Farming is an up-and-down business, and so too are the businesses for farming inputs like equipment and fertilizer. In the case of Mosaic (NYSE:MOS), investors have been trying to digest the news of production cuts across the sector and weighing that against what looks like a pretty healthy North American planting season. Although volatility means this is a poor candidate for long-term buy-and-hold investors, today's valuation on Mosaic makes it worth a look from investors seeking shorter-duration trading opportunities.
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A Decent Fiscal Second Quarter
In many cases, Wall Street doesn't care much about what fertilizer companies like Mosaic or Potash (NYSE:POT) report for earnings, as so much attention is given to forward-looking comments on volume and pricing. Nevertheless, Mosaic did alright this time around. (For related reading, see 2011 Look Back At Agriculture.)
Overall gross profits grew 15% from last year, with the phosphate business basically flat and the potash business up 38%. Volumes and pricing were generally weak in both segments, but the company did pretty well on costs - especially in the phosphates business.
A Tougher Economic Environment?
In recent weeks and months, there has been ample discussion of production cuts and inventory concerns in the fertilizer business. Potash, UKRA and Mosaic have all cut production recently, as it seems that fertilizer purchases for the North American spring planting season have been light.
Analysts are generally blaming this on the macroeconomic situation, but that raises the following question - is that the same macroeconomic situation that has been relatively healthy for seed companies like DuPont (NYSE:DD) and Syngenta (NYSE:SYT) and farm equipment companies like Deere (NYSE:DE) and CNH (NYSE:CNH)?
Like as not, this feels like a temporary problem. The prices of crops like corn and soybeans are still pretty strong on a relative basis and soil quality is not improving. That argues for solid eventual sell-through of inputs like fertilizer, but if this sort of unpredictability bothers you, Mosaic is not a stock for you.
A Solid Long-Term Business
Fertilizer prices always have been volatile and they likely always will be - even though its increasingly an oligopoly type of industry. Mosaic is the largest phosphate producer in the world and phosphate mines are not a dime-a-dozen. Likewise, Mosaic is the #3 player in the increasingly-concentrated potash industry, where 80% of the market belongs to about six companies.
Is fertilizer getting more attractive? Clearly, the recent spikes in food prices have drawn more attention to the importance of agricultural inputs. Moreover, the reported interest of large miners like Rio Tinto (NYSE:RIO) and BHP Billiton (NYSE:BHP) in diversifying and expanding into fertilizer adds some credibility to that thesis. Likewise, that could provide some underpinning to valuations in companies like CF Industries (NYSE:CF), Intrepid Potash (NYSE:IPI), Agrium (NYSE:AGU) or Yara (OTCBB:YARIY) - if these stocks get too cheap, buyers could step up.
The Bottom Line
Although the unwinding of the large ownership interest of the Cargill Trust complicates the picture for Mosaic a bit, it doesn't change the fact that this company is one of the world's largest fertilizer concerns. What's more, positive points like the opening of a new facility in Saudi Arabia and the growth of the premium-priced MicroEssentials product line should mitigate any discount that investors would think of applying because of Cargill.
Like almost any commodity company, cash flow modeling is almost useless with Mosaic and most investors go with EV/EBITDA models. Giving Mosaic a 7-times multiple to 2012 numbers suggests that these shares should trade in the mid-$60s - a decent prospective return as part of a diversified, risk-tolerant portfolio. (For related reading, see Relative Valuation Of Stocks Can Be A Trap.)
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At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.