1st vs 2nd level commodities
In our main article, we note that natural gas supply issues are causing production issues in fertilizer.
Fertilizer is what we refer to as a 2nd level commodity.
1st level commodities rely on few if any other commodities for production.
2nd level commodities rely heavily on another commodity for production.
Miners are typically 1st level commodities. They don’t require a constant supply of equipment, just power.
Grains and agricultural commodities are 2nd level because the production relies on inputs such as fertilizer and chemical availability.
Making this distinction can help you understand the difference between what is a ‘pure play’ on a commodity vs a derivative.
That’s why certain energy companies do better than others when the price of crude oil rises.
The commodity no one talks about
One sector has crept higher that no one seems to smell – fertilizer.
Like many commodities, prices soared in the last year.
With supply chain issues crimping deliveries and insatiable demand, we see a lot of opportunity in this trend.
Can you smell what I’m talking about?
Everyone is paying higher prices for fertilizer.
Just take a look at the price climb for the retail market.
Americans import 20% of their urea and 40% of ammonium nitrate from Russia alone.
Shortages of natural gas, a critical component in fertilizer creation, coupled with higher prices are forcing some manufacturers to cut production.
CF Industries (CF), one of the largest fertilizer companies in the world, said it expects the shortage to continue into the foreseeable future.
What that means for us
Consumers should expect to pay higher food prices on produce and products that use corn derivatives.
Bloomberg’s Green Markets forecasts 2.5 million acres switching from corn to soybeans, which uses less fertilizer.
That puts pressure on companies like Archer Daniels Midland (ADM), one of the largest agricultural manufacturers of corn and ethanol products.
What it means for Ag companies.
Investors in major fertilizer companies such as Mosaic (MOS), Intrepid Potash (IPI), and CF Industries (CF) need to be cautious.
Even with pricing power, fertilizer manufacturers are subject to the same input cost and supply problems as other companies.
The good news is that demand is so high, companies with better inventory management will stand to make a fortune.
For example, Mosaic trades at just ~8x forward earnings with a price to cash flow of just 6.3x, making it incredibly cheap by historical standards.
The Bottom Line: Higher fertilizer prices are bad.
At most, they can lift up specific manufacturers.
At worst, they make food more expensive for everyone.
There’s money to be made within the Ag space. Look for companies that manage inventory more efficiently than others to come out on top.