Investing in Agriculture: An Interview with Robert Winslow


By The Energy Report

via | Thu, 17 January 2013


Global population growth and escalating food demand underpins long-term upside for potash, phosphate and nitrogen producers, but fertilizer oligopolies may have jumped the gun last year with aggressive rates that priced farmers out of the market. As farmers expand acreage rather than boost yields in now-tired fields, grain prices have backed off recent highs. That's why Robert Winslow, agriculture research analyst and director at National Bank Financial, is picking his stocks with care. In this interview with The Energy Report, he shares where he sees strengths and weaknesses in the industry and names some interesting contrarian plays.


The Energy Report: Your last interview took place in April of 2011. What have been the major developments on the agricultural front impacting the fertilizer markets since then?


Robert Winslow: Increased weather volatility, like last summer's drought in the U.S., which led to modern-era highs in corn, wheat and soybean prices, have had a significant impact on the market. Although grain prices have softened of late, I believe you're likely to see somewhat higher-than-usual grain prices through at least the first half of 2013, given the persistent dryness in the U.S. corn belt and wheat-growing regions. Grain prices drive farmer sentiment and buying, and therefore the price and the demand for fertilizer.


We've seen some disconnects when it comes to potash, such as in India: Because the rupee was devalued about 20% through 2012, Indian farmers can't afford to pay the prices that the potash companies would charge, and this resulted in subdued demand. Chinese demand has been somewhat subdued as well. Globally, we've had this really interesting dichotomy with high grain prices buoying larger demand in places like North America and even Brazil, but softening demand in yet other parts of the world with country-specific issues. In total, we haven't seen the demand strength in potash that you might have otherwise expected with this high grain-price environment.


Some would say it's partly because grain prices are not sustainable at these high levels. We are actually of that view. Like any commodity, when the price gets too high, two very simple things play out: demand destruction and supply response. You've seen demand destruction over the last 3–6 months. For example, high-cost ethanol plants have been shuttering production. High-cost producers of cattle, pigs and chickens have been culling their herds because they can't afford the feed costs unless meat prices rise in conjunction, which they have not.


Then there's supply response. Farmers are expanding acreage by moving into marginal land. You may not get robust yield on that land, but you can still increase production, which we're seeing play out now. Brazil is expected to increase soybean acreage by 8–10% this year. With these dynamics playing out, the grain prices are beginning to come down. We expect that by the second half of 2013 you should start to see lower fertilizer demand reflected in pricing, even in the U.S. and Brazil. That is why we maintain a fairly cautious view on the fertilizer sector at this stage.


TER: How might continuing climate change and severe weather affect grain prices and fertilizer demand?


RW: Nobody really knows the answer. I don't pretend to, but I will say that the stocks-to-use ratio for grains right now, globally, is about 68–69 days of supply. It's relatively tight compared to the last 30 years or so, and it doesn't take much to tip over and get a real spike—or falloff—in grain prices. When you do get these supply shocks through floods or droughts, the relatively tight supply situation can move prices quite dramatically, which we saw just this past year.


Many investors don't believe such price spikes are sustainable and they aren't going to pay for them. We're probably at least two years away from where we have a bit more of a buffer in the stocks-use ratio to get us away from this tightness that is causing more volatility in the grain price. In the meantime, we can expect continued volatility in both grains and fertilizer equities.


TER: How have the various segments of the fertilizer industry performed in the last year and a half?


RW: Potash has been the commodity with the most interest. We've been a bit of an outlier in the investment community, with a rather bearish view on both the commodity itself and on some of the senior potash producer equities. We are of the view that the potash oligopolies (and we all know who they are) have been rather aggressive with their pricing. In a perfect world, you might be able to raise your prices every year, but we don't live in a perfect world. Places like India just couldn't afford the higher prices, so they bought less. The oligopolies and agronomists are right in saying that parts of the world, like India and China, need more potash in the soil, but ultimately, demand is price dependent.


In 2012, global potash demand looked to be in the neighborhood of 50 million tonnes (50 Mmt), which is below the levels we saw back in 2004. Thus, the commodity usage has been basically flat to down over the last 7–8 years—not a compelling investment theme. But the potash price more than tripled over that period. This aggressive pricing has since come back to bite the oligopolies. I expect a demand recovery in 2013 because India has been under-applying fertilizer, and it will need to make up for that at some point. I doubt India would purchase its full allocation, which would be 6–7 Mmt, unless it can buy potash near or below $400/Mmt. And if it does buy the 6-7 Mmt, then there's a good chance India might buy less again in 2014, with Indian farmers trying to mine the soil. Of course, if the rupee comes back with vigor, India would have more buying power.


On the supply side, there's tremendous brownfield supply expected over the next three to four years. Most of it is coming from the oligopolies themselves. It looks like the global supply will be growing about 4% per year, on average, over the next four years. So if your demand is flat and supply is up 4% per year, it doesn't bode well for potash prices. That doesn't include the greenfield supply that could come on from BHP Billiton Ltd. (BHP:NYSE; BHPLF:OTCPK), K+S Potash Canada (SDFG:FSE) or any of the juniors that are working to build mines. So the supply/demand dynamics are not, in our view, compelling for potash over the next two years, particularly if we get less volatile global weather patterns and grain prices trend down.


TER: How do the prospects look in the other fertilizer segments?