What happens to a forest after a forest fire?
More often than not, it grows back even healthier than before. Trees damaged in a fire typically die within two years, and dead vegetation falls to the ground. The remaining snags provide a habitat for wildlife and eventually fall to the forest floor, becoming a long-term source of nutrients. It’s a process of creative destruction.
Financial markets can behave the same way. They can crash and burn, clearing out irrational excess in order to build a foundation of sustainable growth. Two prime examples: the tech bubble of the late 1990s and the so-called commodities supercycle.
“Technology is here to stay.”
This is one of the most ridiculous statements I’ve heard uttered by investors as they bid up the likes of Pets.com and CMGI to ridiculous, stratospheric prices. Along the way, the stocks of many great long-term companies were lifted as well. One of my favorite “Forever Stocks,” chip-making giant Intel Corporation (NASDAQ:INTC), has been punished for over a decade, thanks to guilt by association.
But what happened after the crash is that investors are able to buy shares of a great company that consistently makes money and rewards its shareholders with a rising dividend. Best of all, the shares can be purchased at a 36% discount to the price-to-earnings (P/E) ratio of the S&P 500 index.
After The Fire
The overhyped commodities supercycle has experienced a similar rise and fall. The rise was twofold. First, as emerging markets became more developed economically and their citizens became more affluent, they ate more. Food producers needed to produce more and in the meantime, commodity prices on the in demand agricultural products went up. This nearly decade-long chart tells the story.
The second cause of rising commodity prices was fueled by the decade-long bear market in equities. Investors needed to go somewhere. The commodity train was leaving the station, and they hopped on. Then the train wrecked, as it always does during any type of investment mania or bubble, and like the tech bubble, many high-quality companies were swept up by the rising tide and mercilessly pummeled.
I’ve found two ideas that spell profit for investors. Best of all, these companies manufacture an essential component to agricultural production: fertilizer. You really can’t farm without it. It doesn’t matter whether commodity prices are in the clouds or the toilet. People have to eat, farms have to grow food, and fertilizer is needed, regardless.
The 900-Pound Gorilla
Potash Corp./Saskatchewan (USA) (NYSE:POT) is the world’s biggest diversified fertilizer company and one of the world’s largest producers of potash. Estimates peg the company’s contribution right at 20% of global capacity of potash production.
During the decade long commodities supercycle party, Potash Corp./Saskatchewan (USA) (NYSE:POT) definitely made hay while the sun was shining. From 2004 to 2012, earnings per share grew at a compound annual rate of 30% while the dividend grew 24%.
Based on how well the company took advantage of the macro trend, it’s no wonder investors bid the share price up to lofty heights. But that was then.
With the realization that rapid growth in emerging markets would eventually slow, the financial markets took their toll. The stock is 60% off of its pre-financial crisis highs and over 30% off of its 52-week high. But there’s another issue compounding the problem.
Recently, the largest Russian potash producer, OAO Uralkali, said it would begin selling its own potash rather than using a marketing group model as it had in the past. The company also said that it would focus on volume over price. This announcement has caused massive confusion in the potash market and pummeled the stock prices of potash producers. So, if prices are going down and competition is heating up, should you own shares of Potash Corp./Saskatchewan (USA) (NYSE:POT)? Yes.
Aside from the two major influences on the potash industry, Potash Corp./Saskatchewan (USA) (NYSE:POT) is an incredibly well-run company. Shares trade at around $29.50 with a forward P/E ratio of 11.9 and an attractive dividend yield of 4.7%. The financials are impressive, too. The long-term debt-to-capitalization ratio sits at an extremely comfortable 25%, and return on equity (ROE) is a strong 23%.
The company still sees growth despite the tough environment projecting global potash shipments to rise 7.8% to 55 million tons from last year. It’s obvious that Potash Corp./Saskatchewan (USA) (NYSE:POT) prepared for the famine during the feast.