Investors Bet on Fertilizer Plays as Food, Oil Spike

Japan’s 9-magnitude earthquake put the breaks on runaway oil prices last week, but only just, as the Middle East turmoil pushed Brent crude beyond $115/bbl on Monday. Food prices continued their surge with corn prices up 86 percent from a year ago.

Matt Rourke

But some portfolio managers have found a way to ride out this inflation trend. They are looking at fertilizer plays to hedge against higher oil and food costs. Prices of major fertilizers like phosphate, sulfur and ammonia have been rising since mid-2010, given higher grain prices, and so have the stocks of the companies that produce them.

One of them is Incitec Pivot, which is the only manufacturer of phosphate fertilizers in Australia. The company's main product is di-ammonium phosphate fertilizer, or DAP. It's used intensively to produce corn, which in turn is the main raw material for producing bio-fuels such as ethanol.

"[Incitec Pivot] is a double hedge because a lot of DAP production that comes out of the Arab world is disrupted and higher oil prices would push for more use of ethanol as a source of energy," said Sean Fenton, Portfolio Manager of Tribeca Investment Partners, a fund management company based in Australia.

Other DAP producers such as U.S.-based Mosaic, Canada's Potash and Agrium are also good fertilizer plays cashing in on higher prices.

DAP prices have risen 35 percent since July last year. Prices have continued to rise this year as well with current prices above $600 per ton compared with $570 per ton at the beginning of the year. But farmers in the US, for example, have not been deterred by the high cost of fertilizers.

According to Ben Clark, Portfolio Manager of TMS Capital, which is also invested in Incitec Pivot, farmers are willing to pay more for fertilizers now because of strong corn and wheat prices. “They want to make their crops as productive as possible [in order to] take advantage of strong prices."

Corn prices are just off the two-and-half-year high of $7.4 a bushel. They've risen 10 percent over the last three days on news that China has entered the market to buy corn after staying away for a year.

As a result, shares of Australia-listed Incitec Pivot have surged almost 60 percent since July 2010. Shares of competitor Mosaic have shot up 24 percent in the last six months and Agrium is up 19 percent. On the other hand shares of Potash have plunged 63 percent over the same period, but that has been largely due to the failed bid from BHP Billiton.

According to Daphne Roth, Head of Equity Research from ABN AMRO the reason why Incitec Pivot is especially attractive is that it has a lower cost base compared with other fertilizer manufacturers. The company mines its own phosphate rock, which is the raw material for DAP. It also has long term natural gas supply contracts (to produce ammonia) at prices below current international levels. As a result, its input costs are less than half of most of its peers in the world.

Roth thinks this is a good time to get in as Incitec Pivot’s stock has pulled back about 10 percent over the past two weeks to $4.20 (Tuesday closing price) due to the overall negative sentiment. Her 6-12 month target price for the stock is $4.77. Tribeca Investment's Fenton has set the target price at $5.47.

Incitec Pivot is also trading at a lower price to earnings ratio than most of its North American peers. The stock is currently at 12.1 times 2012 forecast earnings, compared with Mosaic's, 14.1, Agrium's 11.6 and Potash's 14.4.

But fertilizer producers, especially those that manufacture DAP, also face a growing risk from high energy prices. If oil prices shoot up to levels that would push the world back to recession, fertilizer stocks could see a rapid unwinding of recent gains. "But as long as grain prices stay high, I can't think of a reason why the stock won't do well," said Roth.