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Retail urea prices may bottom, fundamentals likely to stabilize

Xun Yao Chen

Fertilizer retail price falls but competition is high (Part 4 of 4)

(Continued from Part 3)

The significance of retail urea prices

Analysts use retail urea prices to illustrate the supply and demand dynamics between farmers and retailers. When retail prices are rising, they can point to rising costs or higher demand for urea. On the contrary, when retail prices are falling, they can mean increased supply, lower production costs, or lower demand. Changes in retail price can affect sales volume and sales price for wholesalers.

Retail urea prices appear to be bottoming

According to DTN Energy Source, retail prices of urea in the United States last traded at $488 per mt (metric tonne) on October 4, bouncing back up from the $484 seen on September 27. Prices have been in a waterfall decline since May, falling as much as ~23% from ~$630 per mt (metric tonne). These declines are driven by two key factors: increased supply due to lower cost of production in China and falling crop prices.

Lower wholesale prices and crop prices driving retail prices down

Although fertilizer producers don’t receive a retail price quote, except for Agrium Inc. (AGU), which operates one of the largest retail businesses in North America, falling retail urea prices can reflect lower wholesaler prices. In fact, retail prices tend to lag wholesale prices if the catalyst behind lower retail prices is falling cost of production and supply. The wholesale-to-retail price ratio shows these characteristics. Since March, the ratio has fallen from 70% to as low as 55% on August 29.

Up until the end of June, retail prices weren’t falling as quickly as wholesale prices because crop prices were still high. So there was little incentive for farmers to cut back on fertilizer purchases. However, as corn prices fell ~33% from July highs, retail prices have come under pressure. Based on the wholesale-to-retail price ratio, it looks like retail prices still have a bit of room to fall. But wholesale prices are showing signs of bottoming, so we’re possibly close to bottoming.

Impact on the financials and share prices of fertilizer stocks and ETFs

Falling retail prices will make fertilizers more affordable to farmers, which will support retailers and producers’ sales volume. However, lower sales prices will negatively impact short-to-medium-term revenue for companies like CF Industries Holdings Inc. (CF), Agrium Inc. (AGU), Terra Nitrogen Company LP (TNH), and, to a much lesser extent, Potash Corp. (POT).

As the spread between retail and wholesale prices narrows, Agrium Inc. (AGU)’s earnings could be negatively affected in the short term as the company generates fewer sales to cover costs (fixed costs) that aren’t dependent on wholesale prices or changes in volume. Example includes marketing and sales expense, as well as general administrative expenses.

And because nitrogenous fertilizers are quite price-inelastic—since the product is consumed in the process of plant growth—price and costs, rather than sales volume, are key factors that affect earnings and share prices. The Market Vectors Agribusiness ETF (MOO), which invests in several large fertilizer companies, will also be negatively affected if this expectation isn’t priced in yet, although fundamentals appear to be stabilizing.

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