Mr. Neivert: At this point, I'm pretty much focused on the fertilizer names here in North America. Those would include the names like Potash Corp., Mosaic, Intrepid, Agrium and CF Industries. Then my other focus is on some of the chemical names. At this point, I've launched on mostly more of the commodity and sort of mid caps - we'll call them "performance, kind of, companies." And specialties will be coming out at sometime in the future.
TWST: A lot of agricultural chemicals firms really struggled in late 2008 and much of 2009. Would you speak broadly about the affect of the economic slowdown on that industry?
Mr. Neivert: It was a combination of events and not simply the economic slowdown that caused a lot of the problems. They had a huge run, both in terms of their shares as well as in terms of the prices of the products that they were dealing with during the course of late 2007 - what really began in as far back as 2003, 2004 - and these really took off in the 2007-2008 time frame. But in doing that, they also brought on some of the seeds of what eventually took them down, like any cyclical industry. When prices get very high, they bring on things like new capacity and they bring on conservation by the users of those products, or substitute if they can figure any of those out. And all of that conservation, and the launching of new capacity and the increases that were coming, began to push down the product prices as demand began to fall and supply began to inch up. So we got a divergence of those two things. And when that split got widened, the prices started to fall much harder. And in doing that, obviously the falling prices brought the stocks back in. We think that there was a bit of a divergence, in our view, of what was the true driver in the industry. We think that the markets began to look at them, the names in general, as some sort of secular growth story. And the story behind it was more people eating better. And all of that would drive significant increases in need for grains for food use and feed use, and all of that would drive up the fertilizers. The problem is, and it is disregarded to some degree, the cyclical story of: Every year you go into the field, and you really never know what you are going to get out of it. But if you give farmers and anybody incentives to grow, they will grow. And the incentive was higher prices for the grains.
The cyclical story began to take hold more strongly, and you've gotten some big grain outputs from a variety of different places due to a combination of good weather and changes in farming practices, all of those things. The inventories for grains, which had been very, very low, also helped drive up these numbers in terms of the grain pricing, and things started to grow again, started to get higher again and get back into a level of greater comfort, so to speak, for the rest of the world. And once that happened, those grain prices started to fall, and the value that fertilizers bring is also falling, and that's basically the issue to us.
The secular story that people talked about has been in existence for literally hundreds of years. You can take it a long, long way back, and you can listen to the conference calls of the different companies over decades, literally decades, and you would hear the same story over and over again. We're taking too much out of the soil; people will eat better. And it's all true. There is nothing wrong with the story. It's just that in our view and in the research that we've done, we found that that single issue has never been a driver of the shares in any particular year.
What has driven shares, either really strongly or to a significant weakness, has largely been a shock of some form. And historically those shocks were drought - which would take out grain, and therefore it necessitated a big increase in planting the next year and high yields - or much more recently, the issues around biofuels. As a result, you can pretty much trace the big run that the fertilizer names in general have taken back into this 2003, 2004 period, when the U.S. first began to get away from MTBE as a gasoline additive and moved toward ethanol. There was no ethanol mandate at that time. What there was, was a Clean Air Act, which necessitated a product called an oxygenate in gasoline. And there were really only two significant oxygenates available at the time. The first one was MTBE, which was by far the preferred product and had a much, much larger share of the market, and the other approved product was ethanol.
When the MTBE bans began to hit and people were taking out significant amounts of MTBE from the gasoline, ethanol was the only alternative and necessitated increases in corn and in corn planting because that's where you were getting your ethanol from. It also had some tax advantages to go along with it. As you move further on from there, after another couple of years more, you began to move now into what we have, which is this whole move toward taking foreign oil out of our economy to some degree. And ethanol was one of the ways of trying to do that, by either having an E85 - not pure ethanol but mostly ethanol fuel - or a 10% ethanol level in the gasoline. So it was no longer a Clean Air Act issue, it was now a mandate to change our energy usage. And that necessitated again very, very large increases and rather rapid increases in ethanol. And that began to strain the system. And when it did, it shot the prices of the grains up. And it wasn't just ethanol in U.S., but it was biofuels globally. So we saw things like palm oil going way up in price in the Asian markets because you now had palm going into not only things like biodiesel, but you also had it in its traditional markets in Asia, which is more like cooking fuels and cooking oils. And again, this sudden increase in demand from sort of - I won't say out of nowhere - but sort of a mandated increase in demand led to a strain on that system, and they were demanding all sorts of fertilizers. So the fertilizer business, which for years was a nice business and you made some money, but it wasn't phenomenal and as a result didn't get a lot of investment, suddenly was being strained, and there was nothing available to raise supply quickly. Again, you ran into the typical situation that drives a "supercycle," as they call it, in any one of a number of commodity chemicals. We saw it in the oil and refining business when refining was a lousy business and, all of a sudden, you needed lots more refining capacity; you didn't have it. It just shot the price of gasoline and the refining spreads wide open. You've seen it in oil. Commodity chemicals saw it back in the late 1980s, when you had a period of no investment and then, all of a sudden, demand starts to move up above supply but there is no way to add to your supply quickly.
So the only thing that can give at that point is price, and that's what we saw this last cycle. That's where we are today. We are now coming off of that because what it also induces is - and its economics will tell you - the worst enemy of high prices is high prices. It has now turned that around. Farmers started conserving and used a lot less, and all of a sudden, demand went way, way, way down. Again, another shock - in part because once you had the ethanol shock and now everyone is sort of used to it. That momentum didn't continue; it faded. Although ethanol continues to grow, it's growing at a much, much slower rate than it did a couple of years ago, when we were bringing these ethanol mandate limits in, when you had to see big increases. You see that in things like the corn acreage. Not too many years ago, probably no more than maybe five or six years ago, a reasonably normal year for corn would have been a planted acreage level of 77 million, 78 million, maybe it reached 80 million acres of planted corn, meaning you would then harvest something in the middle to lower 70 million acres of corn. And all of a sudden, out of nowhere, that number jumped. It was about four or five years ago, it jumped to 92 million acres of planted corn because we found out we had run through much of our corn inventories or a large chunk of our inventories. We weren't growing enough for the ethanol needs, and we've now settled in at a number that is right around 90 million acres, which is 10 million, 12 million acres or higher than what we had been for years before that.
Corn is a big utilizer of fertilizer in North America; it's the biggest market for all the fertilizers in the U.S. market. It's the biggest user of potash; it's the biggest user of the nitrogen nutrient, and it's the biggest user of phosphate. So any time you substitute an acre of corn for an acre of anything else, or at least of the major grains that we are talking about, you are going to get an increase in fertilizer use. And obviously, if we take 15 million acres, you are either going to have new acres, which isn't really available in the U.S. - I mean, there are some ways to do it, but for the most part, what you are doing was you were taking it away from another crop, whether it was wheat or soybeans, or cotton or other substitutions; all of those entailed more use of fertilizer. So this was a big move for fertilizer on top of everything else, and obviously exports were getting tough. And typically when you get a big run like that, you will also get a typical consumer response, which is when prices are rising, the initial response isn't back off, it's buy more, buy faster, store, get product, inventory product - whatever you can do, get your hands on it because next month it's going higher.
That response, coupled with the actual real demand increase that came from additional acres of different crop mixes, things like that, combined to create this extreme demand a couple of years ago. And like I said, at some point, people say, "Okay, I've got enough in inventory," and they start to slow down their buying. And more than likely, there is going to be a response from a producer over time that says, "You know what, I've got this extra product around, what do I with it? Well, hey, if I offer it to the guy for a few dollars less, maybe he will buy it. But as soon as he does, then I've set a new price for the whole market for that one small amount of product." And it just tumbles from that point. Once the demand started to ease off, once people started to conserve. Once they say, "It's just too expensive," these numbers start to tumble rather hard. Nitrogen molecules came down; you saw the phosphates come down, and there were other things going on in phosphates. And the same was true for potash. Eventually potash sellers tried to hold on longer, but in doing that, it severely hurt its demand numbers. If you look at the overall cutbacks in 2009, in use of the product, potash suffered the worst decline in demand against all the other products, in part because they were trying to hold price for too long and the buyers just wouldn't come in until they got something that they believed was reasonable. They had the inventory to play with to keep it that way.
Tickers included in this excerpt: AGU, BHP, CF, IPI, MOS, POT, URKA.RU, VALE
For more information call (212) 952 7433. The Wall Street Transcript does not endorse any of the comments made by interviewees, and does not make stock recommendations.