Why Fertilizer Stocks Are Hot

Their share prices might seem a little high, but they're justified given the growth these companies will continue to see.

By Ilana Polyak

Has the high cost of food put you on a long-term diet? Before you give up eating entirely, here's something that may not whet your appetite but will certainly boost your portfolio: Along with food prices, the price of fertilizer is also soaring. That's provided a terrific wind at the back of a trio of fertilizer companies: Agrium (symbol AGU), Mosaic (MOS) and Potash Corp. of Saskatchewan (POT).

To meet the soaring demand for food -- especially from developing countries -- farmers are looking to increase crop yields. As a result, the fertilizer companies keep upping their earnings forecasts, and the stocks continue to hit new highs even as the rest of the market founders. Shares of Agrium, which closed at $112.45 on June 23, are up fivefold since August 2006. Mosaic, at $150.67, is up more than tenfold since July 2006. At $236.25, Potash shares are nearly 8.5 times greater than their July 2006 price.

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World fertilizer prices soared 200% in 2007, according to the International Fertilizer Development Center. In the first three months of 2008 alone, the price doubled for potash, a key fertilizer used for growing a variety of fruits and vegetables. Prices for nitrogen and phosphate, the other two main fertilizer components, have also risen vastly, although not by as much.

Not great news for consumers, who are also absorbing other costs associated with food production, such as the rising price of the diesel fuel used to transport crops from field to table. But these are happy days for fertilizer manufacturers, especially those that mine the raw materials and make the final products, which Agrium, Mosaic and Potash do.

Why are fertilizers suddenly so hot?

First, people in developing nations are using their increasing wealth to upgrade their diets. As incomes in places such as Brazil, China and India rise, people will want more protein-rich foods, such as meat and eggs, and that means more grain for the animals that provide those foods.

At the same time, the amount of land around the world used for food production is declining. "You still need to feed 1.3 billion people in China, and the only way to do that is to improve the yield of the land," says Lei Wang, co-manager of the Thornburg International Value fund.

U.S. ethanol policy is also spurring the fertilizer boom. Uncle Sam has mandated that more of the biofuel (6.1 billion gallons in 2009 and 7.5 billion in 2012) be used to dilute gasoline, so farmers are boosting production of corn, the crop that is largely used to make ethanol in the U.S.

An imbalance between supply of fertilizer and demand is likely to continue for some time. "It will take another five to seven years for any new mining sites to come on board," says Thornburg fund manager Wang.

These trends are likely to provide just the right growing conditions for fertilizer companies and their stocks for the foreseeable future. "High prices of commodity crops result in farmers being concerned about maximizing yield rather than controlling costs, pushing the rest of the inputs, such as agricultural chemicals, higher," Goldman Sachs analysts wrote in a recent report.

As a result, Agrium, Mosaic and Potash have posted some stupefying numbers over the past year, and there's no indication yet that earnings growth is about to slow down. For example, analysts on average expect Potash to earn $11.34 per share this year and $18.43 in 2009, according to Thomson Financial, compared with actual profits of $3.36 per share in 2007. Mosaic was expected to have earned $4.19 per share in the fiscal year that ended in May; analysts see $12.83 per share in the year that ends next May.

On the surface, the stocks don't look especially cheap. Potash sells for 21 times expected 2008 earnings and Agrium for 14 times estimated '08 profits of $8.18 per share. Mosaic sells for 18 times estimated profits of $8.54 per share for the 12 months that end next November. But with strong profit growth apparently baked into the cake, the stocks should continue to flourish. "They are a little bit rich, but when you look at earnings growth in the triple digits, the share prices are pretty justified," says Shawn Price, manager of Touchstone Large Cap Growth fund.