While it's psychologically much easier to step into a stock or industry that's exhibited long-term bullish momentum, the reality is, it's generally more profitable to step into a stock or industry that's been beaten to death for quite some time, but is suddenly - largely out of nowhere - starting to perk up. That's fertilizer and agricultural chemicals right now. Before you scoff or quit reading though, let me make the case.
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From Worst to... Well, Pretty Good
It may be hard to believe, but the fertilizer and agricultural chemical stocks weren't the absolute worst performers over the last 12 months; that honor is held by the Tires & Rubber Sector (-32.5%). The S&P 1500 Fertilizer and Agricultural Chemical Index comes after that, with a lousy 26.7% loss for the period.
Over the last two weeks, however, these stocks have managed to make their way into the top 25% of all industry groups with a nice 14.6% rebound - much better than the broad market's 7.1% gain for the same timeframe.
Too soon to call a recovery move? I can't entirely disagree. On the other hand, if we were going to wait for perfect confirmation of a rebound before diving in, we'd be wading in around their apex. Sometimes, if you want the bigger rewards, you've got to stick your neck out a little bit.
That said (and here's the one-two punch), the technical demise of fertilizer names has been so mentally taxing, investors have largely stopped looking at them. As such, they've not noticed that many of these names have recently revitalized their income statements. There's your opportunity.
To be fair, there's still some dead weight in the agricultural chemical group. However, there are just as many - if not more - stocks in the group that have started to put up numbers that are better than their stock prices would indicate.
Scotts Miracle-Gro (NYSWE:SMG) is one of them. Though the company took losses in its fiscal Q1 of this year and Q4 of last year, that's the norm for this calendar-based business. What's compelling here is how badly Scotts Miracle-Gro trounced second quarter's EPS estimates of $1.46 with a solid $1.80. Potash (NYSE:POT) is another fert name that's been stunning the analysts of late, with three consecutive earnings estimates 'beats' - the last one being a big one. Potash tuned in a profit of $1.47 per share last quarter, versus an expected $1.31.
So what brought about these changes for the better that nobody really saw coming?
For some time, fertilizer companies had been so unwilling to lower prices that they had priced themselves out of the market. Sure enough. farmers largely skipped the use of fertilizer for 2009's growing season. But farms couldn't forgo fertilizer forever, and would need to resume its use sooner or later - most likely when fertilizer producers priced their goods more reflective of the economic environment (i.e. when they felt the pain of a shrinking top line).
Care to guess what happened between now and then? Potash prices fell from about $440 per tonne to $320 per tonne, and are now well under peak price of $860 per tonne - the price that really started the revenue tumble for fertilizer companies - from early 2009.
So all is better now? I wouldn't bet the farm (no pun intended), but ironically, cheaper fertilizer is actually more profitable - in absolute terms - for fertilizer and agricultural chemical companies than excessively-priced fertilizer is. It makes it affordable. At the same time, the International Fertilizer Industry Association recently published a report calling for 4.8% increase in fertilizer usage in the 2010/2011 growing season over the prior year's - a growth rate that should be sustained for at least the following four years as well.
So yes, this does bode well for the industry's stocks - a welcome relief for investors. In fact, the stronger numbers are already sprouting. For instance, Monsanto (NYSE:MON) topped last quarter's earnings estimates by a penny, which isn't much, but a sign of life all the same.
The real diamond in the rough, however, is CF Industries (NYSE:CF). Though earnings have missed as often as they've hit over the prior four quarters, in summation, they've been more encouraging than not, especially as of last quarter, when lower fertilizer prices had a chance to have an impact. And, considering CF boasts a plausible projected (2011) P/E of 9.5, it's the biggest bargain in the bunch.
The Bottom Line
That said, many fertilizer and ag names have serious rebound potential from here, as long as fertilizer prices don't go hog-wild again. (Learn why it may be profitable to invest in beaten down stocks in Buy When There's Blood In The Streets.)
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