Time to look for some short-term profit-taking in fertilizer stocks?

07/06/2012 5:34 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

Nothing like bad weather in the U.S. farm belt to give a boost to fertilizer stocks—at least according to Wall Street’s logic. On July 2 the U.S. Department of Agriculture slashed its rating for the condition of the U.S. corn crop to 48% good to excellent from 56% a week earlier. (The rating on the soybean crop went to 45% good to excellent from 53%.)

The logic goes like this: A bad drought in the Midwest that has shriveled the U.S. corn crop and driven up corn prices is good news for fertilizer maker. Higher prices for corn and other grains will put more money in farmers’ pockets and increase their purchases of fertilizer and other inputs.

Frankly, the logic seems flawed to me. If the drought is so bad that some farmers are out mowing down their corn fields because they’ve given up on this year’s crop, I can’t see how that’s good for farm incomes or for purchases of farm supplies. If you don’t have corn to sell, higher corn prices don’t translate into higher farm incomes. And in a bad drought no one is buying fertilizer to spread it on fields.

But this is Wall Street’s logic. With grain supplies likely to fall because of the drought, grain prices could return to the highs of mid-2011, the story goes, and that would return the prices of agricultural stocks to the cyclic peak. On the morning of the USDA report, Potash of Saskatchewan (POT) gained 2.6% and Agrium (AGU) soared 3.9%. And it’s not like these stocks were cheap before the report. The gain pushed Potash to a three-month high and Agrium to an 11-month high. Analysts across Wall Street raised their ratings on stocks in the sector and/or upped their target prices.

Could be, but I think there’s a big difference between high grain prices that are driven by soaring demand and high grain prices that are the result of a shortfall in supply when global economic growth is slow.

To me this run up on the drought news looks like an opening for profit taking in the days before these companies report second-quarter earnings and third-quarter guidance. I wouldn’t necessarily rush to sell (Potash of Saskatchewan is a member of my Jubak’s Picks portfolio http://jubakpicks.com/) because the momentum in the sector is strongly positive. On Potash I’d watch how the stock behaves as it challenges resistance at $47. Agrium, on the other hand, has recently taken out resistance at $87.50.

But I do worry that the upcoming earnings reports from these companies and the guidance that goes with them could prove disappointing. Potash reports on July 26 and Agrium reports on August 3.

Those are dates to keep in mind if you’re thinking of taking profits here.

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , may or may not now own positions in any stock mentioned in this post. The fund did own shares of Agrium as of the end of March. For a full list of the stocks in the fund as of the end of March see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/

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