Time to fertilize my portfolio
Investors are ignoring an industry that is crucial to feed 8bn people. Its leading players utilize economies of scale and high entry barriers to return vast amounts of cash to shareholders.
Disclaimer: The information contained in this article is not and should not be construed as investment advice. This is my investing journey and I simply share what I do and why I do that for educational and entertainment purposes.
Based on my overall macro view, I am looking to increase the risk in my portfolio without getting duration exposure. Naturally, that means I am looking for cyclical value stocks.
‘Okay, now he goes full boomer’ you might think. But hear me out.
The past months were characterized by a strong duration bid. In anticipation of falling long term interest rates, investors bought anything with the potential to lock in today’s seemingly attractive discount rates for as long as possible. This does not only include bonds, but also defensive stocks and most importantly growth stocks. The darlings of 2020 and 2021 were back en vogue in 2023.
Cyclical value stocks were left behind. Once again. In 8 of the last 10 years, growth has beaten value globally. And 2023 was in fact the second worst year since 1990.
Many investors have missed out on a lot of gains over the past decades by betting on a revival of value investing. It might indicate that I am about to attempt an act in futility.
But I believe the stars are aligned that 2024 will be the the year of the revenge of the old economy. The reason for this is that I am not simply making the case for value stocks based on a valuation call. I am making it based on investor positioning which has become lopsided as a result of a highly misunderstood macro environment.
Where to go hunting for value?
I have identified three sectors and a number of subcategories that seem to fit my criteria.
Machinery (agricultural, construction, aerospace, logistics)
Of all these categories, fertilizers are the most intriguing to me. Sentiment is completely bombed out and these companies are utterly neglected by investors. Some of them have not participated in the 2023 year-end rally at all. It’s also an oligopolistic sector where players are defending strong profitability, even during downturns. And they are using that to return a ton of cash to shareholders.
For the remainder of this article, I will dive deeper into this sector and the stocks that seem to be most attractive to me. I will likely cover more of the sectors listed above throughout the year depending how the situation evolves.
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The fertilizer industry provides products that are crucial to feed 8bn people. It’s an oligopolist market structure with high entry barriers because access to raw materials and economies of scale are important. These strengths are currently underappreciated by investors as other investment themes dominate the conversation and as the industry is working through the aftermath of their 2022 boom.
While food and fertilizer prices have come down considerably, the underlying fundamental causes of the 2022 shortage fears remain unresolved. Stock levels of staple foods are below their historical averages and crop yields have recently taken a hit from underuse of fertilizer. Investors seem to be completely oblivious to this as evidenced in trader positioning data which suggest disinterest.
Fertilizer companies have used their strong position by building businesses with very strong cash generation which they regularly return to shareholders via dividends, share buybacks and net debt redemptions. Some of them have returned half of their entire current market cap to shareholders over the past 6 years.
In addition to having high output mines for the raw materials, access to cheap natural gas is a key enabler for fertilizer manufacturing. This puts players with a footprint in the US into a very strong position as natural gas prices are in some cases only a fraction of the prices in other jurisdictions.
In my opinion, some of the most important macro risk factors for stocks currently include a rebound in long term interest rates, geopolitical disruptions from various hotspots and the US presidential election. Fertilizer companies are mostly immune to these risk factors. In some instances, they may even be net beneficiaries should certain tail risks materialize.
Lastly, some of these manufacturers will receive hundreds of millions of dollars over the coming 10 years in carbon capture subsidies under the IRA. While this is not necessarily a total game changer, it will further solidify the cost competitiveness of US manufacturers in the global fertilizer market.
There are three main fertilizers: Potash (K), Nitrogen (N) and Phosphate (P). K and P are typically mined. Most of the worlds K reserves are in Canada (30%), Belarus (20%), Russia (10%) and China (10%). By far the biggest reserves of P can be found in Morocco and in some other North African countries. Nitrogen is typically sourced directly from the air. Natural gas is necessary in this process, which makes access to cheap natural gas a key success driver for any company trying to produce Nitrogen. The US has the lowest natural gas prices in the world, which gives US players a key competitive advantage.