Continued weakness in fertilizer company stocks (Part 3 of 5)
Fertilizer prices influence revenues
The price of fertilizer is a key metric that influences fertilizer companies’ revenues. This is especially true for nitrogenous fertilizer producers because demand for their products, such as ammonia and urea, is more price-inelastic compared to demand for potash and phosphate, as farmers must reapply them year-over-year to help plants grow. Whether prices increase or decrease by 50%, farmers won’t change their purchase behavior by much. This makes sales price a significant factor that affects income and share prices.
Urea prices show signs of a bottom
While we saw an overall increase in urea prices from 2009 to 2011 and have generally moved sideways in the second half of 2011 and 2012, urea prices have fallen since the beginning of April 2013. On October 7, prices for urea sold in the United States stood at $336 per mt (metric tonne), unchanged from the end of September. The last two weeks of data show that urea prices may be close to bottoming. US Granular Barge prices have historically led or moved along with companies’ average selling prices, which are announced during quarterly earnings (see below).
Supply: A primary factor driving wholesale pricees
Because demand is fairly price-inelastic, significant changes in urea prices are largely driven by changes in supply. And since urea trades globally, prices depend on worldwide factors such as marginal production cost and production capacity. In the past few years, Europe and China were the marginal producers.
Chinese producers drove world prices down
The large decline in urea prices since April was primarily driven by lower production costs in China. While ammonia and urea are usually made using natural gas, 80% of China’s available capacity uses coal (which is more expensive to produce). As coal has fallen since 2011 due to larger increases in supply relative to demand, production costs fell in China.
However, it was only when coal prices fell below ~$115 per metric tonne (including ocean shipping costs) this year that Chinese producers became really competitive in the world market, with operating capacity rising from a historical average of just ~75% to as high as 90% recently. As a result, the shares of fertilizer producers like CF Industries Holdings Inc. (CF), Agrium Inc. (AGU), Terra Nitrogen Company LP (TNH), and Yara International ASA were negatively affected earlier this year.
Expectation over the medium to long term
World urea prices could be putting in a bottom as Chinese farmers return to purchase fertilizers for next year, and coal prices are showing signs of bottoming too. Over the medium to long term, nitrogenous fertilizers will be primarily driven by movements in coal prices. If prices stay near $350 per mt and analysts haven’t incorporated them into their estimates, then companies’ fourth quarter earnings could miss. The share prices of CF, AGU, TNH, and, to a lesser extent, Potash Corp. (POT), as well as the Market Vectors Agribusiness ETF (MOO), could be hit if this isn’t priced in. Continue to Part 4 to see where coal prices are heading.
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