Credit Suisse likes Potash Corp. of Saskatchewan and Mosaic.
Credit Suisse
Despite the significant unease over the economy and European debt situation, agricultural fundamentals remain positive in our view.
Grain prices are still at profitable levels for farmers, and we see fundamental support for $5-plus per bushel corn prices looking out over the next one to two years. Demand is solid with record high U.S. ethanol production rates helping to offset sluggish U.S. corn export orders. Low inventory levels leave little cushion in the event of adverse weather conditions. At corn prices of $5 per bushel, farmers are incentivized to plant more acres and apply optimal amounts of fertilizer to maximize yields.
North American fertilizer stocks are more than factoring in potential downside risks. Given the economic uncertainty, distributors are exercising more caution and the lack of buying activity has lent a bearish tone to the market. Nitrogen prices have plummeted, and the Indians are requesting discounts on existing phosphate and potash contracts.
However, we anticipate volumes and prices will hold up better than the market expects due to favorable farmer economics, elevated costs for marginal nitrogen and phosphate producers, and strong industry discipline in potash. Based on valuations in the North American fertilizer sector, we estimate the market is pricing in 30% price declines and flat volumes for nitrogen, 30% price declines and 20% volume declines for phosphate, and 15% price declines and 20% volume declines for potash.
The risk/reward is most favorable for the potash and phosphate sectors in our view as the market is already factoring in overwhelmingly bearish scenarios.
Our top picks are Potash Corp. of Saskatchewan (ticker: POT) and Mosaic (MOS). The nitrogen names CF Industries Holdings (CF) and Agrium (AGU) also look compelling as 2012 price expectations are overly bearish with higher-cost Chinese product needed to meet demand. However, with Chinese product not available until the country's low tax export window in July and buyers deferring orders until the first quarter, we see potential for nitrogen prices to fall further near term (potentially towards Ukrainian cash cost levels), which would weigh on nitrogen shares.
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