MOS - Mosaic Might Double As Its Bull Case Returns

2023-08-09 17:03:27 ET

Summary

• The Mosaic Company's just-released earnings confirm higher affordability and strong regional demand in the agriculture industry.
• The correlation between corn and oil prices could be a potential catalyst for Mosaic's growth.
• Mosaic's robust performance, global supply challenges, geopolitical events, and market dynamics support a favorable outlook, aligning with earnings data.

Introduction

I have looked forward to writing this article for two reasons:

1. I always look forward to covering agriculture topics, as they are so important and a big part of the macroeconomic puzzle.
2. I've been very bullish on The Mosaic Company ( MOS ) since early 2020 and get to discuss new data that confirms my thesis.

The company's just-released earnings confirm what we've discussed in a number of prior articles (most recently, this one ). Subdued fertilizer prices and elevated crop prices have created higher affordability, which is fertile (pun intended) ground for higher volumes down the road.

Furthermore, we're seeing strong regional demand as global crop inventories remain subdued, worsened by the weather impact in major growing areas.

When adding energy market dynamics, we get a confirmation of my bull case, which could send MOS shares to $80 and higher.

So, let's dive into the details!

The Bull Case Roars On

The quote below is a big part of the takeaway from my last article (emphasis added):

Mosaic faces a lack of catalysts to attract optimistic buyers despite benefiting from strong tailwinds and an attractive valuation.

However, a potential catalyst could lie in the correlation between corn and oil prices , which directly affects Mosaic due to energy costs driving agriculture prices.

Furthermore, the company's performance remains robust, with increased purchases of phosphates and potash in North America and growth investments underway.

Mosaic expects market dynamics to unfold favorably worldwide and emphasizes the importance of consistent fertilizer application for sustained crop growth.

While it's bad for inflation, I'm glad to say that all these developments are working out very favorably for the agriculture bull case.

Favorable Energy Developments

Starting with energy prices, we see an upswing in key oil benchmarks like WTI and Brent, which are starting to positively impact agriculture crop prices.

The chart below compares December WTI crude futures to December (new crop) corn futures.

This is what the comparison between Mosaic and longer-term oil futures looks like:

Sure, Mosaic doesn't produce oil. It produces potash and phosphates for farmers.

However, energy is a big part of my bull case, as agriculture commodities tend to trade slightly above the cost to produce them. Energy is the single biggest driver of production costs.

Hence, when energy prices rise, it changes supply dynamics, resulting in higher crop prices. This has an impact on farm income and a wide range of other financial numbers.

I expect energy to remain in a bull market, as global demand isn't as bad as expected, and we're now at a stage where US shale production growth is rapidly declining.

Mosaic's Numbers And Comments Are Bullish

First of all, the 2Q23 numbers weren't great. Revenues came in at $3.4 billion, which is 37% below the prior-year quarter. Operating earnings fell below $370 million, which is a decline of 78%.

The decline was visible in every segment as a result of poor pricing and volume headwinds in the Potash segment and Mosaic Fertilizantes, the company's Brazilian operation.

This is what the development of fertilizer prices looks like:

However, these declines were expected. Analysts actually expected total revenue to come in $250 million below the actual result.

What matters more than anything is the company's outlook.

During its earnings call, the company highlighted the constructive fundamentals of the market, supported by robust global demand for crops coupled with supply challenges.

Geopolitical events, such as the war in Ukraine, have impacted supply dynamics. The UN Black Sea Grain Initiative's collapse and subsequent grain terminal bombings have caused Ukrainian corn and wheat exports to plummet by up to 30% compared to the prior year, putting a floor under crop prices and creating a bigger incentive for other regions to boost production.

Furthermore, weather extremes worldwide, including drought conditions in North America and El Nino's effects on Southeast Asia and Australia, are influencing crop production.

To counter these challenges, farmers have to increase fertilizer applications, particularly potash, to enhance drought resistance and crop resilience.

With regard to supply dynamics, China's increased imports of soybean, wheat, and beef are reshaping global trade flows. The reduction in Ukrainian supply affects not only China, but also Europe, Africa, and Asia.

Meanwhile, China's exports of phosphates have been constrained for a while without a high likelihood of a turnaround.

Essentially, China's environmental policy has reduced domestic capacity, affecting exports. Industrial demand, particularly in lithium iron phosphate production, is expected to grow substantially in China.

In India, food security also remains key, which led to export bans on non-Basmati white rice.

Supply constraints and strong demand are creating pressure on global stock-use ratios, which are already at multiyear lows.

These factors collectively support a favorable agricultural market outlook, fostering robust fertilizer demand in key markets.

Improved affordability, inventory destocking, and sustained grain and oilseed demand have stimulated market activity, particularly in the markets that matter most to Mosaic: North America and Brazil.

Furthermore, according to the company, favorable grower economics are driving early supply procurement, despite logistical constraints like low water levels on the Mississippi River and limited trucking capacity.

In Brazil, demand is picking up as anticipated.

Overall, the fertilizer market recovery aligns with the company's expectations, with volumes and prices reacting positively.

(A Rosy) Outlook

As part of ongoing tailwinds, the company is investing in both maintenance and expansions. The company's investments include debottlenecking projects to boost production capacity in both potash and phosphates, reinforcing its position in value-added products, and strengthening its competitiveness, which should be a long-term margin tailwind.

Furthermore, Mosaic is investing in a 1-million-tonne blending and distribution facility in Brazil to extend its distribution footprint.

The company is also exploring opportunities in the lithium iron phosphate battery market, investing in differentiated phosphate products, and expanding its MicroEssentials offerings, which is also a margin-enhancing project.

With regard to the outlook below, the company noted that the guidance for potash volume depends on international shipping capabilities, which have been impacted by labor unrest and ongoing repairs.

Despite these challenges, the midpoint of the guidance aligns with historical averages, emphasizing strong North American demand without pricing in too much optimism.

Furthermore, the company's summer fill program has seen robust demand, surpassing expectations by 30%.

There's also potential for higher phosphate volumes due to global demand, even though inventory constraints exist.

Production is anticipated to increase sequentially, which offers an opportunity to exceed the current guidance range.

Pricing details reveal that 70% of the Q3 order book is committed and priced.

So, better pricing is possible, particularly in the fourth quarter, given a portion of unpriced tonnes.

Valuation

Putting a target on commodity-driven stocks is tricky, as it's impossible without incorporating a thesis for the underlying commodity.

That's also why so many professional sell-side analysts upgrade stocks after a rally has started because (almost) nobody is willing to bet their careers on certain macro trends. They would rather predict based on current numbers and/or stick to stocks that have a much more consistent performance than volatile and cyclical commodity-driven stocks.

Having said that, after rising 15% in the past four weeks, MOS shares are now trading at their consensus price target.

MOS shares are currently trading at 6.2x NTM EBITDA. This is fair and far from overvalued, especially because I expect fertilizer prices to rise meaningfully over the next 12 months.

Hence, I stick to what I wrote in my prior article. Back then, I also reiterated my $70 to $80 price target, which makes me one of the most bullish analysts.

Takeaway

My bullish stance on Mosaic has been vindicated by its recent earnings report and supportive market dynamics.

Affordability driven by subdued fertilizer prices and elevated crop prices forms a fertile ground for increased volumes.

Furthermore, strong regional demand, exacerbated by weather impacts, underscores the company's promising outlook.

Energy market dynamics, particularly rising oil prices, further amplify the bullish case, influencing agriculture prices and potentially enhancing MOS's profitability.

Additionally, the correlation between corn and oil prices emerges as a potential catalyst, while Mosaic's robust performance, strategic investments, and optimistic market outlook reinforce my positive outlook.

As the industry recovers and Mosaic continues its growth initiatives, a target price of $80 and beyond remains within reach.

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