Fertiliser is back in demand - here's how to profit

published 16 February 2010

Farming is not a business you normally associate with the pinstripe-suited cut and thrust of international mergers and acquisitions.

Yet one of the busiest areas for takeover deals this year so far has been the fertiliser sector. Already around $10bn worth of deals have "been thrashed out in the fertiliser market," reports the FT's Lex column. The latest is Norwegian group Yara International's $4.1bn purchase of US rival Terra Industries.

So why is this happening now? And more importantly, how can you profit from it?

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The fertiliser market is booming

Yara International is the world's largest listed fertiliser maker. And it's about to get bigger after taking over US rival Terra Industries. One reason that Yara wants Terra is to secure its access to US natural gas supplies. Natural gas is one of the key ingredients of nitrogen fertiliser. With everyone getting excited about America's reserves of shale gas, having access to the area's reserves makes sense.

But it's just one of many deals done in the sector since the start of this year. Mining giant Vale is buying $3.8bn-worth of Brazilian assets from US group Bunge. And BHP Billiton has spent $320m on potash assets in Canada, and looks set to spend $3bn more over the next ten years, reckons Lex.

We've been fans of fertiliser companies for a while. We most recently wrote about the subject in a MoneyWeek magazine cover story on farming: Grow your profits on a farm. (If you're not already a subscriber to the magazine, subscribe to MoneyWeek magazine.) Why? Because the agricultural commodities story has very strong fundamentals. As Lex points out, by the middle of this century "the world will probably have an extra 3bn mouths to feed." That's a lot of extra demand for food. And supply will be hard-pushed to keep up. In the short-term, that's likely to push up food and crop prices.

A potential short-term play

You could play this by betting directly on soft commodities. As well as spreadbetting, you can trade softs using various exchange-traded commodities (ETCs), issued by providers such as ETF Securities. These track the prices of commodities from grains to cotton. But you must understand how commodity ETFs work. They aren't straightforward instruments. If the words contango, backwardation and roll yield are foreign territory to you, you should study the products before trying to use them. We wrote about some of the complexities of commodity ETFs in a recent cover story on exchange-traded funds: All you need to know about exchange-traded funds.

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In any case, betting directly on commodity prices can only ever be a short-term play. As we've noted in the past, high commodity prices cannot last indefinitely. A solution must be found to high food prices. If the supply of food is so restricted that people can't eat, then they'll starve. That provides a pretty serious incentive to deal with food shortages.

So what are the potential solutions? Finding new land isn't as easy as it might sound. As Lex points out, "environmental concerns will limit the clearing of new farm land, so increasing yields from existing fields is critical." There are all sorts of innovations in the pipeline such as vertical farming and urban farming (which forms the latest plan to regenerate Detroit, as we noted in the current issue of MoneyWeek: Can farming save Detroit?). But these are way off in the future, and may come to nothing.

Why you should be backing fertilisers

So the best bet is to back the companies that can help farmers make better, more productive use of the land we do have, such as fertiliser firms. Fertiliser companies had a tough time in 2009 when overcapacity and lower demand pushed down fertiliser prices. But now it looks as though demand is recovering.

Seasonally, the early part of the year has also often proved to be a good time to buy fertiliser stocks in the past. Broadpoint AmTech analyst Edlain Rodriguez tells Reuters: "We are in the sweet spot of owning fertiliser stocks as we head into the seasonally strong spring season." One of our favourite stocks, fertiliser giant Potash Corp (TSX: POT) has outperformed the S&P 500 by an average 12 percentage points between January and April over the past six years, he points out.

There's also likely to be more merger activity in the fertiliser sector. The enlarged Yara will still only account for 8% of the world ammonia market. So there's plenty of room for more deals to be done. But picking and choosing which companies will be targets and which will be predators isn't easy. What we'd suggest is sticking with any fertiliser companies you already hold and don't worry about second-guessing who'll be trying to do deals with who.

One interesting alternative play could be a company which supplies the fertiliser producers Canada-listed Chemtrade (TSX: CHE.UN). The group is one of the world's biggest suppliers of sulphuric acid, which is a key raw material in phosphate fertilisers. We first tipped it back in May 2009. It's recovered sharply since then, rebounding 74%. However, it's still well below its 2008 high. With demand in the sector set to remain solid long term, it's a hold if you've got it, and worth getting into if you haven't.

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John Stepek is a senior reporter at Bloomberg News and a former editor of MoneyWeek magazine. He graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.