Why I am negative about nitrogenous fertilizers (Part 9 of 11)
Current estimates may be too optimistic
Current analysts’ estimates for the next two quarters may be quite optimistic, which could negatively affect share prices as well as the Market Vectors Agribusiness ETF (MOO). For CF Industries, analysts are expecting sales growth to fall by just 13.3% from 2012′s revenue for 2014. For Agrium Inc. (AGU), sales are expected to increase 2.9% from 2012 to 2014.
Given these declines (or increases in sales growth), net income is expected to fall 34.9% for CF Industries. Agrium Inc. (AGU) is expected to see declines of 15.7% over the same period. As wholesale prices for urea and ammonia now stand about 35% lower than they were on average in 2012, sales projections could miss. While nitrogen-based products made up 30% of Potash Corp. (POT)’s revenue in 2012, its large exposure to potash and phosphate makes it harder to figure out how much is being priced in.
Since the cost of making these nitrogenous fertilizers depends on natural gas prices, and natural gas in the United States is already at a low and has a limited downside, costs won’t fall much. So while prices could fall by 30% and companies won’t be able to cut cost at the same time, these producers would experience a larger decline in earnings. So current earnings estimates for the next few quarters look a bit too bright.
Market not pricing in analysts’ optimism
Has the market priced in analysts’ optimism? Unlikely. Current forward valuation is priced near the five-year historical average for Agrium Inc. (AGU), at 10.77. The valuation for CF Industries based on estimated earnings for the next four quarters stands higher than its historic average of 8.55. We could attribute the premium charged on CF Industries Holdings Inc. to the large cash reserve it has accumulated over the past few years, as well as its plan to increase capacity significantly by 2015 and 2016.
Browse this series on Market Realist: