Global commodity woes increased again on Tuesday after Russia's Uralkali broke up one of the world's largest potash partnerships and ended a marketing venture agreement with producers in Belarus.
This development changes how to invest in agriculture- as it has already sent investors fleeing from nutrient and fertilizer stocks this week.
In addition, the impact will likely crash global potash prices by 25% to 30%, as the collapse of an international duopoly will end a price-fixing agreement that benefited other producers of the key commodity by artificially inflating prices and keeping supply off the market.
Producer shares plummeted Tuesday -- some by nearly 30% -- with the breakup of the Belarus Potash Company, pushing many fertilizer companies back near their 52-week lows.
Following the news, BMO Capital Markets analyst Joel Jackson called this deal the "the end of the potash world as we know it."
But as potash costs likely drop toward $300 a ton, a consensus target among analysts, it's not all bad news for companies in need of this key ingredient in fertilizer. The breakup of the pricing cartel favors key agricultural producers, in addition to a reconfiguration of this key commodity market toward the end of the summer.
And as investors are trying to determine a bottom for these shares, the real opportunity may be elsewhere. Here's how to play this sudden correction in fertilizer stocks and the agricultural market right now.
This Cartel Breakup is Good For Consumers
Prior to this announcement, the Belarus Potash Company and North America's Cantopex (a joint venture of three U.S. producers) accounted for 70% of the global potash trade.
This duopoly effectively kept potash prices artificially high, a boon to producers of the nutrients. With the break-up of the cartel, more potash supply will likely hit the market and prices could slide significantly.
However, with more supply on the market and falling prices, that doesn't suggest that demand won't pick up. In fact, Uralkali is effectively counting on this demand given their unique power over competitors. The company maintains lower production costs of $62 per ton, according to company reports.
The announcement favors certain companies...
Companies like Uralkali will have the lower production costs, providing them a strong opportunity to gain market share and ramp up production. Uralkali announced that it will produce 13 million tons in 2014, a steep increase from the 10.5 million planned for this year. Others will likely follow suit.
A reconfiguration of the marketplace will likely see some potential consolidation in the potash market as the impact of falling prices forces companies to reexamine their production costs.
Merger activity could pick up toward the end of the year, though the dust will need to settle as producers attempt to get their costs in line in an effort to buoy their margins.
How to Invest in Agriculture Post-Potash Collapse
Fertilizer and nutrient stocks fell by 21% in pre-trading sessions and continued their slide as retail investors awoke to the news.
Mosaic Co. (NYSE: MOS) fell by 18%, Potash Corp./Saskatchewan (USA) (NYSE: POT) by 18%, and Intrepid Potash, Inc. (NYSE: IPI) fell by 29%. All three producers are back near 52-week lows, with greater threats of hemorrhaging prices in the near-term.
Though the metrics and fundamentals appear to favor these companies over the long-term (P/E levels are back to single digits in some), a wave of downgrades may follow from many desks in New York and London.
Bank of America analyst Fernando Ferreira downgraded Sociedad Quimica y Minera (NYSE: SQM) to Underperform. The stock fell by 18% as well, and Ferreria slashed his price target to $29 from $57.
Fertilizer stocks had been one of the hottest sectors for the better part of three years as the commodity boom took off. But concerns about China have increased and the realization that its demand levels haven't remained constant has set in for now.
Wall Street appears tepid on agriculture, the primary consumer of potash ingredients, and it's fast becoming a downturn for investors in the sector. In fact, some investment banks have pulled out of soft commodities altogether.
Despite the current downturn for agricultural investors, the world is on pace to feed 9 billion mouths by 2050, placing a significant strain on food, water, and energy resources.
But technological innovation is a key driver in the one major agricultural sector -- one that is primed for significant profits.
That sector is animal technology, a $22 billion market with a lot of upside as dietary transitions take place around the world and an emphasis on quality overtakes the focus on quantity.
Primary drug companies like Pfizer (NYSE: PFE), Sanofi-Aventis, and Merck (NYSE: MRK) maintain animal health units, and at some point the sector will experience an increase in standalone companies.
Pfizer most recently spun off its animal health unit in a $4.2 billion IPO of Zoetis (NYSE: ZTS). In addition, traditional agribusiness firms like Archer Daniels Midland (NYSE: ADM) and DuPont (NYSE: DD) are looking to their animal health units as new sources of revenue as Asian markets continue to transition to a more meat-based diet.
The potash market will continue to experience increased demand, though predicting long-term prices will be a significant challenge until we see what the post-duopoly world looks like in the coming months.
For now, investors pondering how to invest in agriculture would do better to focus more on new forms of innovation in the plant and animal science markets that place an emphasis on quality in growing markets around the globe.
About the Author
Garrett Baldwin is a globally recognized research economist, financial writer, consultant, and political risk analyst with decades of trading experience and degrees in economics, cybersecurity, and business from Johns Hopkins, Purdue, Indiana University, and Northwestern.