Fertilizer!

During the cocktail party scene early in The Graduate, one of the party guests pulls Dustin Hoffman aside and says to him, "I just want to say one word.....just one word: Plastics!" Of course, Hoffman's character, Ben, was about to get too busy with the Robinson women to think about the next big business opportunity--if the story had been about how he made it big in plastics, it wouldn't have been a very memorable movie. If that film were made today, some 45 years after the original, I wonder if the "one word" might be: "Fertilizer!"

One of the long-term investment themes that has investors all excited is the growing worldwide demand for food. While population growth is part of this story, the other aspect involves shifting diets in the developing world. As countries around the world experience more economic development, their populations will demand more protein in their diets. That means a greater need for cows, chickens, and pigs--all of the unsuspecting creatures that have aspiring carnivores all over the planet licking their chops. All of that livestock has to be fed, so that means increasing demand for crops like corn, a typical ingredient for an animal's feed menu.Corn is also the main feedstock used in the production of ethanol here in the United States, so demand for corn has risen as the result of the federal government's mandates to reduce polluting emissions from gasoline. To meet this demand and take advantage of higher corn prices, some farmers have shifted acreage from other crops to corn.

Scarlett O'Hara's father in Gone With The Wind emphasized that "Land is the only thing that amounts to anything, for 'tis the only thing in the world that lasts..." (although Scarlett was more interested in covering Ashley Wilkes's real estate). We might also state the obvious, that land is in limited supply. Farmers, consequently, need to maximize their crop yields, and that's where fertilizer comes in handy.  CF Industries (CF, $175) is a major producer and distributor of nitrogen- and phosphate-based fertilizers, and the growing demand for corn has been great for their business (soybeans actually produce their own nitrogen, but corn does not--one of the many fascinating tidbits I picked up in the course of my investment research). The main input used to produce nitrogen fertilizers is, in fact, natural gas, and lately the price of that commodity has been plummeting. The relatively warm winter so far has reduced the demand for gas for heating, while at the same time supply has increased due to the hydraulic fracturing ("fracking") drilling techniques used to unlock natural gas that is embedded in shale formations. (The Marcellus Shale Formation, which covers parts of New York, Pennsylvania, and Ohio, is the largest source of natural gas ever discovered in the United States.) When we put all of this together we find that CF is in the "sweet spot" of supply and demand, where the product it sells is essential to meet the increased demand for corn, while at the same time the cost of its key input is falling. It's no surprise that CF's stock has risen some 26% over the past year.

CF stock is extremely volatile, owing to its being at the mercy of commodity supply and demand. The stock trades at a price/earnings multiple of just less than 10, a valuation that might at first seem low, but is in fact justified by the commodity nature of its business. Despite the long-term positive outlook for agriculture, CF is not a growth stock in the sense that Whole Foods Market (WFM, $76) and Lululemon (LULU, $60) are growth stocks. As you may recall from a previous post here, any number of products (we noted consumer electronics, sans Apple) can become "commoditized" when producers can no longer differentiate their products (and gain pricing power) through branding and marketing. Here, with natural gas, nitrogen, and corn, we are dealing with genuine commodities, where prices are determined almost solely by supply and demand. For example, when the U.S. Department of Agriculture reports the corn stocks-to-use ratio, a measure of the supply of corn relative to demand, a decline in that number can cause corn prices to rise, and vice-versa. When the price of corn goes up, farmers plant more of it and buy more fertilizer. If the Obama Administration were to outlaw fracking, the price of gas would climb, and that would diminish the profit margins at CF. As a result, we can expect to see CF stock fluctuate with every piece of news about natural gas and corn supplies. When you are in the commodity business, you have very limited control of your own destiny.

So, where is there pricing power in the agricultural sector? Perhaps with a company such as Monsanto (MON, $80), which produces genetically-modified seeds that are designed to be resistant to disease and pesticides. MON has patented many seed varieties and is known to go to great lengths to protect its exclusivity rights. A company that I find intriguing here is E.I. DuPont Nemours (DD, $49). DuPont has long been thought of as a cyclical chemical and coating company, but in 1999 purchased Pioneer Hi-Bred, a developer of hybrid seeds. Such seeds can increase crop yields and provide resistance to disease. Finally, in the heavy equipment arena there is Deere (DE, $87), the maker of all those green tractors and combines that are essential for the planting and harvesting down on the farm. These companies, typically considered to be most sensitive to the economic cycle, stand to benefit from long-term, secular trends in agriculture.

It all makes me want to buy some overalls and plant a tomato garden of my own this spring, or at least do some digging in the dirt. As Scarlett proclaimed when she returned to Tara after the burning of Atlanta (and just before intermission if you saw the movie in a real theater), "As God is my witness, I will never be hungry again!"

Life is short. Get busy.

Jim

Disclaimer/Disclosure: Stocks are mentioned here for the sole purpose of illustrating investment concepts, and nothing mentioned here should be construed as a recommendation to buy or sell a specific security. My family members and/or I own shares of CF and DD.