“‘The Big One’ … The Single Greatest Way to Play the Next Agricultural Boom”

Looking at another "Investing with Michael" teaser from Lombardi

By Travis Johnson, Stock Gumshoe, January 24, 2012

As I promised yesterday, there’s a second “special report” being teased by Michael Lombardi as an enticement to new subscribers to his Investing with Michael newsletter …

… the first one was that “New Swiss Bank” teaser that told us we could get 5% yields, growth and safety on par with the Swiss banks (or on par with how the Swiss banks used to be, at least), if you missed that note you can see it here.

But the other pitch from Lombardi for his “safe, big company investment plays” is a whole different kettle of fish — here’s how he teases it:

The Single Greatest Way to Play the Next Agricultural Boom….

“Why are average farmers making so much money? You can thank high prices for crops, livestock and farmland, strong global demand for corn used in making ethanol, and growing demand for food from India and China.

“In fact, farm profits are expected to spike by 28% this year to $100.9 billion, according to the U.S. Department of Agriculture. ‘We’re just experiencing the best of times,’ said Bruce Johnson, an agricultural economist at the University of Nebraska in Lincoln. ‘It’s a story to tell.'”

So it’s a play on agriculture, and we’ve certainly seen plenty of those teased over the years (and bought some of them) — so what is it? Farmland? John Deere tractors? Grain elevators? Seed companies? Fertilizer companies? Let’s see what clues Lombardi gives us:

“I have the name of one company that is supplying a substance essential for modern agricultural production.

“This company is super-safe, with a market cap exceeding $36 billion. It also currently pays an annual dividend of $0.28 per share. But more importantly—because of the unique product this company supplies—I believe this company is the best way to play the coming global boom in agriculture.

“Based on my analysis, I’m forecasting this company will easily surpass the 25% average returns I’ve made in Investing With Michael since 2009…indeed, this stock could be ‘the big one.'”

So … not exactly a shakedown cruise for the Thinkolator this time, it takes barely a few moments to generate our answers …though we appreciate an easier one every now and then — there just aren’t that many $36 billion agriculture companies out there, and this one is … Potash Corp (POT)

Yep, remember them? No one had heard of Potash in 2004, then suddenly it became clear that the Chinese wanted to eat chicken instead of beans, at a time when corn production started moving aggressively into our gas tanks, and the demand for fertilizer went through the roof for a few years. The stock went up from the single digits to almost $80 over the next few years, peaking out in 2008 along with everything else, and the lust for agricultural investing was born.

The market adjusts, of course, and the crash in the global markets and in the global economy cratered the stock, from $80 back down (briefly) below $20 at the bottom of the market, back when we all thought the world was going to end and we’d all end up living in yurts and collecting mouse dung to make our own fertilizer. Remember that? Hard to believe it was less than three years ago.

Since then, POT has recovered some and then, when it became clear that fertilizer capacity had gotten a bit ahead of itself due to overinvestment, the shares came back in in recent months — along with most of the big competitors like Mosaic (MOS) and Agrium (AGU). Shares have come back off the lows, but POT has at least temporarily shut down production at three of their potash mining operations this year in order to stave off oversupply and lower prices (sound familiar? Chesapeake is doing the same thing with natural gas this year, though more aggressively), so analyst estimates have come down a bit over the last few months and POT is now trading at a forward PE of about 11 on those lowered estimates.

POT produces the raw material for fertilizers — potash and phosphates, for the most part, so they are the very essence of a “commodity” company, they’re not adding much to the mix, or creating something unique, their advantage lies in the fact that they have massive high-quality deposits and economies of scale. So really, it’s about global demand for potash salts and phosphates — and to a lesser extent, it’s about new production coming online thanks to big investment in the sector during that 2005-2008 huge investor bull run in fertilizer explorers and producers. In general a slightly weakening market should work in favor of the huge low cost producers like POT and MOS, since it’s almost impossible for new producers to compete on margins or production costs, but that’s more of a long-term picture. In the short run, new producers are going to produce even if they don’t do so very profitably, and any sagging demand puts pressure on leading operators and, as in this case, sometimes causes them to have to try to manage the market by cutting off supply and investment a bit.

I can’t claim to have any brilliant insight into the fertilizer markets, though with the undercurrent of potential political unrest in Morocco and the general lack of big supply I do still like the little phosphorous subsector of the fertilizer market. I don’t happen to have any direct fertilizer investments right now, but phosphates are probably the most underappreciated and critical crop nutrients that face eventual supply problems. I just don’t know where the balance tips for any fertilizer supplier versus constantly fluctuating demand for different types of nutrients (and just to emphasize that I don’t know anything about short-term market forces in agriculture, Mosaic has been cutting phosphate production this winter because of weak short-term demand).

Still, in the big picture it’s hard to argue against the huge players if you think they’ve got the long-term wind at their backs — POT is far more expensive than the more diversified Agrium (AGU), and trades at substantially higher price/sales and price/book numbers than Mosaic (MOS), which are probably the two most similar large companies to consider, but the firms are not really directly comparable and Potash Corp has far better margins than these competitors (much higher profit margin, much better return on equity, etc.). Mosaic is interesting in part because the Cargill spinoff of shares didnR