On Wednesday morning, Deere & Co. (NYSE:DE) reported blowout earnings that beat analyst expectations and came in 46% above year-ago levels. Deere also raised its outlook for 2012, saying it expects strong commodity prices and another robust year for the farming industry.
Deere isn’t the first farm equipment company to come through with a beat-and-raise in this earnings cycle. During the past month, AGCO (NYSE:AGCO) and CNH Global (NYSE:CNH) also surprised to the upside and boosted their outlooks. All three companies offered positive quotes about the sector in their respective calls and press releases:
Deere: “Farmers in the world’s major markets are continuing to experience favorable incomes due to strong demand for agricultural commodities.”
AGCO: “Modest growth is expected in North America as the healthy financial position of row crop farmers and the projection of farm income above historical averages is expected to support strong demand in the professional farming sector.”
CNH: “We’re going to have a very solid 2011 and we expect the farm income to be equivalent in 2012, so, we’re looking forward to continued good year in agriculture.”
That’s the good news for ag-related stocks. Now for the bad news: Fertilizer stocks have been taking it on the chin in recent weeks, on fears that falling crop prices will reduce farmers’ ability to invest in potash and other nutrients. Shares of Potash Corp. of Saskatchewan (NYSE:POT) have nearly round-tripped from their recent rally, falling over $8 from their October 27 high of $50.92. In the $42 range now, POT shares are nearing their 52-week low of $39.54.
The story’s the same for Intrepid Potash (NYSE:IPI): On Wednesday morning, it stood just above its 52-week low of $22.47 and well below its 2011 high of $40.22. Mosaic (NYSE:MO) and Agrium (NYSE:AGU) have been hit similarly hard during November, while CF Industries (NYSE:CF) and Terra Nitrogen (NYSE:TNH) have held up somewhat better.
The primary reason for the underperformance of companies like Potash and Intrepid is that their share prices tend to track the price of corn, which has been falling throughout the second half of this year.
This has created a disconnect between the stocks of farm equipment companies and the shares of the major fertilizer companies. While it may be dangerous to generalize because the equipment companies have exposure to other industries besides farming, the strong earnings, positive outlooks and favorable comments from the equipment makers indicate that the sell-off in fertilizer names may be overdone.
On a longer-term basis, fertilizer stocks have a lot going for them. The three key pillars of the bull case are likely familiar to most investors: a rising global population, higher protein consumption in the world’s developing economies (which raises the demand for feed) and the potential for industry consolidation. These points are critical, since they create a longer-term bid — and a strong institutional investor base — for these stocks.
Potash Corp., for example, was initiated with a buy rating from Lazard Capital last week on the basis of low potash inventories and its belief that the U.S. Agriculture Department estimates for feed demand are too low. Despite these positive factors, valuations aren’t demanding. Most names in the group are trading at or below a market P/E on a forward basis:
Mosaic 8.4 (trailing)
Anyone thinking of putting on a trade in any ag-related stocks needs to take great care. They’re high-beta and thus exceptionally vulnerable to negative news flow on the macro level. Also, their correlation with the price of corn leaves investors exposed to the rapid price swings associated with agricultural commodities.
But the recent strength in the equipment sector indicates that fertilizer stocks have the potential to play catchup and outperform if the market turns positive. These names belong on the radar screen of anyone preparing a buy list to capitalize on the recent downturn.