Urea, phosphate producers should benefit from prolonged supply dislocation

China’s recent decision to extend a 35 percent temporary tax and a 75 percent special tax on the export of fertilizer including urea and diammonium phosphate (DAP) until next June in order to help control inflation and to guarantee fertilizer production and supply to domestic farmers will likely “create potential supply shortages in both nutrient groups that should cause nitrogen and phosphate prices to go higher, benefitting global nitrogen and phosphate producers,” according to a research note from Barclays Capital.  China was responsible for roughly 14% of the global supply of urea in Q12010.

Urea is formulated by a reaction between liquid anhydrous ammonia–a form of nitrogen–and carbon dioxide at high temperature and pressure.  And in a write-up on Saudi Arabian Fertilizer Company (SAFCO), TAIB Securities, a brokerage, reiterated that producers in the Middle East are at a particular cost advantage in terms of production given their relatively cheaper access to raw material like natural gas (ranging from S$0.70 /MMBTU to US$1.5/MMBTU per one estimate, versus $4.5 and rising, for instance, on the New York Mercantile Exchange).  In addition to SAFCO, Arab Potash and Qatar Industries are regional players that, as one analyst notes, are not only attractive given their dividend yields but also may trade at a discount to global producers.  Finally, producers in Pakistan (namely the country’s two dominant firms, Fauji Fertilizer and Engro) both expect strong final quarters due in part to peak demand (stabilized by post-flood recovery and state-run farming subsidies) augmented by yet another supply shortage in the run-up to Rabi season that producers say is a direct result of the government’s gas curtailment policy in which gas has been diverted to power plants.   That shortage will be met through imports, though for Engro in particular the gas shedding policy may curtail projected earnings related to the opening of its new plant.  Yet Karachi’s JS Global Capital kept the firm as a ‘buy’ recently, concluding that “although the fertilizer industry was hit hard in August with depressing urea offtake (down 8%YoY in 8M2010) due to the floods, we expect the numbers to improve in the coming months.”

Arab Potash a play on food, feed and fuel

A new $500 million potash production plant will increase the overall production capacity to 2.5 million tons per year from two million tons currently, per Nabih Salame, Chairman of the Board of Directors of Jordan-based Arab Potash Company (APC), whose annual sales of roughly $634 million correlates to approximately 4 percent of global potash production, and which sports a nifty ttm ROE of 60% as it targets growth markets at home as well as in China, India and Malaysia.  Potash prices made headlines this summer (and continue to do so as global food prices spike once again) during miner BHP Billiton’s attempted hostile takeover of Canada’s Potash Corporation (a 28% shareholder in APC).  While technically a chemical concoction (consisting of potassium carbonate if not other compounds) used as an agricultural fertilizer (it contains essential plant nutrients), “potash, for all intents and purposes, is food,” according to Vincent Andrews, agriculture analyst for Morgan Stanley.  “Because without potash you are not making corn and soybean and without corn and soybean you are not making chicken or beef and that’s what people want to eat.” 

Spot potash prices ballooned over $1000/metric ton back in 2008 but fell to $300 last summer and have dallied sideways for much of this year around $340-375–buoyed by rumors of declining inventories and then quickly hampered by suggestions that major producers are barely running at half capacity.  Yet per one report, Patricia Mohr, a commodity market specialist at Scotiabank Group in Toronto, noted recently that “some recent sales at higher prices are starting to materialize for the coming months.  Belarusian Potash Co. (BPC) sold some product to Brazil at prices rising to $410 for December delivery, and Canpotex followed suit with December and January deliveries to Brazil in the same price range.  On top of that, demand has strengthened in southeast Asia, allowing Canpotex to sell 150,000 tones of standard and granular product around $405 and $420, respectively. China’s Sinofert also signed a three-year supply agreement with Canopotex for more than 1 million tonnes each year, a sign that China wants to secure longer-term supplies because it believes demand will rise.  This demand could continue to grow.”

Worth noting finally is APC’s competitive advantage in an industry that already has considerable barriers to entry given the expense involved in potash production.  Per NBK Capital, due to the firm’s extraction technique (APC mines surface brine deposits, utilizing solar evaporation, which is significantly cheaper than conventional mining of deep marine deposits) “it remains one of the world’s lowest cost potash producers, enjoying production costs roughly one quarter of producers in Western Europe, for instance.  Moreover, the bank noted, “long term secular drivers” (food/feed/[bio]fuel) underpin its bullish outlook for fertilizer.

World’s food dilemma highlights deep-rooted problems, as well as promise

Per the FT’s recent insert on world food, “the prevalence of hunger in developing countries has fallen but is stuck at 16 percent, and there will not be enough time or money, according to many experts, to hit the 10 percent target by 2015.”  Solutions are as varied as they are complex, though for certain there is room for “improving agriculatural yields, especially in Africa, where the sector has lacked investment.  Only 4 percent of sub-Saharhan African cropland was irrigated in 2002, up from 2 percent in 1962, compared with almost 40 percent in South Asia.”  Analysts note that every step of the production process must be targeted–from farming techniques themselves that educate about pesticide use, cutting waste, and improving quality through using best practices such as better seeds, soil testing, and planting and harvesting techniques, to increasing access to customers not only be removing costly intermediaries, but also by improving substandard roads and communication networks that, coupled with increasingly volatile commodity market prices (due in part to climate change as well as protectionism abroad), is particularly devestating to the vert supply chains most abundant in poorer countries that tend also to be more reliant on vulnerable smallholders.  To that end, better access to credit and more transparent and credible land rights are crucial to production as well, experts note.  

Finally, an underlying issue may not just be sufficient production of quality food, but also sufficient variance in terms of quality of nutrition.  Per the UN’s Food and Agricultural Organization (FAO), for instance, ” at a global level, the world already has enough food . . . but if diets are not sufficiently varied, they may lack vitamin A, iron, zinc and iodine, causing infants and young children irreparable harm.”  Couple the need for properly diversified nutrition (which in turn is linked not only to fortification of staple foods, but also to sanitation and, most importantly, antenatal care and education of, and perhaps direct transfer-payments to mothers) with Nicholas Kristof’s latest piece in The New York Times on just how crucial the role of the uterine environment is to a given individual and thus, society’s welfare in the aggregate, and it is to easy to argue that the quality and supply of the global food chain is the single most important issue facing developing (and developed?) countries today in terms of their long-term evolution. 

That said, I continue to maintain that an even more basic issue–the supply and suitability of water–is even more crucial, in that it lays the groundwork essential to efficiently meeting demand.  Admittedly, the topic of usable water goes hand in hand with ‘best practice’ farming techniques and more pointedly, irrigation (agriculture accounts for roughly 70 percent of water consumption).  For example the FT cites Daniel Wild, an equity analyst with Sustainable Asset Management in Switzerland, who points out that “with conventional food irrigation, the efficiency level is often well below 50 percent, and important nutrients or corp protection agents are [thus] washed away in the process.”  This and other measures, such as horizontal ploughing and preventing farmers from tapping underground sources without limit (if usable water is a scarce commodity, isn’t there a moral hazard to not effectively pricing and treasting it as such?) may in turn boost crop yields by up to 150 percent or more.  The FT points out that several emerging market companies–most notably Jain Irrigation Systems in India amd Israel’s Netafim–are experiencing rapid growth in micro irrigation systems (MISs), which include drip systems, sprinklers, valves, water filters and plant tissue products and help to enhance the productivity of seeds and fertilizer while conserving water.  Additionally, said firms are exploring solar water pumps, a sort of leapfrog technology in a sense that could be used by farmers even in power-deficit states (of which they are plenty in frontier regions).  Ultimately, “[Jain] plans to enhance its distribution by adding new dealers and distributors to penetrate [frontier markets] in Africa and the Middle East,” per Anil Jain, its managing director.  Analysts and investors alike, including asset managers and private equity funds, would be wise to keep a watchful eye on this growing sub-sector of agribusiness.

Engro Chemical a play on cheap fertilizer production

Bloomberg relays Citigroup’s sentiment that frontier markets, which trade at roughly 13x earnings (compared with emerging markets at 20x) and many of whom still trade at 50% or more below their 2007-2008 highs, are due for a “good year” on the back of low interest rates and rising commodity prices.

One of Citigroup’s favorite frontier stocks is Karachi-based Engro Chemical Pakistan Limited, the country’s second-largest urea maker which, aside from spending $1.7 billion to expand its operations into milk and consumer goods (Engro Foods) in the past three years, announced in November that it would construct a $1b phosphate fertilizer plant in North Africa in order to further fuel demand in both Pakistan and Western Europe. The company also deals in energy, polymer and bulk handling. Yet fertilizer remains the firm’s cash cow, BMA Capital explained last fall in the linked research piece, and will continue to provide the impetus for future growth:

Protection of agrarian policies by the government and stable gas supply has greatly helped the fertilizer arm making it stable, profitable and secure. Urea is locally available at a significant discount to the international landed price of the product. Current retail prices of PKR797/bag compared to international landed cost of PKR1,200/bag means that locally available urea will continue to be preferred. Engro will become the largest urea producer of Pakistan by mid-CY10E with additional capacity to the tune of 1.3mtpa coming online.

As urea goes, so does QAFCO, Industries Qatar

According to Abdulla Salatt, chairman of the company’s fertilizer unit (QAFCO), Industries Qatar–the country’s largest firm by market cap–will increase production of urea (used as a nitrogen-release fertilizer) and related products to supply growing global demand with a specific focus on South America, and in particular, Brazil.  “We are thinking of sending more products to Brazil because it is a big agriculture country, consuming a lot of urea, and we see their appetite for urea opening up year after year,” Sowaidi told reporters.  The company is currently contemplating a proposed $610 million plant which would increase urea production to 5.6 million tons/year by 2012, up from the current rate of 3 million.  Upon completion the fertilizer unit would hold 15% of global urea production, say analysts.  Urea has the highest nitrogen content of all solid nitrogenous fertilizers in common use (46.7%).

The company overall is still reeling from recession, as last month it announced a 47% drop in 9 month profit due largely to decreased demand for petrochemicals, fertilizers and steel, as well as new capacity across the region.  In 2008, the fertiliser unit alone accounted for almost half of the firm’s total profitability.  That said, the future looks bright.  Bloomberg noted that petrochemical production in Qatar, which is the holder of the world’s third-biggest natural gas reserves, is expected to rise to 4.3 million tons a year by 2015, an increase that would parallel an increase in natural gas output to 23 billion cubic feet by 2014.  Moreover, analysts maintain that by 2013, income from the natural gas sector and the petrochemicals business will be more than double that of Qatar’s oil revenue.  As for urea, it could be the lynchpin for the company’s ROE going forward: “If Qafco can guarantee the sale of this new urea capacity, this should be very positive for the company’s revenues and bottom line,” said Hala Fares, an analyst for Shuaa Capital, an investment bank, on Thursday.  “Fertilizer prices are relatively stable currently, so any increase in sales volumes should reflect positively on revenues. Any improvement in fertilizers prices should further increase revenues.”  Additionally, Last month EFG Hermes, an Egyptian investment bank, projected that it remained “positive” on fertilizer price estimates for 2010.

 

Chile’s SQM a prime recovery play

While most finance wonks opine that dominant indices will need to double bottom (at the very least) before a secular, bull rally can take form, many also agree that the first-mover advantage in such a global rally will start in both commodities and emerging markets.

One such firm could be Sociedad Quimica y Minera de Chile (NYSE:SQM), a Chilean chemical manufacturer that deals in specialty fertilizers (its principal revenue source), iodine and iodine derivatives (used to produce polarizing film for LCD screens and contrast media), lithium and lithium derivatives (vital to the production of rechargeable batteries powering modern electronics and hybrid cars worldwide), potassium nitrate (to make glass or enamel coatings for refrigerators and bathtubs), and industrial chemicals.

SQM thus taps into two growing industries–agriculture and “green” technology. A report issued last month noted that:

Chile is the leading lithium producer in the world with SQM being the word leader with a 30% market share. The company has nine plants in the Salar de Atacama, which is considered the driest place on earth and holds the highest lithium concentrations currently recorded. Bolivia is estimated to have about half the world’s proven lithium reserves. Bolivia, however, lacks the expertise and infrastructure to compete with Chile and Argentina, which together account for more than half the world’s 27,400 tons of annual lithium production.

In February SQM announced 4Q08 net income increase of 170% year-on-year to US$120mn, while revenues climbed 29.9% year-over-year in the recent period to US$398mn. That said, the firm admitted that it expects 2009 to be a tougher year for the company. Yet at the same time, it also predicted that the recent decline in sales volume for fertilizer was “not sustainable given that specialty crop producers must fertilize to maximize yields and continue to provide export-quality products in order to maintain margins.”

OCI’s FY net jumps 230%

Orascom Construction (OCI), Egypt’s largest listed builder, announced Monday that full-year 2008 net profit from continued operations was $719.8 million, up 230% on the year.  Revenue in 2008 rose 56.2% to $3.72 billion, while EBITDA was up 151% at $878 million.  Concurrent with the news, the firm signed a deal with a unit of Brazil’s Group Fertipar for the supply and import of granular urea fertilizers into Brazil; OCI currently has fertilizer operations in Egypt, Nigeria, and Algeria.