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September 2012 Archive for Guest Blog by Mark Gulley

RSS By: Mark Gulley

Mark Gulley is a principal at Gulley & Associates LLC.

Crop Inputs Pricing Underway

Sep 25, 2012

Harvest is in full swing- Conditions in the U.S. farm belt are ideal and corn is 39% harvested as of last week compared to an average of 13% over last year. Growers I've spoken to say they're about a month ahead of schedule. This is putting short-term pressure on cash crop prices which should ease when harvest exceeds 50% complete.

Fall spreading of P&K is also in full swing- Growers are taking advantage of ideal weather conditions to spread P&K. But with corn and soy yields 25% below normal, P&K application rates are likely to be down, subject to actual soil tests. This warm dry weather could delay ammonia application into later December since soil temperatures need to be below 50 degrees and sufficient soil moisture is required.

Growers pricing next year's inputs- While seed companies have not announced official seed prices, growers are budgeting a 7-8% increase in hybrid corn cost on-farm. This reflects a modest increase in corn hybrids carried over from last year plus the traditional 20% price-lift for brand-new higher-yielding hybrids, which replace lower-yielding four-year-old hybrids. There is also a positive mix effect for soy, but to a lesser extent.

Acreage mix 2013-14E- While the corn acreage forecast for next year remains 96 million acres, growers are frustrated by low yields, due partly to insect pressure on fields where they're doing corn-on-corn, and are thinking about going back to a more traditional corn-soy rotation. If so, it would reduce fertilizer use since corn requires more nutrients than soy. Still, the crop economics for corn remain superior to soy.

Investment Risks- Risks for agricultural input equities reflect the fact that the production agriculture business is subject to significant volatility owing to several factors that lie outside the control of the customer base of millions of individual growers that affect supply and demand for crop production, and therefore crop prices: (1) variable weather; (2) changing government policy; (3) varying crop yields (4) the relative value of the U.S. dollar.

PotashCorp (POT) $43.79; The Mosaic Co. (MOS) $59.20; Agrium (AGU) $101.72; CF Industries (CF) $217.64; DuPont (DD) $51.28; Monsanto (MON) $90.60; Syngenta (SYT) $74.30; Intrepid Potash (IPI) $21.88; Compass Minerals (CMP) $76.80.

MONSANTO: My current 12-month price target of $95 is based on 19.7x my current C2013E EPS estimate of $4.83 based on an arithmetic average of four valuation approaches: DCF, EBITDA multiple, P/E multiple, and sum-of-the-parts. I reiterate my cautious stance on crop nutrient equities but reaffirm my "Buy" rating on Monsanto (MON, Buy).


 

Crop Profitability Correcting: Crop Nutrient Prices Essentially Flat

Sep 19, 2012

Agrium and PotashCorp released their September monthly crop input market report data series Monday September 17, 2012 after the close, three months into this weather driven, supply-based crop price rally.

 

Crop Profitability Correcting-

The report showed that crop profitability was highly volatile. The previous up-cycle began in June 2010 with returns over variable cost (ROVC) at just $19 billion, peaking in June 2011 at $87 billion. ROVC troughed twice at $49 billion, soared back to $87 billion in July 2012, but was hit hard by falling crop yields, dropping to $69 billion in September 2012.

Nutrient prices have shown a trend toward de-coupling from grain prices. The season's big rally in crop prices has yet to show-up in crop nutrient prices, which have bucked grains' up-ward movement. While soy and corn prices have soared, crop nutrient prices have been flat for 12-24 months and were essentially flat month over month (MoM). Urea (NOLA, New Orleans) was down 1%, Midwest potash was unchanged and Central Florida phosphates were up 3%.

Crop Profitability Stable At High Levels-

Overall farm belt crop profitability is stable at high levels, but spot cash margins are not representative of farm-year crop margins since growers have been selling into this rally on the way up. Plus crop profitability could correct, given normal planting conditions and trend-line crop yields for the next crop.

This would result in more normalized on-farm prices with corn around $5/bu, soy around $12/bu, and wheat around $6/bu. Still, as the September 30 Grain Stocks Report is likely to show, the beginning inventory for this year’s 2012-13 crop starts off the lowest since the mid-1990’s.

P&K Inventories-

North American potash inventory has been above the five-year average since December 2011which is now 33% above the five-year average - an increase over August's 29% reading, which was due to a 0.22 million tonne decrease in North American inventory. Exports to China and South America and summer fill still needs to ramp up to affect supply. Do not expect much movement on potash until inventory softens and exports increase.

U.S. Phosphate inventory is now 14% below the 5-year average, better than the 10% below average in August, due to a 98 thousand tonne decrease. Phosphate inventories are much tighter than potash.

Crop Nutrient Pricing Essentially Flat-

Nitrogen remains flat after peaking in May at $765/tonne, the NOLA urea price was essentially steady, down 1% ($4/tonne) to $480/tonne. The Black Sea price was flat at $385/tonne. The spread between NOLA and Black Sea shrank to $95/tonne, which should still attract imports into the NOLA market, though to a lesser extent than the past several months. The spread began 2012 at $65/tonne and peaked at $286/tonne in April 2012.

Midwest potash price was flat at $558/tonne after peaking at $634/tonne 13 months ago in August 2011. The Saskatchewan potash price declined MoM $9/tonne to $532/tonne.

Central Florida MAP price was up 3% in September to $588/tonne. After peaking at $664/tonne 13 months ago in August 2011, prices fell 1% per month over that 13 month period.

Natural gas prices are trending up from very depressed levels. The spread between North American natural gas and European natural gas may have peaked at $12/million metric british thermal units (MMBTU) in April 2012 when the Ukraine price was $14/MMBTU vs. NYMEX at $2/MMBTU. The spread is still high but is trending narrower at $11.21/MMBTU for September.

 

Investment Risks
Risks for agricultural input equities reflect the fact that the production agriculture business is subject to significant volatility owing to several factors that lie outside the control of the customer base of millions of individual growers that affect supply and demand for crop production, and therefore crop prices: (1) highly variable weather; (2) changing government policy; (3) highly varying crop yields (4) the relative value of the U.S. Dollar; and (5) the recent spike in the corn price; and (6) resulting overhang in the U.S. Ethanol mandate due to the prospect for high food inflation in a deflationary environment, as evidenced by very low bond yields.

Mr. Gulley rates Agrium(AGU) a buy and PotashCorp (POT) neutral.


 

Nil Phosphate Pricing Flexibility

Sep 14, 2012

Phosphate Price
Stuck in Neutral - as is the case with potash, the phosphate price has been roughly flat over the course of around two years, since October 2010. The Central FL MAP price has round-tripped from $583/tonne in October 2010 to a peak of $667/tonne in October-November 2011, back to $573/tonne in August 2012. This is despite elevated crop prices, corn at $6.55/bu (Dec. '13), soy at $13.54/bu (Nov. '13), and wheat at $8.71 (Dec. '13).

I maintain a generally negative stance on P&K crop nutrient equities, except for Agrium (AGU), an event-driven situation. It's becoming increasingly clear that two conditions must both be met in order for P&K pricing flexibility; (1) fertilizer affordability driven by supportive crop prices and (2) tight operating rates.

Indeed, there's been nil pricing flexibility as the DAP price has been essentially flat for nearly two years. This report is a follow-up to my recent potash analysis.

Phosphate Capacity:
An inflection point in operating rates tied to capacity growth...

The global phosphate industry is at a crucial inflection point in 2013E and 2014E. This is because capacity is set to grow at a much higher rate 2010-15E (4.3%/yr) than 2005-10 (1.4%/yr). Over the 15-year period both demand and capacity grow at right around 3%/year, but with variability intra-period.

2005-2011: An eventful period. The operating rate averaged in the low 80's, from a low of 75% to a high of 89%. Demand (3.7%/yr) grew faster than capacity (1.4%/yr), so operating rates rose. The ethanol era began in 2005, there was the 2008 bubble, the great recession of 2009, and the recovery which began in 2010 and extended into 2011.

2013E-2015E: Capacity overhang brewing. The operating rate should again average in the low 80's, from a high of 90% to a low of 81%. Capacity (4.3%/yr) is now set to grow faster than demand (2.5%/yr), so operating rates should decline. Operating rates are expected to peak at a strong 90% in 2012E but decline to 81% by 2015E, which would be the lowest since 2007 except for the mid-70's 2008-2009.

Ma'aden Greenfield Capacity
Saudi's Ma'aden $6 billion large complex with capacity of 3 million tonnes per annum and which will take 6 full years to construct had been a disappointment in terms of completion date and ramp-up schedule. But it is finally expected to ramp-up during the course of 2013E and 2014E.

A marker for an inflection point in a basic material is when greenfield capacity is being built as this implies that re-investment economics has been achieved. This can occur even if larger incumbents insist that this hurdle has not been overcome because incumbents have the most to lose.

Phosphate Demand
The U.S. accounts for a third of global P&K consumption. Both potash and phosphate demand could potentially falter for the upcoming 2013/14E crop due to the drought in the U.S. corn belt. To be conservative, I have not yet reflected this impact in my N.A. phosphate demand forecast. P&K are usually applied together as the "dry" fertilizer every two years after soy harvest. Soil tests taken post-harvest will actually determine application rates.

Total crop production for the three major row crops (corn, soy, wheat) is estimated to be down 12% for the 2012/13E crop currently being harvested. Using this as a rough proxy for crop nutrient removal during this harvest, and all else being equal, growers could cut-back on application rates for the 2013/14E crop due to lower crop uptake. Demand should presumably recover for the 2014/15E crop to reflect more normal growing conditions.

Mosaic (MOS) forecast goes out to 2013E. It's currently looking for global phosphate demand to increase from 59.6 million tonnes in 2011 to a midpoint of 65 million tonnes in 2013E, a CAGR of fully 4.4% per year as detailed in its most recent outlook, its September 2012 Investor slide deck. This compares to a long-term phosphate growth rate estimated at 2-3% per year.

Summary & Investment Conclusion
I maintain a cautious stance on P&K crop nutrient equities due to lack of pricing flexibility despite elevated crop prices. The exception is Agrium (AGU, Buy), based on the potential for a break-up into retail and wholesale.
o Outperformance problematic: Since only one condition is being met over the next several years, and since pricing is a key driver of EPS and equity valuation, P&K equities could struggle.
o Nutrient affordability is satisfactory: At a long-term corn price of $5/bu, total fertilizer expense would account for 17% of corn revenues compared to a 10-year average of 19%. Of that 17%, phosphate would account for 4%, which is about the 10-year average.
o But phosphate operating rates continue to trend lower: The global phosphate operating rate is peaking at a strong 90% this year, 2012E. But we estimate it could decline at 200 bps per year from this 90% peak to an 81% trough in 2015E.

Investment Risks
AGU: My current 12-month price target of $120 for Buy-rated Agrium is based on 11x the current 2013E EPS estimate of $11 per share. This is based on an arithmetic average of four valuation approaches: DCF, EBITDA multiple, comparables, and sum-of-the-parts.

Risks to our Agrium price target as well as for neutral-rated Mosaic (MOS) and PotashCorp (POT) reflect the fact that the production agriculture business is subject to significant volatility owing to several factors that lie outside the control of the customer base of millions of individual growers that affect supply and demand for crop production, and therefore crop prices: (1) highly variable weather; (2) changing government policy; (3) highly varying crop yields (4) the relative value of the U.S. Dollar; and (5) the recent spike in the corn price; and (6) resulting overhang in the U.S. Ethanol mandate due to the prospect for high food inflation in a deflationary environment as evidenced by very low bond yields; and (7) the remote possibility that EPA could grant a waiver on the ethanol mandate due to the worst farm-belt drought since 1988.


 

 

Potash Stuck in Neutral

Sep 13, 2012


Potash prices have been roughly flat since November 2010. The Midwest potash price has round-tripped from $546/tonne in November 2010 to a peak of $626/tonne in October 2011, back to $541/tonne in August 2012. This is despite elevated crop prices, corn at $6.55/bu (Dec. ’13), soy at $13.54/bu (Nov. ’13), and wheat at $8.71 (Dec. ’13).

Two conditions must both be met for increased pricing flexibility - fertilizer affordability driven by supportive crop prices, and tight operating rates.

Outperformance is likely to be problematic. Since only one condition is being met over the next several years, and since pricing is a key driver of EPS and equity valuation, P&K equities are likely to struggle.
Nutrient affordability is satisfactory. At a long-term corn price of $5/bu, total fertilizer expense would account for 17% of corn revenues compared to a 10-year average of 19%. Of that 17%, potash would account for 3.5%, which is the 10-year average.
But operating rates continue to trend lower. I estimate the global potash operating rate could decline at 150 bps per year from the 98% peak in 2004 to the 80% trough in 2015E.

Potash Capacity
An inflection point in operating rates is tied to capacity growth. The global potash industry is at a crucial inflection point in 2012E. This is because capacity is set to grow at a much higher rate over the next several years (5%/yr) than in the past several years (2%/yr). Even if brownfield expansions don’t ramp-up quite as rapidly as expected during this period, it’s largely academic since the industry would need operating rates in the high 80’s to enjoy supplier-power pricing flexibility in any event.

I see three distinct periods in terms of capacity additions during the fifteen-year 2000-2015E period; stable capacity, moderate capacity increases, and excessive capacity increases. Over the 15-year period both demand and capacity grow 3%/year, but with variability intra-period.

2005-2011: An eventful period. The ethanol era began in 2005, there was the 2008 bubble, the great recession of 2009, and the recovery which began in 2010 and extended into 2011. PotashCorp began planning its brownfield expansion strategy in 2007. During this period, operational capacity grew at 2.6% per year, demand grew at 1.4% per year, but operating rates eased from a strong 95% in 2005 to 91% by 2011.

2012-2015E: Capacity overhang brewing. Our analysis suggests operating rates will plunge to 84% in 2012E from 91% in 2011, remain stuck in the low 80’s through 2015E. An operating rate of 84% in 2012E would be the lowest since 2002, except of course for the 51% in the great recession of 2009. Even if demand grows at a robust 3-4% per year during this period, it will not be enough to overcome 5% capacity growth.

2012E: The short-term issue is that capacity could be up 5%, 3.5 million tonnes, this year, which hits global operating rates by around 500 bps.

2012E-2015E: Capacity should be much more than adequate over the next five years. K+S Group (SDF.DE, Not Rated) has a recent view of supply-demand forecasts, having just updated its roadshow slide-deck. It forecasts that operational capacity will increase by 15 million tonnes, 5,000 tonnes/year-year, 5% per year, 2012E-2015E.

Brownfield Capacity

PotashCorp and Mosaic are the most aggressive in terms of adding brownfield potash capacity at each of their Canadian mines by the 2016-2017E time frame. PotashCorp is adding 5.6 million tonnes, Mosaic 3.3 million tonnes, Uralkali 3 million tonnes, China’s QSLI and Agrium roughly 1 million tonnes each, SQM, Israeli Chemicals Ltd, and Intrepid at 0.4-0.5 million tonnes. We don’t anticipate Mosaic backing off of its plans to execute on its brownfield expansion plans so as not to lose capacity share to its Saskatchewan rival.

Green-field Capacity

A marker for an inflection point in a basic material is when green-field capacity is being built because this implies that reinvestment economics has been achieved. This can occur even if larger incumbents insist that this hurdle has not been overcome because incumbents have the most to lose. This is especially the case in potash because it’s been fully 40 years since the last potash mine was built in Saskatchewan.

K+S. Moose Jaw, Saskatchewan - K+S is committed to its first N.A. potash mine, a solution mine to be built in three phases, located near Moose Jaw, Saskatchewan. K+S faces declining reserves and rising costs for environmental compliance at its conventional potash mines in Germany. It established a beach-head in Saskatchewan with its 2011 acquisition of a publicly traded company, PotashOne, for $0.4 billion. The announced capital investment for phases I & II is $3.25 billion . Initial capacity is 2 million tonnes/annum in 2017E and the date for ramp-up to begin is 2015E. K+S has said the final long-term capacity could be 2.86 million tonnes by 2023 and the ultimate capacity could be 4 million tonnes.

BHP. Jansen, Saskatchewan. - BHP appears to be slow-walking its entry into the global potash industry with a conventional shaft mine located at Jansen, SK. Investment to-date is $1.2 billion The projected on-stream date is late 2015 for first saleable product, which is not reflected in our 2015E capacity estimate due to project risk. Ultimate capacity is to be 8 million tonnes/year.

Potash Demand

Both potash and phosphate demand could falter for the upcoming 2013/14E crop due to the drought in the U.S. corn belt. To be conservative, I have not yet reflected this impact in my N.A. demand forecast. (P&K are usually applied together as the "dry" fertilizer every two years after soy harvest). Soil tests taken post-harvest will actually determine application rates. The U.S. accounts for a third of global P&K consumption.

Total crop production for the three major row crops (corn, soy, wheat) is estimated to be down 12% for the 2012/13E crop currently being harvested. Using this as a rough proxy for crop nutrient removal during this harvest, all else being equal, growers could cut-back on application rates for the 2013/14E crop due to lower crop uptake by the plants. Demand should presumably recover for the 2014/15E crop to reflect more normal growing conditions.

Investment Risks

Investment risk reflects the fact that the production agriculture business is subject to significant volatility owing to several factors that lie outside the control of the customer base. Millions of individual growers affect supply and demand for crop production, and therefore crop prices are subject to: (1) highly variable weather; (2) changing government policy; (3) highly varying crop yields (4) the relative value of the U.S. dollar; and (5) the recent spike in the corn price; and (6) resulting overhang in the U.S. ethanol mandate due to the prospect for high food inflation in a deflationary environment as evidenced by very low bond yields; and (7) the remote possibility that EPA could grant a waiver on the ethanol mandate due to the worst farm-belt drought since 1988.

My current 12-month price target of $120 for Buy-rated Agrium is based on 11x our current 2013E EPS estimate of $11 per share. This is based on an arithmetic average of four valuation approaches: DCF, EBITDA multiple, comparables, and sum-of-the-parts. Risk to my price target also reflect the fact that the production agriculture business is subject to significant volatility.

Until fertilizer affordability supported by crop prices merges with tighter operating rates, I expect potash to remain stagnant. I maintain a negative stance on P&K crop nutrient equities due to lack of pricing flexibility, despite elevated crop prices. The exception is Agrium (AGU, Buy), based on the potential for a break-up into retail and wholesale. Drought year corn prices support greater price flexibility, but I do not see this having any leverage on the market at large without operating rates first coming down amid strong grain prices.


 

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