Sales Drivers and What to Expect for Fertilizer Companies

Originally published on January 13, 2017, this article was substantively updated on December 27, 2019.

The world has a problem that’s actually good for the fertilizer industry. This problem relates to the world’s population, which is ever-growing, as is food consumption. However, the land available to grow crops is limited and shrinking as a ratio to population.

The land is finite on Earth, and the percentage of agricultural land is an important data point that investors have to look at. Many factors affect agriculture, including climate, soil conditions, and the availability of resources to support agricultural activities. Invariably, these drivers affect the land available for agricultural purposes. So, how much agricultural land is there, really?

According to the Food and Agriculture Organization, agricultural land in 2016 was 37.4% of the total land in the world. Notably, over the 24 years from 1992 to 2016, total agricultural land as a percentage of total land remained fairly stable. And in 1992, agricultural land accounted for 37.2% of Earth’s total land. This number was slightly higher at 37.4% in 2016. You can see how little the growth in arable land was over those 24 years.

But a little change in agricultural in the face of the ever-growing population is an issue. The world’s population increased from about 5.4 billion in 1992 to 7.4 billion in 2016. So the total agricultural land available per person shrunk over these 24 years. And the arable land available per person in 1992 was 0.258 hectares (~0.62 acres). In 2016, it was 0.192 hectares (~0.47 acres).

Limited land growth and a growing population are a problem that has given rise to industries that develop technologies and products that provide solutions. These industries include fertilizers, seeds, herbicides, and agricultural equipment. According to the World Bank, in 2016, agriculture accounted for 3.5% of the World’s GDP.

Out of the above factors, we’ll mainly talk about the fertilizer sector and why it serves one of the most important functions in the agricultural industry. While we focus on that question, we’ll also discuss what drives the demand for fertilizers. And we’ll also look at some of the fundamentals for the companies that serve this sector.

Fertilizers play an important role in the development of crops by providing the required nutrients for plants to grow. As a result, they may also improve the quality of crops.

Also, fertilizers also help in improving farmers’ crop yield. This advantage is one of the most crucial requirements for bridging the gap between an ever-increasing human population and limited arable land. But how do you know which nutrient a given crop needs most?

To help answer that question, we have Liebig’s “law of the minimum.” This law states that a plant’s development is limited by the most deficient nutrients in the soil, even if other nutrients are abundantly available.

As a result, an expert can analyze how much a plant develops and determine which nutrient it requires the most. The key to a healthy crop is to have balanced nutrients, which these products can supply.

Fertilizer is the single most important catalyst in improving crop yield. So fertilizer use has increased around the globe in the past century.

Also, investors have seen global fertilizer NPK (nitrogen, phosphorus, potassium) fertilizer use increase over the years. According to the IFA (International Fertilizer Industry Association), consumption in the 2010–2011 season was 173.0 million tons. And it was close to zero about 90 years ago. Also, developing countries consumed about 70.0% of the 173.0 million tons of fertilizer. The remainder went to developed countries.

We saw a fall in fertilizer consumption in the early 1990s due to the collapse of the former Soviet Union, according to the IFA.

Fertilizer use over the years has increased significantly. Research has shown a high and “near-linear” positive correlation between fertilizer use and cereal yields. Cereal includes corn, wheat, rice, oats, barley, rye, sorghum, millet, buckwheat, and mixed grains.

For example, cereal yields increased from 3,110.0 kg (kilograms) per hectare in 1992 to 3,910.0 kg per hectare in 2013. And over this period, fertilizer consumption increased from roughly 107.0 kg per hectare in 2002 to 136.0 kg per hectare in 2013. So the growth in fertilizer use versus cereal yield growth showed a high correlation.

Companies like CVR Partners (UAN), Mosaic (MOS), and Nutrien (NTR) play critical roles as fertilizer producers.

The majority of fertilizer consumption in the 2010–2011 season took place in China, with a 29.0% consumption rate, or 50.7 million tons. About 20.0% of use came from South Asia, with India as the largest consuming region. Excluding China, use in East Asia accounted for 8.0%.

And North America consumed about 13.0% of total global fertilizer use during the same period. Next came Latin America and the Caribbean, which accounted for 10.0%. Brazil and Argentina are key agricultural markets in Latin America. West and Central Europe, along with Eastern Europe and Central Asia, contributed 13.0% of the total global use.

Now, there are also several types of fertilizers. So, what types see the most use?

There’s been a lot of focus on a few subtypes of NPK (nitrogen, phosphorous, and potassium) fertilizers. Naturally, the subtypes that see the most use globally get the most attention. So let’s look at which NPK subtypes are the most popular.

Nitrogen fertilizer consumption

Urea is the most consumed nitrogen fertilizer globally at about 56.0% of all nitrogen fertilizers, according to the IFA (International Fertilizer Industry Association). India, China, and Brazil consume mostly urea for their nitrogen fertilizer use, according to the IFA.

AN/CAN (ammonium nitrate/calcium ammonium nitrate) is the second-most globally consumed nitrogen fertilizer at about 9.0% of all nitrogen fertilizers. West and Central Europe mostly consume nitrate for their total mix of nitrogen fertilizer consumption.

Phosphorous fertilizer consumption

Among the total phosphorous fertilizer consumption, DAP/MAP (diammonium phosphate/monoammonium phosphate) gets the most use globally, at about 57.0% of the total phosphorous fertilizers. Next come SSP (single superphosphate) and TSP (triple superphosphate).

Potash fertilizer consumption

MOP/SOP (muriate of potash/sulphate of potash) are the most consumed potassium fertilizers in the world at about 71.0% of potash consumption.

Each NPK fertilizer provides different value to a plant. Nitrogen helps increase the yield and is often the most commonly lacking nutrient in a crop. And Potash and phosphate fertilizers add to the quality of a crop.

Potash and phosphate input materials are limited by globally available reserves. Almost 81.0% of known potash reserves are in Canada and Russia. Meanwhile, about 75.0% of known phosphate rock reserves are in Morocco and Western Sahara. As for nitrogen fertilizers, the key input material is natural gas or anthracite coal, which are abundantly available.

So, the potash and phosphate fertilizer industries are more concentrated than the nitrogen fertilizer industry, which has far more players around the globe.

Investing in the agricultural fertilizer industry can be challenging. Very few companies have publicly listed. And this industry has also come under severe pressure. So it’s important to understand what drives sales for agricultural fertilizer companies.

Most standard fertilizers are essentially commodities. So companies that manufacture fertilizers such as urea, DAP (diammonium phosphate), and MOP (muriate of potash) don’t have control over prices.

Fertilizer prices are affected by supply dynamics such as total available production capacity, capacity operating rates, raw material costs and their availability, and government regulations.

Note that fertilizer companies don’t operate at 100% capacity. A company that operates above its historical average operating rates may indicate a need for expansion. Consequently, a company operating below its historical operating rates may indicate an increase in market total supply or a reduction in demand.

Demand dynamics include:

• GDP growth.
• Planted acres.
• Weather.
• Crop prices.
• Crop inventory.
• Dietary patterns.
• Population growth.
• Application rates.
• Alternative use of crops, such as ethanol made from corn.
• Currency fluctuations.

These supply-and-demand dynamics are, in turn, affected by a host of drivers.

Fertilizer sales have a “lumpy” life cycle. And this lumpiness comes from the imbalance in supply and demand due to the several factors. On the demand side, improved weather expectations can lead to an increase in demand for fertilizers. On the supply side, while most fertilizer companies do prepare for such an environment, they aren’t quick to react to a sudden, unexpected surge in demand. The lead time to expand capacity can take years. And by then, the demand would have vanished, leading to product curtailment.

Production curtailment remains on the horizon as a result of weakness in demand in 2019. According to Mosaic, the market imbalance tilts toward the supply side with weak excess product and low fertilizer application in North America. This trend has led to an increase in inventories and downward prices for these products.

Over the long term, the population’s growing food needs will remain the key driver for the fertilizer industry. However, low-cost producers will have an edge over peers as the margins will remain thin. Profitability for players in this industry largely depends on the type of fertilizers they’re exposed to the most. And as we’ve already seen, most fertilizer companies (MOO) produce macronutrients such as NPK (nitrogen, phosphorous, and potassium).

Plus, there will be a difference in regional players as some will continue to import from other countries due to low cost. North America, for example, experienced excessive phosphate imports while China remained a net exporter.

The fertilizer industry has a handful of big players competing with each other—which is usually the case in a commodity business. Thin margins are unattractive to new entrants. Moreover, setting up shop within this industry requires huge capital, which makes for a high barrier to entry. The availability of raw materials, especially for potash and phosphate, also limits entry into the business.

Since fertilizers are critical to the development of crops, there are several incentives for governments to provide subsidies to industries within their jurisdiction. Also, governments can also set up trade barriers that could further restrict the movement of fertilizers coming into the market. Subsidies and trade barriers can make free-market players uncompetitive. Nonetheless, let’s look at some of the top players in this industry.

With a market capitalization of $27.7 billion, Nutrien (NTR) is one of the largest producers of potassium and phosphorous fertilizers in the world. Mosaic (MOS) has a market capitalization of $7 billion and also produces potash and phosphate products. CF Industries (CF) produces nitrogen-based fertilizers and has a market capitalization of $10 billion. These three companies are in North America.

Outside North America, Uralkali and Belaruskali are the largest producers of potash fertilizers in Eastern Europe. K+S AG, a potash producer, is headquartered in Germany. Meanwhile, EuroChem, which is headquartered in Switzerland, produces potash and nitrogen products. Yara International is headquartered in Norway and produces nitrogen fertilizers. Another phosphate and potash name, Israel Chemicals (ICL), is headquartered in Israel.

In 2019, the agribusiness sector has underperformed the S&P 500 Index. For example, the VanEck Vectors Agribusiness ETF (MOO) has returned 21.5% year-to-date while the S&P 500 has returned 28.3% as of December 22.

The sector saw its worst struggle in 2016. Falling prices year-over-year were at the heart of the concern for this industry. The cause of falling prices stemmed from overcapacity within the industry. Clearly, this trend wasn’t sustainable. And some producers curtailed their production, adjusting to demand dynamics. Things haven’t changed much in 2019.

The performance of fertilizer stocks has lagged behind the agribusiness sector. For example, CF Industries (CF) has returned 14.87% while Nutrien (NTR) has returned 5.36% this year. Mosaic (MOS) has been had a terrible year in 2019 with a -25.6% return.

If you invested in any of the agricultural fertilizer companies I discussed above, you’ve failed to beat the S&P 500 (SPY). However, investing in fertilizer stocks means more or less investing in commodities, which have a lumpy cycle.

Perhaps the most important metric that matters to investors is returns on their investment. With the focus on common equity investors, we use ROE (return on equity) as a measure of return.

The industry median return for the fertilizer sector over a five-year period is about 6.2% as of 2019. CF Industries (CF) tops the list with a median ROE of 10.35%, followed by Mosaic—which had a ROE of 6% over the past five years.

While these two companies had a positive ROE, some experienced a negative ROE over the past five-year period. For example, CVR Partners (UAN) had a negative ROE of -0.25% while LSB Industries (LXU) had a negative ROE of -4.2%.

Companies with large operations such as Mosaic can attain economies of scale and afford to outplay other industry participants.

Over the long term, the Mosaic Company (MOS) expects supply for potash fertilizers to be in balance with demand. However, the company expects the market conditions for phosphate fertilizer to improve significantly.

For nitrogen fertilizer, CF Industries expects demand to exceed supply over the next four years. CF Industries also expects capacity additions to remain limited. And this outlook could explain why fertilizer demand will rise in the near term.