Agrium Inc. vs. PotashCorp./Saskatchewan: Which Offers Better Value and Potential Returns?

The facts are simple: Over the next 30 years, the United Nations predicts the global population will rise by approximately 3 billion. This, coupled with increasing life expectancies, will result in an estimated doubling of world food population over the same period to meet demand.

Food production and demand for fertilizer are strongly linked, and with arable land declining due to climate factors and industrialization, fertilizer production will need to rapidly increase. The fundamental long-term economic factors driving both fertilizer production and price are strong, and it is an excellent industry to invest in for investors with a long-term focus, as part of a diversified portfolio.

The question then becomes how can you best profit from this industry? Canada’s two main players are Agrium Inc. (TSX: AGU)(NYSE: AGU) and PotashCorp./Saskatchewan (TSX: POT)(NYSE: POT). Let’s take a look at both.

Business model and strategy

The fertilizer industry has suffered through difficult conditions recently as a result of the dissolution of the joint potash marketing cartel between Russian-based Uralkali and Belarus-based Belaruskali, which will result in increased volumes and decreased prices for potash fertilizer. This caused potash prices to drop by $100 from roughly $400 to $300 per metric ton in mid 2013, and they have yet to recover.

This has influenced share prices of both Agrium and Potash Corp., and resulted in Potash Corp. initially laying off 18% of its workforce. Although this weakness is expected to continue, with the Bank of Nova Scotia predicting a decline in potash demand in 2015, Agrium is far more capable of surviving and thriving in these conditions due to its highly diversified portfolio.

A quick look at Agrium’s and Potash Corp.’s 2013 gross profit sources reveals this diversity. In 2013, Agrium received 34% of its gross profits from nitrogen, 14% from potash, and 3% from phosphate. Potash Corp received 57% of its sales from potash in 2013, 32% from nitrogen, and 11% from phosphate.

It is clear from this that in 2013, only 51%of Agrium’s gross profits came from actual fertilizer sales, with the other half coming from Agrium’s highly profitable and growing retail division. While Potash Corp receives 100% of its gross profits from currently weak fertilizer sales, Agrium receives half of its gross profits from its retail segment, which sells crop protection products, nutrient products, and seeds, and is currently the largest agricultural retailer in the world.

From 1997 to 2005, retail EBITDA rose from 50$ million to 110$ million, increasing annually, and from 2005 to 2013, retail EBITDA has increased 10x from $110 million to $1 billion. This provides Agrium a huge competitive edge over Potash Corp. during periods of weak fertilizer prices.

Valuation

Agrium is currently trading at a discount to Potash Corp on several measures. Despite the fact that Agrium and Potash Corp are exposed to the same industry risks and weakness, Agrium still trades at an irrational discount, likely due to the fact it suffered production disruptions and was unusually affected by the harsh winter of 2014.

This implies that Agrium is likely undervalued, and investing in Agrium would represent a lower-risk, higher-reward option than investing in Potash Corp. Below is a chart comparing Agrium and Potash Corp. on price-to-earnings ratios, price-to-book ratios, and price-to cash flow ratios.

More interestingly, analyst consensus gives Agrium a long-term growth rate of 7.82% vs. Potash Corp.’s 7.26%, which implies similar long-term prospects for both companies. This implies Potash Corp. is likely too expensive for its growth rate, and that Agrium represents better value for money.

With the long-term outlook for the fertilizer industry sunny, Agrium currently represents a better option than Potash Corp. for exposure to this area, due to its strong retail sector and excellent valuation.