An Ag Cycle

Food price inflation.

I can’t get over the move we are seeing in ag prices.

To think that corn is over $7 a bushel right now. Its pretty much a parabolic move.

My first foray into agriculture was in 2006. Donald Coxe, who I followed closely, became a huge agriculture bull. I did extremely well buying fertilizer stocks, seed stocks and machinery stocks. Then 2008 happened and the party ended.

I made a second foray into Ag from 2009 to around 2012. Again, a sustained move that lasted a few years.

I learned from Donald Coxe not underestimate the duration of a bull market in ag. You don’t see this kind of move unless there is something tectonic going on below the surface. Something that will last 2 years, not 2 quarters.

Corn acres in the United States came in well below early expectations while soybean acres beat only modestly. I see estimates from January that there would be 95-97 million acres of corn and 87-89 million acres of soy beans. The latest estimate right now are showing corn coming in at under 93 million acres and soy beans just over 90 million acres.

In Brazil there are drought conditions that are not looking good for their corn crop. And in Canada, I can attest to the fact that moisture this year has seemed low.

What could go wrong? Well for one, a lot of buying is coming from China. They are restocking and dealing with rebuilding their swine herds after the last bout of African swine flu and that demand might be transitory. China loves to blindside the market by stepping away if it’s in their best interest.

Never underestimate the ability of the North American farmer to squeeze more yield out of the same acre.

And is this (and every other inflationary force) a one-time global restocking after the pandemic that will end in a couple quarters?

Picking Ag stocks is tricky. There is interplay among Ag commodities – what is good for corn is bad for chickens, bad for soybeans but often good for wheat. Ag stocks often have a finger in many pies so you really have to be careful with what you are buying.

The two things I felt most sure of, at this early stage of my research, are that A. there is going to be more demand for fertilizer and B. farmers are going to do very well.

So I took a couple mid-cap positions.

I bought Mosaic and Nutrien, which are fertilizer plays (though Nutrien is diversified beyond fertilizer). Mosaic has the best leverage to potash (other than Intrepid Potash, which I looked at and based on the earnings reaction today maybe I should have bought instead). And I bought Ag Growth International, which should benefit from increased farm income. I’ll talk about Mosaic and Ag Growth for now.

Mosaic

I have always loved potash stocks. I know the nutrient has its limitations – it is not as necessary as N and K and so farmers (and countries) can balk and walk away if prices rise too quickly.

But from what I’ve read the potash producers have some cards in their favor. India just signed a surprise contract at $280 per tonne, $50 per tonne higher than the previous agreement. Port inventories in China are low. And of course grain prices are high.

Spot potash prices in Brazil are already $330 per tonne.

Mosaic put together the classical “bull case for fertilizer” slide in their March presentation.

Simply put, the bull case is – yes fertilizer prices are up but grain prices are up even more! And you presumably should get a better yield per acre with better fertilizer application.

Mosaic will benefit. They own two potash mines in Saskatchewan and another small one in Texas. Mine capacity a little under 10 million tonnes. They produced 8.4 million tonnes last year.

I calculated that every $50 per tonne increase is another ~$400 million of revenue. Most of that, ex-taxes, should drop to the bottom line. That is close to a buck a share of EPS.

Mosaic’s other major business is phosphate. Midwest phosphate prices are $600 per ton FOB right now. This is up substantially year-over-year.

Inventories for phosphate look an awful lot like they did in 2009-10.

Mosaic’s phosphate operations are in the United States and Brazil. In the US they have capacity for just under 10 million tonnes of processed phosphate while in Brazil they have capacity for another 4 million tonnes (that is equal to 70% of Brazil’s annual production). They produced about 8,500kt of finishes product last year at a selling price of $360 per tonne.

Mosaic’s revenue from phosphate this year is, so far, significantly above last year. February revenue was $297 million vs $172 million in 2020. January revenue was $337 million versus $198 million. This does not include the Brazil operations, where sales were roughly flat yoy.

The Phosphate segment did about $2 billion in sales and $400 million in gross margin in 2020. This year I think they’ll do well over $3 billion of revenue. Probably over $3.5 billion. That extra $1.5 billion of revenue is going to almost all fall to operating income.

If you look at analyst estimates, they are pegged for ~$2.6 billion of EBITDA this year. That is after $1.5 billion of EBITDA last year. When you look at where potash and phosphate prices are, I think Mosaic is going to beat those estimates by a lot.

What’s more, the stock is anything but expensive. On analyst estimates the stock trades at a little over 6x this year’s EBITDA. In the 2009-2011 cycle, Mosaic’s EV/EBITDA got to over 11x. Once they show they are beating estimates, the multiple goes up.

Ag Growth International

AFN provides grain handling equipment to farmers and grain buyers. Augers, belt conveyors, bins, aeration equipment.

The bet here is that a reopening and rising grains prices has got to boost demand. It appears to be so far. On the fourth quarter call the company said backlog entered the year up 20% yoy and was up 40% yoy in March – and that March comp had not been impacted by COVID yet.

There are a couple of negatives that are going to hit their business this year. First, the bins are steel, which is going up in price (though that actually might pull forward demand in the short run).

Second, they sell into the US but costs are in Canadian, so this rising Canadian dollar (the bane of my existence) is going to be a headwind.

And third, they had a bin collapse last year, and that creates some uncertainty. I will get to that later.

But the stock is not super expensive. I bought it at $40. That is under 13x trailing (adjusted) EPS. The company had a dividend of $2.40 per share in 2019, which would be a 6% yield if reinstated.

While just a general improvement in business conditions is the main story, the kicker comes from their AGI SureTrack product. SureTrack is a connected farm type of product. It is directed at both farmers and grain buyers.

SureTrack is made up of a number of tools to monitor the farm. There is a grain bin monitor that tracks your grain level, quality and bin conditions. A field monitor keeps track of conditions in the field. There is tank manager for monitoring fuel and liquids. a dryer manager for monitoring grain drying. There is a marketplace for monitoring prices and connecting buyers and sellers. And there is an economics module that helps you maximize your margin based on growing, hauling, labor and fuel costs.

There is a very good discussion on the fourth quarter call where a lot of detail on SureTrack is provided.

They put together the platform through acquisitions of IntelliFarms, Affinity Compass, CMC as well as our investment in Farmobile.

AFN describes what SureTrack provides as follows:

They sell SureTrack through 3 principal channels: direct to farm, direct to commercial users, including grain buyers and food processors and through their dealer network.

AFN already has a large dealer network – they can sell SureTrack through 1,000 existing dealers in the United States.

There is a comp here with the recent IPO FarmersEdge.

SureTrack and FarmersEdge have one big similarity – they are both SaaS solutions for managing farm operations.

But Suretrack is not really in competition with FarmersEdge. There is a bit of overlap, but not much.

FarmersEdge is really a monitoring and predictive tool for managing the crop in the field. Seed selection; precision planting; precision application; machine automation; soil probes, satellite imaging and telematics data used to determine plant health and problem areas.

SureTrack provides a platform to manage the farm itself. FarmersEdge is upstream, SureTrack downstream.

FarmersEdge did about $46 million of revenue this year, up about 100% yoy. They lost $8 per share and had $44 million of negative free cash flow. SureTrack did $23 million, with less growth – 16% yoy or 33% on a retail equivalent sales basis (more on that shortly). While SureTrack is not yet cash flow positive, they said on the Q3 call they expected to reach that shortly.

The FarmersEdge solution is definitely the sexier of the two products but the fact remain that they both manage operations on the farm. With that in mind, FarmersEdge has a market cap of $740 million. AFN is going for about $1.5 billion, including debt.

Now there is a question of how much SureTrack is really a SaaS business. AFN sells the IoT hardware and the subscription. The hardware currently makes up most of AFN’s revenue. The company breaks down the revenue buckets in their MD&A where they reconcile their “Retail Equivalent” revenue with the actual revenue that they are allowed to book.

There are positive and negative takeaways here. The negative is that the actual data subscription revenue is small. The positive is that the real apples-to-apples sales number should be the “Retail Equivalent”, which means the business is growing at a 33% clip.

It sounds like AFN is changing the way they sell SureTrack this year. They will be selling more of the IoT hardware upfront rather than packaging it with the subscription. This is actually going to make revenue look better than it should this year.

While the subscription revenue is, so far, small, that also means the market left to tackle is large. On the fourth quarter call they pegged the North American addressable SaaS market for SureTrack at $2 billion. The IoT side is another $10 billion.

CIBC is targeting 50% growth for SureTrack this year. That seems a little aggressive to me, but I do note that the data subscriptions grew at 44% last year, and that was with COVID. When one analyst asked about margins Tim Close, the CEO, seemed to agree with the assessment that 60-70% gross margins and 20% EBITDA margins would be in the ballpark. Close has talked about 50% growth in the past.

Whether this is a true SaaS business or not, I could see analysts getting onboard with comps to FarmersEdge and viewing AFN as a technology play. If SureTrack can pull off some eye-popping growth numbers this year, I think that could generate excitement and boost the stock quite a bit.

The rest of the business is not that exciting, but it is steady. They did $1 billion in revenue last year and generated $149 million in EBITDA. The year before that they did the same $1 billion in revenue and generated $144 million in EBITDA.

The company does have an albatross around its neck because of a pretty large mishap they announced in September. One of their bins collapsed at a commercial installation in Vancouver. This SA article goes over it quite well. There are two sites, with the same customer, that were affected. They have allocated $70 million as their cost of remediation of the two sites (they said they would be replacing the entire structures, including the hopper base). They said in the original press release that the original cost was $19.1 million so I’m not sure why its so high, unless maybe they are expecting legal costs too?

Anyway, what’s done is done and this does appear to be done. I mean its not great, it raises some questions about their ability to execute (assuming they are at fault, which has not been determined yet). But the biggest concern would be if this incident caused them to lose customers.

That doesn’t seem to be the case. As I mentioned at the start, the backlog is strong.

My last comment is there is quite a bit of debt here. There is $409 million of long-term debt and another $307 million of debentures. So the overall enterprise value is about $1.5 billion.

On an EV/EBITDA basis that puts the stock at 10x. On an adjusted EPS basis its cheaper – at 13x trailing earnings where I bought it.

On a free cash flow basis RBC puts 2020 at $2.44 per share – or 17x trailing FCF. RBC forecasts free cash flow at $3.16 per share this year and $4.67 per share in 2022. That seems pretty aggressive to me but if they hit it, the stock should be higher. I saw that CIBC is also forecasting $4+ of free cash flow in 2022.

So those are my two main farm plays. I havee a couple micro-cap bets as well that I will maybe talk about in detail another time. Imaflex and Flexible Solutions. Both provide solutions that reduce crop input costs.

Imaflex does it by producing crop protection films that cut down on pests and weeds in the soil around the plant. I’ve owned this stock for a long time and they finally seem to be putting together the results I’ve long hoped for. They did 12c EPS last year which means this is not an expensive stock.

Flexible Solutions markets a chemical call thermal polyaspartate that prevents fertilizer from crystallizing and therefore reduces the amount of fertilizer that needs to be applied. The company announced a disappointing number for Q1 revenue due to shipping constraints and the stock tanked on that. I decided to buy that dip to $3.

With respect to the rest of my portfolio, the mega-cap drug stock trade did not really work out as well on earnings as I had hoped. I screwed up on COVID. First Lilly, then Bristol Myers both took hits on earnings due to COVID. The problem (or not problem, depending on how you want to look at it) is that with vaccines here (none of which are supplied by BMY or LLY), the treatments these companies were supplying for COVID patients are no longer required.

I originally sold my BMY but decided to buy it back yesterday. I am keeping LLY because the pipeline is better and the Alzheimer drug could still surprise, which I believe would send the stock through the roof.

I forgot to mention retail in my last post. I was listening to a podcast of Mad Money a couple of weeks ago. Cramer had on Matt Boss, Retail Analyst from Morgan Stanley. Boss described retail as being in the second inning. I found it compelling.

So I looked at some of these retail stocks and yes, they have moved a lot, but they are not that expensive. Foot Locker trades at 15x this years earnings and 12x next years. Big Five Sports, I’ve talked about a lot in the past and it remains under 10x earnings if you believe they can do $2 EPS this year (they guided to 50c in the first quarter). The Gap

I bought Foot Locker and Big Five Sports early last week.

Finally, I bought Chemtrade International last Monday. I timed that one well (for once). The stock is up 8% since I added it. It has a great dividend, is cheap and its products should be levered to both recovery and to price pressure. Another one to talk about more another time.