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The Mosaic Company (MOS) is the largest producer of phosphate fertilizer in the world, accounting for 15% of global supply, and 59% of the US production of phosphate fertilizer. It is also the third largest potash producer in the world, accounting for about 14% of world supply and 38% of the US market. Mosaic is a vertically integrated producer of phosphate and potash fertilizer, owning phosphate mines and phosphate production facilities in Florida, and potash mines and production facilities in Michigan, New Mexico and Canada. The company also owns smaller production and blending facilities in nearly a dozen other countries. The company makes 66% of its profits from phosphate sales, 28% from potash sales, and 6% from fertilizer blending operations in foreign countries.

Fertilizer is a global commodity, with price being the main competitive factor. The main costs in fertilizer production are material and transportation costs. Phosphate fertilizer is made by converting phosphate rock into phosphoric acid, and then reacting that with ammonia. Sulfur, another crop nutrient, is often added to phosphate fertilizers. Potash fertilizer is made by separating impurities from mined potash. Mosaic owns the mines that produce both crude phosphate rock and potash. It also owns 50% of Gulf Sulphur Services, which allows it to purchase sulphur cheaply. Mosaic owns an ammonia plant in the US that produces about one-third of its annual ammonia needs. Therefore, Mosaic directly owns most of its key inputs, with the exception of ammonia and natural gas, where Mosaic is moderately exposed to volatile prices. Mosaic also owns key blending facilities, and an extensive network of storage and distribution facilities in the US. Its vertically integrated structure gives it a large cost advantage, especially in its domestic US market, where its economy of scale and low transportation costs (all of its mines are in North America) dominate the domestic market. Mosaic also owns 8 blending plants in Brazil, through which it supplies Latin-American countries, as well as one blending plant each in China, India and Thailand. Mosaic’s “on-the-ground” presence in these key growth markets gives it accurate market intelligence about the state of global fertilizer demand, although the profit it makes from the Asian markets is nearly negligible, owing to the fact that it incurs a transportation penalty in supplying these markets compared to Chinese fertilizer producers. Its sales in the Latin-American countries make up the bulk of its overseas sales.

In the first half of 2008, the rising price of oil led to an agricultural boom, as a large fraction of the US corn crop was used to produce ethanol to be blended into gasoline. As many farmers rushed to plant corn to take advantage of the high prices, supply of other major food crops became constrained, leading to global inflation in food prices. During this period, Mosaic’s stock price soared above $100. This trend has reversed in dramatic fashion in the latest quarter, with the collapse in global demand leading to a large drop in oil prices, which in turn led to a large decline in fertilizer prices, which is still ongoing. Despite recent production cuts, Mosaic and other fertilizer producers report an increase in fertilizer inventory. US farmers, faced with uncertain crop prices in the next year, are reluctant to spend on farm inputs. Many have switched from broadcast fertilizer application to customized or row-based application, which saves fertilizer, or simply switching to cheaper but less effective nitrogen-based fertilizers or hog waste. Some are switching to crops that give reasonable yield even if you skip a year of fertilizing, such as soy beans. In the worst case scenario, farmers can always stop planting and just collect federal farm subsidies. In the face of unprecedented economic uncertainty, Mosaic has stopped providing sales guidance for 2009, and has announced major production cuts aimed at firming up prices. The company believes that farmers are postponing fertilizer application until the 2009 spring and summer growing season, when it should be able to provide better guidance. In addition, there is some concern that Chinese fertilizer producers could resume exports. Previously, the Chinese government has slapped on heavy tariffs on fertilizer exports in order to control domestic food inflation, but may reverse this decision. However, fertilizer production is generally a capital-intensive rather than a labor-intensive process, so it is unclear if the cost of production in China is significantly lower than in the US. Coupled with a transportation disadvantage in the US market, it seems likely that Chinese fertilizer exports will not be a serious competitive threat.

As an investment, Mosaic has many appealing points. It has the lowest cost structure of phosphate producers in the US domestic market due to its size and infrastructure, and is in an excellent competitive position. It also has an extremely clean balance sheet, with some $850 million of excess cash over debt, meaning it can take losses for quite some time if necessary. Also, food is not something you can easily cut, and current food stocks are at multi-year lows. Demand for zinc or rubber can drop 70% at the drop of a hat, but fertilizer is so fundamental to modern agriculture that only marginal cuts (say 10-20%) are really possible. Furthermore, federal rules mandate that ever-increasing amounts of ethanol must be blended into gasoline. In 2009, 9 billion gallons of ethanol is required for blending into gasoline. Due to these factors, Mosaic is considered a defensive stock, and is a favorite play for those who believe that the current commodity slump has been overdone. In addition, Mosaic is 64.4% owned by Cargill, the agriculture conglomerate that is the largest privately held corporation in the US, with over $120 billion in 2008 revenue. Cargill dominates the US agricultural sector, and has steadily built up its empire by picking up assets on the cheap during the down periods of commodity cycles. Cargill had a standstill agreement preventing it from buying or selling Mosaic stock which expired in October 2008, sparking speculation that it may take Mosaic private.

Projecting earnings for Mosaic is difficult; even the company itself has declined to give 2009 projections. Mosaic has a tangible book value of approximately $13 per share, which likely significantly understates the economic value of its vast array of assets. If one applies a PE of 10 to its current share price of $30, then the market is expecting forward annual earnings of $750 million, vs earnings of $2 billion in 2008. In the first fiscal quarter of 2009, the company has already booked $1 billion in earnings. Based on industry news about very low fertilizer demand currently, the second quarter of fiscal 2009 (report due in early Jan 2009) is likely to be breakeven or even negative. However, if demand recovers in spring and summer of 2009, then 2009 earnings of $1.5 to $2 billion is possible. My own opinion is that the company is minimally worth around $15 per share, in the extremely unlikely event that it is unprofitable in the next year. With minimal profits of $200 million, it is worth $20 a share. At prices below $30, I feel that the risk-reward ratio is very attractive. Beyond 2009, it is unlikely that fertilizer use will stay depressed. A structural decline in fertilizer use is essentially impossible unless we change the way we eat (i.e. more vegetables and less meat). Modern intensive agriculture means that fertilizer use cannot be put off indefinitely.

I have sold December put options for MOS at $17.50 and $25 strike prices. In addition, I am likely to purchase MOS outright if it drops below $30.