Fertilizer's Farming Problem

Hostile takeover attempts have kept fertilizer companies in the news. The acquisition talk has helped to overshadow a negative trend that should have investors concerned - ongoing cuts to full-year profit forecasts.

During the past 90 days, the Zacks Consensus Estimates have been revised downwards on several fertilizer companies, including Agrium (AGU - Analyst Report), Intrepid Potash (IPI - Snapshot Report), Mosaic (MOS - Snapshot Report) and Potash of Saskatchewan (POT - Analyst Report).

The most recent cuts were related to a warning from POT. The company predicted that its full-year profits would be in the range of $3.25 to $3.75 per share, instead of the prior guidance of $4 to $5 per share. The company blamed "continued slow demand and limited restocking by fertilizer distributors" as the reasons for the revised forecast.

All Is Not Well on the Farm

The big reason why profit projections for fertilizer companies have been falling is not weaker demand for fertilizer, but rather why demand is down. After enjoying very strong profits in 2007 and 2008, many farmers are now seeing their incomes drop. Even after adjusting for a recent rebound, corn futures are down substantially from the start of the year. Wheat prices are also down. Soy prices have plunged over the past few months.

Supply is a big reason why. Though the spring planting season was delayed, favorable weather patterns resulted in bumper crops throughout the summer. At the same time, a decline in oil prices hurt demand for ethanol, which, in turn, impacted farmers.

Compounding matters is the economy. The worldwide contraction likely reduced food consumption. (Did you notice how there were not any headlines about food shortages this year?) Plus, consumers have looked for cheaper ways to feed their families. These factors have kept cattle prices weak, which contributed to weaker demand for grains.

Then there is the banking crisis. Bank closures affect rural areas worse than urban areas because of a lack of competition. In some rural communities, the only nearby bank was seized by the FDIC. Not to mention the increased difficulty of securing loans.

The net result is lower farm profitability. In late August, the Department of Agriculture forecast that farm profits would fall 38% this year. There has been relatively little since then that would cause a big, positive revision to that forecast.

Mergers Are the One Positive

The one positive for the group are the proposed deals.

CF Industries (CF - Analyst Report) announced on Monday that it bought 7% of Terra Industries' outstanding stock over the past 2 weeks. CF wants TRA shareholders to accept a merger agreement that would represent an approximate 15% premium over TRA's current share price.

However, Agrium wants to purchase CF. AGU recently extended the deadline for its acquisition offer of CF to Oct 22. (The offer represents approximately a 4% premium over CF's current price.) It is probable that if AGU were to buy CF, CF's acquisition of TRA would be called off.

Compounding matters is the fact that TRA recently announced a special $7.50 per share dividend, payable in the fourth quarter. CF's offer for TRA would be adjusted to reflect this dividend.

The merger activity makes shorting these stocks risky over the very near-term, even with the falling estimates. On the other hand, much of the upside from the proposed deals appears to be priced in. Overall, the downside risks outweigh probable short-term upside, particularly if neither acquisition offer is accepted.

Zacks Rank

IPI, MOS and POT are Zacks #5 Rank ("strong sell") stocks. AGU and CF are Zacks #3 Rank ("hold") stocks. They are all classified in Fertilizers, which has a Zacks Industry Rank of 206, placing the group near the bottom of the Industry Rank List.

Fertilizers stock also account for a significant portion of Market Vectors Agribusiness (MOO), something to consider when evaluating this ETF.

Charles Rotblut, CFA, is the senior market analyst for Zacks.com. He can be reached at crotblut@zacks.com.

Read the full analyst report on POT

Read the full analyst report on AGU

Read the full analyst report on IPI

Read the full analyst report on CF

Read the full analyst report on MOO