Aggie Stocks Look Tasty

After the credit crisis hammered farmers across the globe, it looked as if the agriculture boom had come to an end. Prices for key crop-boosting chemicals such as phosphate, nitrogen and potash, along with share prices of the companies that produced them, plunged sharply.

Related Quotes

Symbol	Price	Change
AGO	11.94	+0.28
AGU	31.34	-0.85
CF	48.35	-2.25
MON	73.43	-1.05
MOS	33.74	-1.01

While that scenario has played out in a number of commodities, agriculture demand -- and pricing -- should be the first to rebound. Demand for industrial commodities and precious metals are highly correlated with construction. Besides a near-term stimulus plan out of Washington, there are few drivers for renewed construction right now. In contrast, human appetite for food is fairly constant.

The relatively bullish outlook for agricultural chemicals stems from several factors. First, the sharp drop in energy prices has put a lot more money in the hands of farmers and consumers. Second, the amount of crops sitting in silos remains near record-low levels, which implies strong crop planting in future years. And lastly, production of key chemicals is being throttled back to account for the recent crisis-induced slump in demand.

But it is the current slump that should serve as the primary catalyst for a rebound in demand and pricing. Right now, farmers are cutting back orders, choosing to apply far smaller amounts of chemicals to their current planting. However, farmers will need to compensate for that under-application this fall by applying greater amounts in the spring. If they fail to do so, crop yields will be subpar, creating dangerously low inventory levels of key crops. That would just set the stage for the next industry boom.

Let's look at nitrogen as an example. Prices have dropped from $350 a ton to just $125 a ton. At that price, a number of European producers cannot make a profit, and are ramping down production. In contrast, U.S. producers such as Terra Industries and CF Industrial Holdings have lower-cost extraction processes and can take market share -- and turn a profit. Shares of both of those companies trade for less than 5 times projected 2009 profits (despite a sharp rally on Tuesday). And this is one of the few corners of the market where you could argue that 2009 forecasts are too conservative rather than too aggressive.

Mosaic , which controls 15% of total global phosphate production, has been showing industry leadership by cutting 2 million tons of supply. The market has applauded that production discipline, pushing shares up off of their lows in recent sessions.

Mosaic remains an investor favorite when the ag cycle is moving in the right direction, and that is likely to be the case again in 2009. The company's massive size creates strong scale economies. Mosaic owns the phosphate mines, manages the intermediate phases of the phosphate production process and is less captive to price increases at the intermediate stage. Competitors have recently seen their variable costs spike higher as prices for phosphate rock, phosphoric acid and sulfur have surged.

Mosaic is also a large producer of potash, and should benefit from last week's announcement that Potash would trim production by 20%.

Cargill, the nation's largest privately held firm, owns 66% of Mosaic, and it's curious that Cargill did not look to acquire the remaining stake when shares were below $30. That said, a future move by Cargill bears watching, as it would likely be highly accretive to Cargill in the context of the longer-term farming cycle.

Investors are likely to warm up to this sector for a more prosaic reason: Many of these stocks were held by momentum-chasing hedge funds that ultimately imploded and shed their stakes in a hurry. That selling appears to be largely complete, signaling the "all clear" for bottom-fishing investors.

ByDavid Sterman, RealMoney Contributor
Thursday December 18, 2008, 9:01 am EST

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Know what you own: Sterman mentions Potash. Other companies in the ag chemicals industry include Monsanto , Syngenta and Agrium .