2015 was a particularly rough year for the commodities sector, which saw a significant pullback in its constituents ranging from corn and copper to gold and sugar. The rout further deepened with a precipitous drop in oil prices, geopolitical events and slowing economic growth in emerging markets, particularly China.
While it's impossible to tell if commodity prices have bottomed out, the sharp declines have created some distressed opportunities for value investors looking for an entry point. The Dow Jones Commodity Index has posted a one-year loss of 18.12% while the S&P Systematic Global Macro Commodities Index was down 7.25% for the same period, as of March 16.
This may, therefore, be a good time to consider individual companies and commodities poised for a multiyear recovery as market forces recalibrate. Valuations are attractive at current levels, making a compelling case for select stocks to be added to investors' core portfolios.
Although their fair value uncertainty remains high, these companies have demonstrable potential for sustained growth based on healthy product demand, pricing power, competitive advantage and a significant exposure to fast-growing emerging economies, according to Morningstar equity research.
Potash Corp. of Saskatchewan Inc. | ||
Ticker | POT | |
Current yield | 8.16% | |
Forward P/E | 14.8 | |
Price | $24.25 | |
Fair value | $34 | |
Data as of Mar. 16, 2016 |
The world's largest fertilizer company, measured by capacity, Potash Corp. of Saskatchewan (POT) produces and sells potash to agriculture and industrial companies globally. The company also owns nitrogen (about 35% of gross profit) and phosphate (about 10%) fertilizer assets, but is primarily focused on its potash business, which accounted for 60% of gross profit in 2015.
While the Canadian dollar's depreciation has chipped away at the firm's cost and competitive advantage relative to its peers in Russia and Belarus, the concentrated nature of the potash industry and several large price-first producers will cause potash to be priced at a premium to marginal costs, said a Morningstar report. "PotashCorp's solid asset base should allow it to pump out profits even if potash prices should approach marginal costs of production in the future," said Morningstar equity analyst Jeffrey Stafford, who put the stock's fair value at $34, incorporating an enterprise value/EBITDA (earnings before interest tax depreciation and amortization) ratio of 12 times.
Stafford forecasted mid-single-digit sales growth in the firm's potash business after 2016, as volume gains from expansions in its existing production facilities drive growth. PotashCorp also boasts exemplary equity stewardship. "Given the company's discipline in the past, we expect management will begin returning more cash to shareholders following the current round of potash expansion, instead of chasing growth projects in nitrogen or phosphate," said Stafford.
Monsanto Co. | ||
Ticker | MON | |
Current yield | 2.27% | |
Forward P/E | 15.6 | |
Price | US$90.71 | |
Fair value | US$120 | |
Data as of Mar. 16, 2016 |
Monsanto (MON) is an agricultural giant that provides seeds and crop-protection products. The firm, which generated more than US$15 billion in sales in 2015, is developing new biotechnology traits to help farmers improve crop yields.
"Our long-term view of the company is bolstered by our forecast for caloric intake in emerging markets, which will put stress on crop yield improvements globally and should play to Monsanto's strengths," Stafford said in a Morningstar report.
The company's businesses include crop chemicals and genetically modified seeds. "Monsanto's efforts in biotechnology have been hugely successful," said Stafford, who appraised the stock's worth to be US$120, implying an enterprise value/EBITDA ratio of 16 times. "About 90% of the soybeans and 80% of the corn grown in the U.S. contain a Monsanto trait."
The company's strong competitive advantage stems from a portfolio of patent-protected traits. "Monsanto's proprietary seed companies use the traits it develops, but the firm also licenses traits for use by others," he said. "This strategy has led to dominant market share, and premium pricing for its patented traits."
The firm, added Stafford, is well positioned for growth as it expands to international markets and as the "current wave of [the company's] new products achieves market penetration."
CF Industries Holdings Inc. | ||
Ticker | CF | |
Current yield | 3.51% | |
Forward P/E | 9.6 | |
Price | US$34.15 | |
Fair value | US$44 | |
Data as of Mar. 16, 2016 |
CF Industries (CF) is a leading global producer and distributor of nitrogen fertilizers. The company operates seven nitrogen facilities in the United States and Canada and holds joint venture partnerships in the United Kingdom and in Trinidad and Tobago.
The company is due this year to close its acquisition of Netherlands-based OCI. The US$8 billion deal would create the world's largest publicly traded nitrogen company, Stafford said in a Morningstar report. The merger, said the report, would lower the company's overall tax rate to 20% from 34% by moving its address to the UK, and realize US$500 million in annual cost savings. The OCI acquisition will also expand the company's footprint in Europe, said Stafford, who put the stock's fair value at US$44, implying enterprise an value/EBITDA ratio of roughly 8.5 times.
"The acquisition and the company's already planned expansions will boost CF's production capacity from 15.2 million product tons to 25.1 million product tons by 2018, an increase of 65%," he added.
The fertilizer maker recently announced 2015 net earnings of US$700 million, with EBITDA of US$1.7 billion. The company's CEO, Tony Will, said the (http://www.morningstar.com/news/business-wire/BWIPREM_20160217006644/cf-industries-holdings-inc-reports-fourth-quarter-net-earnings-of-27-million-and-ebitda-of-254-million-adjusted-net-earnings-of-180-million-and-adjusted-ebitda-of-451-million.html) company "remain(s) highly profitable with a gross margin of over 25%," despite the most difficult market conditions seen in a decade.
Cameco Corp. | ||
Ticker | CCO | |
Current yield | 2.35% | |
Forward P/E | 12.4 | |
Price | $17.04 | |
Fair value | $25 | |
Data as of Mar. 16, 2016 |
One of the world's largest uranium producers, Cameco Corp. (CCO) mines, refines and sells uranium to nuclear reactors in Canada and internationally. The firm produced a staggering 27.2 million pounds of uranium in 2015, and plans to increase annual uranium production substantially over the next several years.
"Cameco shares continue to be undervalued as they reflect current weakness in uranium prices," said Morningstar sector director Daniel Rohr, who raised the stock's fair value from $24 to $25, prompted by a weaker loonie. "Going forward, higher prices are required to encourage new mines to meet strong demand growth from emerging markets led by China."
The company's fourth-quarter results showed quarterly revenue growth of 10% year over year, driven by higher sales volumes from its Cigar Lake mine in Saskatchewan. "With the higher run rate at Cigar Lake, the company expects annual production to increase 10% to 30 million pounds in 2016," said Rohr, who forecasted the production to rise more than 30% by 2019. Although uranium prices remained weak in 2015, they are poised to tick higher driving significant earnings growth. "We expect new reactor capacity to drive the strongest uranium demand growth in decades," said Rohr. "A quadrupling of China's reactor fleet headlines this growth."
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