Barron's Streetwise - Almost Fresh Fertilizer Episode

Episode Date: August 25, 2023

In this rerun, Jack breaks down the worldwide trade in plant nutrients. Learn more about your ad choices. Visit megaphone.fm/adchoices

Calling all sellers, Salesforce is hiring account executives to join us on the cutting edge of technology. Here, innovation isn't a buzzword. It's a way of life. You'll be solving customer challenges faster with agents, winning with purpose, and showing the world what AI was meant to be. Let's create the agent-first future together. Head to salesforce.com slash careers to learn more. Hi, I'm Jack Howe. This is the Barron Streetwise podcast. And that smell, that's an encore presentation of an episode we did on fertilizer about a year ago.

Here's our audio producer, Metta. Hi, Metta. Hi. Anything else people need to know? They're singing. Oh boy. We'll be back with new episodes after August. Thanks and enjoy, or endure. So the farmer's still in good shape. They're still making money. And that's ultimately going to drive continued planting. And if you want to have high yields, you want to boost the amount

of income you can make. Fertilizers are an area where you're not going to skimp significantly. Hello and welcome to the Barron Streetwise podcast. I'm Jack Howe. And the voice you just heard is Joshua Spector. He's an analyst at UBS covering chemicals, and he's talking here about fertilizer. The war in Ukraine has upended fertilizer production in Europe, sending profits for U.S. rivals to record levels. In a moment, we'll answer all your fertilizer questions, assuming you have questions and that they relate mostly to investing we'll also say a few words about apple's chunky new extreme sports watch and the latest phones

and what the new product lineup means for profits listening in is our audio producer jackson hi jackson hi jack did you see the new ultra watch that apple introduced this past week and should i order one and why is the answer yes i think you should get it because that's definitely the next step to becoming an elite athlete. I'm almost there. My watch broke and I need a watch and I'm going to be 50 in a few days. So it's time for a midlife crisis and I'm not getting a pricey convertible or anything like that. So I think the watch might be it. All I have to decide, the only decision you have to make is which band. And there are three, which one do you like for me? The Ocean Band. It looks like an accordion. It says the tubular design allows it to flex and stretch even over a wetsuit.

I think what they really mean is fat wrist, but okay, let's call it a wetsuit. How many people do you think are in a wetsuit using these watches? Zero. I think it rounds to zero. I think there are no eliteuit using these watches. Zero. I think it rounds to zero. I think there are no elite athletes buying these watches. These pictures, they're so over the top. Like this guy looks like he's on Mount Everest. The trail loop, a guy's running down a sand dune. In the ocean band, you got scuba divers. I'm all of those people in my head,

but in reality, I'm in the drive-thru line of McDonald's. I think that means you should get all three bands. Okay, so Apple this past week hosted its yearly iPhone event, which was also its watch event, and to my eye, there were zero new killer features, but that's not as bad as it sounds. The phone's got speedier chips and better cameras. They get that every year. The high-end models now have always-on displays so you don't have to tap the screen to see basic information. And they replaced the little black notch at the top of the screen, the one that hides the camera and the speaker and other hardware, with a little black island that doubles as part of the software interface. It looks nice, but I don't know

anyone who was looking for that. There are also safety features, like one that calls for help if it detects a crash, and another that allows people to call for help from remote locations using satellites. The Watch is being talked about as the more innovative update, but again, I'm just not seeing it. There's a new high-end model called Ultra geared toward performance athletes, or aspiring performance athletes, or people who want to look like aspiring performance athletes. Some of the features have niche appeal. There's a night mode wayfinder watch face in case you want to make your way by compass in the dark.

A gauge for scuba divers measures underwater depths down to 40 meters. The most perplexing feature might be the 86 decibel siren. That's presumably to call out for help to passersby in the backcountry if you're lost or injured and need assistance. Apple says it can be heard from 180 meters away. If you don't have a feel for how far that is, you can ask a golfer because they spend a lot of time thinking about yardages and yards are pretty close to meters. Hitting a golf ball that far is not such a big deal. You can easily yell to someone at that distance. You can yell, four. You can yell, hi, Bob. You can yell, help, I'm lost in the backcountry.

I'm having difficulty imagining the exact circumstances where you'd rather use your siren than just yell, but maybe there's one that'll come down the road with a software upgrade, like the ability to use the watch as an avalanche rescue beacon. For now, I'm guessing that the main use for the distress siren will be showing your friends what the distress siren sounds like. watch as an avalanche rescue beacon. For now, I'm guessing that the main use for

the distress siren will be showing your friends what the distress siren sounds like. Now, if all this sounds like I'm poo-pooing Apple, I'm not. I use an Apple phone and watch and I get new ones every few years, even though the last must-have hardware change I can recall was the shift to phones with bigger screens eight years ago, and that was to keep up with Samsung and others. The main appeal of Apple products has long been the software and service ecosystem, and if you're locked in with something like years of family photos stored in the cloud, and you're busy and more or less satisfied, there's little reason to switch.

Relative to minutes of usage, I view even a pricey iPhone as a solid deal. One study found that Americans spend an average of 5.4 hours a day on their phones. Based on that, if you splurge on a $1,200 phone and use it for three years, that works out to about 20 cents an hour, or much less than that if your carrier offers incentives for phone purchases. Smart watches aren't quite as obvious of a bargain, but I've found that those little rings on the Apple watches are a useful nudge for exercise. One study by the American Heart Association found that the difference between getting enough exercise and not is worth

an average of $2,500 a year in reduced medical bills. That doesn't include the financial return of a longer and more productive life. Am I using some questionable mental accounting here to justify getting new toys every few years? Probably. But I'm hardly alone, and my point is that Apple doesn't need killer features every year to drive enormous profits. Wedbush Securities estimates that among 1 billion iPhones in use worldwide, 240 million are at least three and a half years old. In other words, a lot of users are due for new phones. Wedbush predicts that this cycle's phone sales will be flat with last year's, which were excellent. Bank of America Securities points to a subtle but important calendar shift.

Apple's fiscal year ends in September, right around when its new phones typically ship, which gives it some leeway around how much of the revenue falls into the current year versus the next one. The new crop of phones will have nine selling days that count toward this fiscal year versus just two days last year. And finally, although I'm not wowed by the new watch siren, another safety feature that emergency satellite calling is free for the next two years and after that it gives Apple the opportunity to

add on to its paid services. The stock is not especially cheap at 23 times forward earnings estimates, and earnings growth from here is expected to be steady but not fast, pegged at high single-digit percentages in the years ahead. Bank of America Securities predicts 19% upside for the stock of the next year, which seems ambitious. Among the factors it cites are a strong upgrade cycle for phones in the year ahead and the ability of Apple to outperform in a broad market down cycle. We'll see if that pans out, but I don't see anything in Apple's ho-hum iPhone day this past week that would give shareholders reason for concern. Now then, let's move on from iPhones and talk about fertilizer.

What does one have to do with the other? Tell them, Jackson. Go ahead. I think absolutely nothing, but I can imagine a scenario where maybe you're a farmer and you have an app on your iPhone that shows you where to fertilize to get the best yield. Exactly what I was thinking. I feel like you nailed that one. All that is next after this quick break. Welcome back. Let's talk for a moment about dung and nitrogen and German chemists and why the world has twice as many people as was once thought possible. When you hear the word fertilizer, you might think about manure or the dung of animals like cows, pigs, chickens, and horses, which can be composted and applied to soil to help plants grow.

But why is dung good for plants? It does many useful things to improve soil, but none is more important than reintroducing key nutrients. Plants need more than a dozen elements to thrive, and worldwide, none of these are more important than nitrogen, phosphorus, and potassium. They're sometimes referred to collectively as NPK for their chemical symbols. And if you had to pick the star of the NPK trio, you would surely pick nitrogen. Plants absorb more of it than any other element. You need nitrogen to make proteins, and you need proteins to make tissue,

and you need tissue to make living things. Nitrogen isn't at all scarce. It makes up three quarters of the air we breathe, but that nitrogen is inert. It's not quite as inert as a noble gas like helium, but it's inert-ish. It doesn't react easily with other elements at normal temperatures, and

it doesn't give plants the nitrogen they need. But manure contains nitrogen in the form of reactive compounds like ammonia, NH3, which can be broken down by soil microbes and put to work by plants, and then consumed by animals, which produce dung, which can be used to reintroduce nitrogen to soil and so on. I think this would be easier to follow if it were in song form. It's a good point. I'm going to start and you pick it up. The animals produce the dung and then go ahead.

The dung goes into the ground and the plants eat the dung and they grow nice and tall. What? That's kind of what you said, right? Is that a song? It's no despacito, but. You got to get to the hook faster. So that process more or less describes organic farming, which has much to recommend it, but feeding the planet in its entirety is not one of those things.

If all farms followed the best organic practices and people ate only as much as we needed to live, there would be food for maybe 4 billion of us. But in a couple of months, on November 15th to be exact, the Earth's population is projected to hit 8 billion. So how did that happen? Where did all the nitrogen come from? It came from Fritz Haber. He was a German chemist who figured out how to combine atmospheric nitrogen with hydrogen gas using high pressure and a catalyst to make NH3. In other words, he made ammonia from air. And the process was scaled up by another German chemist named Karl Bosch, and today it's known

as the Haber-Bosch process. It is the dominant way that ammonia is manufactured today. More than 170 million metric tons of the stuff each year. Most of the hydrogen that's used comes from hydrocarbons like natural gas. Even organic farms use manufactured ammonia whether they realize it or not. Maybe they use only manure, but the manure came from animals, and those animals ate plants, and those plants required nutrients, and at least some of those nutrients were likely manufactured. It is estimated that half of the nitrogen found in human tissue today came from Fritz Haber's process. He won the Nobel Prize in Chemistry in 1918, by the way. That was controversial because Fritz Haber also developed poison gas

used by Germany during World War I. History is complicated. You can read more about Fritz Haber in a book called The Alchemy of Air, A Jewish Genius, A Doomed Tycoon, and The Scientific Discovery that fed the world but fueled the rise of Hitler. Like I said, history's complicated. Okay, fast forward to today. Fertilizer prices have gone bananas.

U.S. government statisticians track a fertilizer index made up of four components, synthetic ammonia, nitric acid, ammonium compounds, and urea. They're all reactive forms of nitrogen used in agriculture. Yes, urea is found naturally and abundantly in urine, but it's also a key manufactured fertilizer. It's also used in skin creams, and it's what gives pretzels their brown color, but I don't want to put anyone off their favorite snack or get off track. The index, ammonia, urea, and so on, it's up 168% from the end of 2019. It shot higher because of pandemic bottlenecks. It has stayed high in part because of the war in Ukraine. Right now, you've got gas prices in Europe that are equivalent to

$80, $90 in MMBTU, whereas here in the US, I think they're sitting at around $9 a day or something like that. So when, again, 70 to 80 percent of the production cost of ammonia and nitrogen fertilizers is decided by natural gas, that has resulted in lots of the European producers idling or curtailing their production and therefore having to pull that nitrogen from other parts of the world. And one of the options is the US. That's Chris Lawson. He's the head of fertilizers at a commodity research group called CRU. And there's a lot to what he just said. Russia is a key natural gas supplier to Europe, and it's been an open question whether Europe would cut gas purchases to pressure Russia over its invasion of Ukraine.

But Russia has forced the issue by preemptively restricting gas supplies. So natural gas prices in Europe have shot higher. That's raising all sorts of questions about gas reserves and alternatives and the cost of heating homes this winter. There's an enormous gap between gas prices in Europe and in the U.S. because, although gas can be liquefied and shipped, capacity there is limited and expanding that capacity could take years. We've talked about all of that before on this podcast. What we haven't talked about is that if modern fertilizer is made cheaply from air and natural gas using Fritz Haber's process, then natural gas is the

biggest cost driver, explaining about three quarters of fertilizer prices, as you just heard Chris say. And whereas natural gas is a challenge to transport, fertilizer mostly isn't. Here's Chris. The main form of nitrogen fertilizer around the world is urea. So again, it's a small little white granule that is undoubtedly the most popular form of fertilizer all around the world. So we see them importing more urea. Lots of farmers in the US consume a product called UAN, which is like a liquid form of fertilizer. European farmers can also consume that. So we're seeing a little bit more of that being imported into Europe as well.

imported into Europe as well. As Chris says, different forms of fertilizer are popular in different parts of the world. Europe has historically used ammonium nitrate, which is banned in many countries because of its potential to be used in explosives. The U.S. uses a lot of urea ammonium nitrate, or UAN, and much of the world uses urea granules but farmers can adjust and urea granules are as easy as grains to ship and it's much cheaper to make them at the moment in the US than it is in Europe to the point where many European fertilizer plants have simply shut down as you might imagine that has contributed to a profit windfall for U.S. fertilizer manufacturers. And that's only the supply effect. There's a demand effect too. Here's Chris.

The war in Ukraine has impacted demand in the sense that there's less grain that's been able to leave Ukraine. So therefore that props up your corn and wheat prices. If they're propped up, then there's theoretically a greater demand from farmers for nitrogen. So grain prices are up, which means farmers everywhere want to increase output, which means they need more fertilizer. And fertilizer prices are up, driven in part by a dislocation in natural gas prices. And Chris doesn't see conditions returning to normal soon.

Based on our current base case, we still see a dislocation in gas markets And Chris doesn't see conditions returning to normal soon. given the massive reorganization of energy that they need to go through over these coming three years. So they're still going to be paying inflated prices for gas. So that's ultimately a positive for some of the large North American nitrogen producers. To see the economic effect on those North American producers, look at a company called CF Industries, which is a publicly traded fertilizer pure play, so its finances are readily available and telling. Revenues this year are projected to hit $11.4 billion, up from just $4.6 billion in 2019, just before the pandemic. Earnings per share this year are expected to come in at more than $18 versus closer to $2 in 2019. The shares are up a lot too, although not nearly as much as the profits.

Since the end of 2019, the stock is up 139% versus 29% for the S&P 500. One of the reasons the stock prices lag behind the profits is that investors seem confident that this year's profits will represent a peak. But not all investors agree on that, and the predictions are all over the place. A moment ago I said that earnings per share have multiplied an estimated 9 times since the end of 2019 and are pegged at more than $18 this year. The consensus view is that they'll dip to $14 and change next year. But some analysts see them rising to over $20 and others see them falling

below $10. That kind of uncertainty tends to keep a lid on stock valuations, which helps to explain why CF trades at less than six times this year's earnings consensus, making it only about one-third as expensive as the broad stock market. Joshua Spector, who covers fertilizer stocks for UBS, is bullish. For him, the war in Ukraine represents more than a temporary disruption. Even though the disruption in Russia is temporary, less material getting out, inefficient trade routes, you're not having the amount of investment you need to grow capacity. A lot of incremental fertilizer capacity was coming out of that region. And now my view is that that's going to be delayed pretty significantly.

Certainly not a focus right now to expand fertilizer output in that region. And that's going to impact global supply demand. Josh keeps a close eye on farmer incomes, and he's going to impact global supply demand. Josh keeps a close eye on farmer incomes, and he says they support continued strong fertilizer demand. Not only fertilizers, all the costs are up for the farmer. Fuel, equipment, crop chemicals, fertilizers, everything else. Normally, you'd say the fertilizer cost might be 5 to 10 percent of a farmer's cost, and that's obviously up 2x, maybe more from where that is. But if you look at where crop prices are today,

so corn back near approaching $7 versus $3, $4 a number of years ago, they've essentially doubled their revenue. So the farmer is still in good shape. They're still making money. And that's ultimately going to drive continued planting. And if you want to have high yields, you want to boost the amount of income you can make, fertilizers are an area where you're not going to skimp significantly.

Keep in mind that while higher fertilizer prices might not last forever, the cash that those spikes are generating for companies can be put to profitable long-term use. Josh says that companies under his coverage could generate free cash equal to 15 to 20 percent of their stock market values over the coming year. He predicts 25 percent upside for CF shares and 27 percent for a smaller fertilizer company that he recently began covering called LSB. He also predicts about 20 percent upside for a company called Nutrien. That one's a little different. We've talked mostly here about nitrogen-based fertilizers that are made from fossil fuels using the Haber-Bosch process. Nutrien specializes in something called potash. That's another name

for fertilizer potassium. It's called potash because an early means of making this stuff involved soaking wood ashes in pots. But today, potash is made largely from mined salts. Canada is a big producer, but so is Belarus, and supply there has been disrupted by sanctions. So Nutrien is seeing a profit boom similar to those of the nitrogen specialists. There are obviously fertilizer questions in play here that go beyond the scope of an investing podcast and are more important than stock targets and earnings per share, including those related to food scarcity in poor countries. For now, let's just say that Fritz Haber's process has been both a blessing and a challenge. Manufactured ammonia is how the world feeds itself. It's also an enormous producer of

greenhouse gases. Think about it. Fossil fuels are called hydrocarbons because of their hydrogen and carbon, and fertilizer companies are using the hydrogen, which leaves behind all that carbon. Research is underway to make so-called blue ammonia by capturing rather than releasing the carbon, or green ammonia by replacing the Haber-Bosch process altogether. For example, if you can get the hydrogen from water rather than fossil fuels, there's no carbon to leave behind. And if you can do that, rather than view ammonia as a nitrogen fertilizer with some hydrogen tagging along, you can start to think of it as a hydrogen fuel source with some nitrogen tagging along. Research is already ongoing to use ammonia to co-fire coal electricity plants to cut emissions, or as an alternative to

diesel to power ships. Josh says that some of these new uses could expand the market for fertilizer companies by 10% over the next decade. If you ask me, that's even more interesting than using urea to make pretzels. Thank you for listening. Jackson Cantrell is our producer. Jackson, any last thoughts you'd like to share on fertilizer? It's used as a browning agent in pretzels. You're looking up the urea thing, aren't you? Yeah, I think I'm just a little bit disturbed. No reason to change your snacking patterns. It's perfectly, it's factory derived stuff and it's all probably okay for you. Or there's always popcorn. Subscribe to the podcast on Apple Podcasts, Spotify, or wherever you listen to podcasts.

You can write us a review. If you want to find out about new stories, new podcast episodes, or snack oddities, you can follow me on Twitter. That's at Jack Howe, H-O-U-G-H. See you next week.