The prices of food commodities and fertilizers are hitting new highs. Demand for fertilizer products is high while supplies are constricted by several factors. Producers of fertilizer are seeing large margins and tremendous growth in earnings.
One of the most undervalued fertilizer producers is The Mosaic Company (MOS). The stock has returned 59.8% in the last year, quite the bumper crop indeed. I bought the stock in 2021 with the backdrop of inflation and higher food prices. The fundamentals still look healthy, but this trade is starting to look ripe for the picking.
The Business Model
The Mosaic Company (MOS) is one of the world’s leading producers of fertilizer. The company primarily produces Phosphate and Potash fertilizers and have capacity for 25 million tonnes of annual production. They are the largest producers in North America accounting 73% and 40% of North America’s phosphate and potash annual production.
Their main products include:
Diammonium Phosphate (DAP)
Monoammonium Phosphate (MAP)
White, Red, and Crystal Potash
Nitrogen, phosphorus, and potassium are the three most needed and applied fertilizers for crop production. Unlike nitrogen, which is easily used or lost each year, potassium and phosphate fertilizers are often applied irregularly as concentrations in the soil are slow to decline and can remain at sufficient levels for multiple crops.
Nitrogen is produced by fixing atmospheric nitrogen with large amounts of energy, usually from natural gas. There are no nitrogen deposits. Phosphorus and potash, on the other hand, are found in mineral deposits that are mined out of the ground. This means that potash and phosphate producers have better inflation protection as they already own their minerals and aren’t as reliant on energy to produce them. It also means that they own mineral assets that are few in number and depleting.
Most of the MOS deposits are in the US, Canada, and Brazil. These are also the primary countries they market to.
The most significant crops for MOS’s market is corn and soybeans. In the US there is a positive trend for acres planted of both crops:
Brazil is an agricultural market demonstrating strong growth. The soils in Brazil are generally low in fertility, due to the climate, and the company is expected to finish 2021 with record fertilizer shipments to Brazil:
At the company’s Q3 2021 earnings call, management emphasized that demand for fertilizers continues to be strong. They provided updates for a few production changes, which will cause a reduction in CapEx spending this year:
- Hurricane Ida caused a production loss of 300,000 tons at the New Wales facility in Q3. They expect to be back to full production by Q4 or Q1 2022.
- The K3 facility is expected to reach full production by Q2 2022
- The Colonsay mine is now at full production of 1 million tonnes per year
Company performance is closely correlated with farm profits of major crop commodities, with the exception of the energy and commodities frenzy of the late 2000’s:
This is because higher commodity prices can support, and often cause, higher fertilizer prices as farmers are willing to pay more. Fertilizers and crop prices have been accelerating dramatically since 2021:
Despite higher prices production has not been able to catch demand. The global balance, or difference between supply and demand, for fertilizers are expected to decline in 2022, suggesting further deficit:
North America is not expected to have a deficit but Latin America, including Brazil, is expected to be among the worst deficits:
Partly this is because world crop production continues to grow at a steady rate:
MOS expects agricultural commodity prices to remain strong in 2022. Nutrien CEO Mayo Schmidt observed that demand is still high when he said this in November:
We’ve had very good pricing and we’re continuing to see very good strength. Our greatest challenge is getting the tanks filled because the lineups are significant.
Nitrogen prices are elevated primarily due to high energy costs and recent drops in production. Natural gas inventories are expected to improve as production catches up with demand, and consequently so will nitrogen production. MOS expects nitrogen fertilizer prices to come down this year due to these factors. This will benefit MOS as it reduces costs for both farmers and MOS, as the company uses nitrogen for the production of phosphate.
The company says that high fertilizer prices are due to reduced exports globally, especially from China, coupled with strong demand and reduced inventories. The International Fertilizer Association in their Medium-Term Fertilizer Outlook Report expects global fertilizer demand to grow by 0.9% in 2021/2022.
Josh Linville, director of fertilizers at StoneX Financial expects phosphorus demand to remain steady in 2022 if commodity prices stay elevated. Farmers tend to cut back on inputs, such as fertilizer, when prices rise, bringing self-regulated balance to the market. This is a risk to MOS if demand starts to decline and takes prices and margins with it. However, with crop prices as high as they are most farmers are trying to maximize profits which means planting the most acres and trying to get the best yields.
In December, the US imposed sanctions against the potash exporter Belarus Potash Company. The company sells potash globally, including to Brazil one of Mosaic’s primary markets. US companies have until April 1 to cease doing business with the company which accounts for 21% of all potash trade worldwide. On February 1, Lithuania halted the use of rail freight and sea ports to transport Belarusian potash to Europe, accelerating the impact on global markets.
Last September China banned exports of phosphate until June 2022 at the earliest. This represents about 30% of world phosphate trade. This dramatic policy may be solely responsible for the increase in phosphate prices since the announcement. Until the ban is removed and China starts exporting into the market again the supply side of the market is going to be significantly constrained.
The conflict between Russia, Ukraine, and the US continues to escalate. With peace, analysts are forecasting lower fertilizer prices in the second half of 2022. But with Belarus fertilizer supplies now rerouting to Russia, and Russia being a major exporter itself, any conflict will have a major impact on markets.
These global market conditions justify current fertilizer prices. However, there are not many catalysts left for higher prices besides war. Inflation and supply / trade disruptions produced the current environment. If any of these situations were to improve prices would decline. We know that China might be back into the market in June. Belarus could take longer than that.
Signs of inflation easing are beginning to appear. A series of economic indicators are forecasting low growth, including Manufacturing ISM:
Inflation breakevens are falling, suggesting near term weakness in oil:
With the probability of rate hikes a near certainty this year, the new rate hike cycle does not bode well for agricultural commodities.
The worst thing that can happen to a company like MOS is lower fertilizer prices. Given all this information my judgment is that fertilizer prices will remain strong through the first half of 2022 and begin weakness in second half of 2022.
The company is trading at several low valuation metrics. It boasts a forward GAAP P / E of 9.63 and historically low EV to EBITDA ratios.
I find the P / OCF attractive at 6.57x with 56% OCF growth forecast for FY2022.
Because I’m expecting weakness in fertilizer prices soon I prefer to stick with the current P / E multiple for forecasting. This still results in a 58% total return this year.
I’m not super excited about the company’s history of EPS and profit margin. They’ve been under-performing until this price shock in 2021. I hope they do well with their new good fortune. Management announced $ 1 billion stock repurchase program in August but its hard to get excited when they later announced that a stockholder will be selling 34.1 million shares in a secondary offering, even though they plan to buyback 25% of those shares.
The Mosaic Company sells a product that everyone needs. Right now, customers are willing to pay up for it. The company is profiting handsomely from these ideal market conditions. But this success is likely fleeting. It’s hard to get much better and its easy to get worse. Given their current valuation I can see one more good year with double digit gains for MOS. If China extends the export ban, may be more. But I think this one is getting close to ripe and I will not hesitate bringing in the harvest.