this was the name we liked the best.
TER: Even though CF Industries is your only straight out buy-rated
stock, you still recommend that money managers create a basket of these
stocks, do you not?
CN: Right.
TER: And, what would that basket include?
CN: We are sort of constructive on all the fertilizer names, at least
through the fall application season and possibly a bit beyond. CF is only in
nitrogen with some phosphate exposure and no potash exposure. So, we would
tell people to get some potash exposure, but pick your name carefully. We
lean toward PotashCorp as a name, but you have to look at it at that moment
in time and see how the company is performing against The Mosaic
Company (NYSE:MOS) or Intrepid Potash Inc. (NYSE:IPI). It's really a close call
based on a lot of different metrics. That is why we recommend a basket within
the group to your preferred weighting. You have to own some of everything,
but include some of all of the nutrients. You could cover it all with two or
three stocks in the basket.
We have upgraded the entire industry to an attractive level, and in a strong
agricultural situation, you don't want to be left completely unexposed to one
particular nutrient because they will all move well and you want to catch
some of that. It's always hard to tell which one will be the best of the
group.
TER: These companies are all mid- and large-cap. Are there any small-
or smaller caps under a billion dollars where
investors might be able to get a little more leverage?
CN: The only one that I deal with that gets down close to that range
is CVR
Partners LP (NYSE:UAN). It is a pure play on the nitrogen side structures
as an MLP (Master Limited Partnership). It features a good payout, but tends
to mute the share price a bit.
TER: Want to mention any other phosphate, potash or nitrogen
companies?
CN: The only company I haven't mentioned in the universe is Agrium Inc.
(NYSE:AGU). I hesitate to use the word defensive play, but it has a big
retail operation that it uses very effectively to move an awful lot of
product. It does very nicely in that business. It is also spread across all
the nutrients. It has nitrogen, potash and phosphate exposure. It also
happens to be based-in and sell a lot of product in Canada, which means that
it is a bit isolated from the rest of the market. That actually gives the
company a pricing advantage because the market up
there is a bit higher-priced. Its big retail exposure is sometimes a little
bit of a turnoff if what you are trying to do is play the fertilizer space in
a pure way. It's a good company and well run. But, people tend to look at it
and say it's not exactly what they are after.
TER: Charles, thank you very much for your time today.
CN: Thank you.
In May 2009, Charles Neivert joined investment bank Dahlman Rose &
Company LLC as managing director to head the firm's new Agriculture and
Chemicals Research division. Prior to Dahlman, Charles was an executive
director at Morgan Stanley where he re-launched the firm's commodity,
specialty and fertilizer chemical equity research practice. He was also
co-founder and president of New Vernon Associates, an equity research
boutique specializing in global chemicals, which was awarded Institutional
Investor’s "Best of the Boutiques and Regionals—Commodity
Chemicals" honor for nine consecutive years. At New Vernon, Charles
conducted all fundamental industry research on a global level, including
analysis and forecasting of 50 distinct chemicals. He earned his Bachelor of
Arts degrees in chemistry and economics from the University of Pennsylvania.
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