Fertilizer Turmoil

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It has been an interesting 24 hours for fertilizer stocks, to say the least.  Yesterday, Dan Loeb said in an investment letter that his firm had taken a stake in CF Industries (CF), North America’s largest nitrogen fertilizer manufacturer.  The investment thesis was fairly straightforward – the company’s access to low-cost natural gas (the primary input into fertilizer production) provided it a sustainable, competitive advantage as the global, low-cost producer.

Meanwhile, less efficient cost structures at other fertilizer companies would sustain the wholesale price of nitrogen fertilizer, allowing for significant and sustainable free cash flow trends at CF, warranting a return of cash to shareholders and a premium valuation versus the group.

As if that wasn’t enough in terms of news flow, this morning Urakali (the world’s largest potash producer) announced that it was exiting a marketing venture that represented 43% of global potash exports in order to go it alone in the hopes of aggressively gaining market share.  Not coincidently, Urakali also enjoys the lowest production costs among global peers.

The company announced its intention to run at full capacity in ’14, increasing output over 20% versus ’13.  For reference, the production costs per ton for less efficient global potash companies is closer to $200 (we have seen estimates for Urakali in the range of $65- $75 per ton).  There is potentially a great deal of pain between the current potash price of nearly $400 per ton and Urakali’s cost of production.

An industry leader abandoning a price before volume strategy in such abrupt fashion is uncommon to say the least, but Marlboro Friday seems to make for an interesting point of comparison.  Back on April 2, 1993, Philip Morris announced a 20% price cut to its iconic Marlboro brand in an effort to stem market share losses to generic competitors.  Philip Morris’ stock price declined 26% that day and it took the shares nearly two full years (March 20, 1995) to recover to a pre-Marlboro Friday level.  We offer this analysis as a cautionary tale for investors tempted to wade in this morning – unless Urakali reverses course in short order and elects to play nice, it is unclear what the magnitude or duration of the price weakness across the fertilizer group will look like, making it difficult to formulate an investment thesis over shorter to medium term durations.

The various types of fertilizers are substitutable to a degree, so this morning’s news does call into question the pricing assumptions in Third Point’s thesis on CF.

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