An Intriguing Mosaic

The relationship between grain prices and fertilizers is pretty clear. It’s all about profits. Let’s take corn. Higher corn prices mean more profits for farmers. Fertilizers help grow more crops. So high corn prices encourage more corn planting – which leads to more fertilizer use. At today’s prices for corn and fertilizer, a US farmer can clear about $2 a bushel on corn. So net cash income is high for farmers right now. Today’s farmer also carries low levels of debt, relative to times past.

All of these factors add up to one very likely result: robust demand for fertilizer.

About a year ago, I urged the scrubbers of my investment letter, Capital & Crisis, to invest in PotashCorp (NYSE:POT), the world’s leading supplier of potash fertilizer. The stock has nearly doubled since then. Despite the strong performance, I still consider POT a very solid long-term investment. But POT is not the only attractive opportunity in the fertilizer sector. The Mosaic Co. (NYSE:MOS) also offers a very compelling investment profile.

Mosaic is the leading producer of phosphate fertilizer and the No. 2 producer of potash. The company, which operates primarily in Canada and the US, generates about half of its earnings from potash and half from phosphate. However, the company will be expanding its potash production from 10.4 to 16.8 million tonnes over the next 10 years. This will move the business mix to about 60% potash and 40% phosphate. A good thing too, as the investment case for potash is the strongest of all the nutrients. (High-quality potash mines are scarce, and most of them are in the hands of only a few players.)

This fact does not diminish the potential of Mosaic’s phosphate business, as the company’s phosphate operations are among the lowest cost in the industry. But I think Mosaic’s potash operations provide most of the sex appeal for this stock.

This year, worldwide potash purchases fell to unprecedented lows. In the first half of the year, the major markets cut their import needs dramatically, as the nearby chart shows.

As a result, potash prices and volumes fell. That is why Mosaic’s stock price is 60% off its all-time high of $163. Yet the long-term picture looks as bright as ever for this stock. So I’m expecting a big rebound.

One other potash-specific nugget: Passport Capital estimates that the potential demand for potash just from the BRIC countries – Brazil, Russia, India and China – is about 30 million additional tonnes. That’s a big nut for a market that has only 54 million tonnes of total capacity right now.

So Mosaic sells a product that is not going out of style anytime soon. Investors can afford to wait for the rebound, which could begin as early as next spring, when the new planting season begins.

But even if fertilizer demand does not recover as quickly as I expect, Mosaic’s solid balance sheet provides a large margin of safety. The stock sells for less than its net asset value, or what it would cost you to rebuild the company from scratch. As you can see, Mosaic’s NAV is about $68 per share, compared to the current price of $60 per share. [The stock was changing hands below $50 when I recommended it to my subscribers on November 6. But I would still recommend buying MOS on pullbacks].

This table utilizes approximate replacement values based on industry estimates to start, say, a new potash mine. But these estimates give no additional credit for the fact that it would take at least seven years to get a new potash mine up and running; or that it would take three to four years for a new phosphate facility. Add a few more years to those numbers if you would need to install infrastructure like ports, rail and roads.

At current potash prices, new expansions don’t make economic sense. Many new projects have been deferred or canceled altogether, which sets up the potential for more bottlenecks and price spikes in the future.

Cargill owns 64% of The Mosaic Co., which means that there is some rock-solid agricultural expertise behind this company. Cargill, privately owned, is a large agricultural firm. It started with W.W. Cargill’s small granary on the American frontier in 1865. Today, Cargill employs 159,000 people in 68 countries. James Prokopanko, the CEO, is a Cargill man. (He is a former Cargill VP. Much of the Mosaic board has connections with Cargill.) Rest assured he doesn’t do much of anything without checking in with the boys in Minneapolis first.

Mosaic is an excellent way to participate in the long-term bull market for agricultural commodities. If things play out as I think they will, the stock could be a $100 by next spring.

Regards,

Chris Mayer,
for The Daily Reckoning