I have long been an interested watcher of fertilizer stocks. I still vividly remember the days of early 2008 when commentators on the various investment websites would vehemently tout their belief on how soon Potash (NYSE:POT), would hit $300 or $350 per share. Well, POT topped out at about $240 in July 2008, then started an agonizing (for shareholders and touts) fall to under $50 near the end of the year. Potash is the most visible example of this, but the other major fertilizer companies all had similar stories. Some other major stocks in this sector are Mosaic (NYSE:MOS), Agrium (NYSE:AGU), CF Industries (NYSE:CF) and Terra Industries (NYSE:TRA).

The bull argument for fertilizer stocks was that the global demand for food would continue to increase and that fertilizer production was in a handful of companies that could continue to ratchet up their prices by maintaining tight control on the supply side. As prices for grains continued upwards farmers were able and willing to pay for the fertilizer that increased 6-fold in cost over the course of a couple of years. If you look at profit growth at the fertilizer companies from 2006 until the 3rd quarter of 2008, the gains were all pricing driven and almost no production growth.

The happy times for fertilizer companies ceased due to several factors. The financial crisis made it impossible for farmers in places like South America to get loans during much of 2008 to buy fertilizer for their next crop so they planted without fertilizer. Then a drought in much of the growing areas of Brazil, Argentina and Paraguay has left farmers their with even less resources to purchase still relatively high priced fertilizers. In North America, the collapse of grain prices as the commodity bubble burst has made farmers unwilling to pay high prices for fertilizer. Things were not looking good for fertilizer companies.

The catalyst for a resurgence in fertilizer stock prices was a bid in January by CF Industries to buy out Terra Industries. Terra has rejected the offer but CF is still trying. Later Agrium made an offer for CF, also rejected but the offers are still in play and they have definitely helped move up values in the sector. At this point I see both strong bullish and bearish arguments for the sector:

The bears:

The agricultural situation in South America is still in turmoil, with drought continuing in many areas and a pending farmer's revolt in Argentina about taxes.

Fertilizer companies are sitting on a large amount of high-priced inventory. Witness Mosaic's recent 88% drop in earnings on higher costs and lower sales volumes.

A wet spring in North America has delayed fertilizer applications and American farmers are still resisting paying higher prices for product.

A significant shift from planting corn acreage to soybeans seems to be underway for 2009. Soy planting needs only a fraction of the fertilizer required by corn.

Fertilizer companies may have to slash prices to move out the build up in inventory, hurting profit margins.


The bulls: 

The South American agriculture problems will lead to grain shortages, resulting in a re-ignition of commodity price inflation.

When grain prices start to increase U.S. farmers will be willing to pay up for fertilizer again.

The global trend of growing population and a growing need for food is still in place and fertilizer companies will see demand increase again sooner rather than later.

Low natural gas prices will allow excellent profit margins for the companies selling nitrogen based fertilizers.

I currently think the bear arguments are more persuasive for the short term, yet the fertilizer stocks are doing well. As more of these companies start reporting 1st quarter results it will be interesting to see how they are faring in the current commodity environment and how the stock market reacts.