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Planet Earth is in the midst of a food bull market. Wellington West
Capital Markets Managing Director Robert Winslow follows small-cap
agricultural stocks that can give investors both diversification and leverage
to achieve double-digit percentage growth. In this exclusive interview with The
Energy Report, Robert shares some small-cap names where investors can
plant capital and reap vigorous rewards.
The Energy Report: We know that a
growing population is a long-term driver of fertilizer, but what has driven
the potash market so dramatically higher over the last six months?
Robert Winslow: Well, it's
interesting and it's pretty simple. The key driver for all these Ag equities
is rising grain prices—whether it's potash, phosphate, agricultural
equipment manufacturers or any companies in the Ag space. These equities
generally benefit when grain prices are rising.
It's a function of farm income—the grain complex drives farm
income, which drives farm expenditures. We called the bottom of the grains back
in July 2010. As the grains have come off the bottom, the obvious expectation
of farmers is that they're going to make more money and they feel a little
bit better. The result is that they'll spend a little bit more money perhaps
on seed, fertilizer, tractors, storage bins—you name it. So, it's all
driven by what the grains do.
TER: The potash stocks have had a good run over
the last six months.
RW: I would actually suggest it's more like
the last three or four months. Even though the grains really bottomed last
summer, it took some time for the fertilizer stocks to move. When I say
"the fertilizer stocks," I'm talking about the smaller-cap equities
primarily; that's our focus area. And I think one of the big drivers of the
move in the equities was that rising grain and food prices got picked up by
the media. If you go back to December 2010, we started to see reports in
leading magazines, newspapers and on TV suggesting that, based on UN data,
food prices had gone back to 2008 levels. Once that kind of news gets picked
up on the front page of newspapers, it does tend to drive investor interest.
TER: When the media picks up on it, retail
investors come in. Is that what you're saying?
RW: Well, I think it does bring retail
investors in, but not exclusively. There are also a lot of institutional
investors—sophisticated investors—who are looking for the next
cycle and, indeed, Ag equities are cyclical. You always want to be looking
for cyclicals that are at or near a bottom or
coming off a bottom; that's when you buy them. Then you want to sell them
when they get toward the top. Ag was a sector wherein the
fundamentals—the grain prices and supply/demand situation—were
teeing up nicely and coming off a bottom, but the equities weren't moving.
TER: Does potash lag grains or other Ag crops?
RW: We've run correlations between our
coverage universe of equities and the grains, and the short answer is no. I
cover 15 equities in the Ag sector and when you run a correlation between
those equities and the three major grains and oil seeds (i.e., corn, wheat
and soybeans), it's almost a 90% correlation. So,
really it's difficult to find a leader or laggard in there. They basically
move together and are driven by the expectation of what the farmers will do.
When I say "grains" are going up and farmers will spend more money,
they won't actually spend the money until they've got it in their coveralls,
so to speak; but, the investment community recognizes farmer enthusiasm and
improving expectations. So, the grains and the equities move very closely to
each other.
TER: The potash producers now have pricing
power. But is this across the board to all the fertilizers—phosphates
and others?
RW: Generally speaking, yes. Again, it's a
function of higher grain prices. It's interesting; we saw this back in '08
when corn approached $8 a bushel. A lot of the major fertilizer companies
were talking about $1,000/ton potash; in fact, some transactions were done at
spot prices, which were around $1,000. There wasn't a lot of volume there,
so, arguably, it wasn't a good indicator of price.
Depending on what part of the world you're in, potash pricing is
$400–$500 per ton. And there's still some flexibility for those prices
to stay there or go a little higher because it's not becoming a burden to the
farmer. I would suggest that there's room to go on potash pricing still. I
would say the same with phosphate because we've got pretty tight supply and
demand dynamics for those fertilizers. But, I don't think that we're talking
$1,000 potash again anytime soon.
TER: With the strength potash stocks have
demonstrated, do you expect them to take a break?
RW: Yes, a lot of them already have taken a
break. Again, coming back to the grain prices, we feel there is more risk to
the downside than the upside. The grains have come off a little bit and the
equities accordingly. So, yeah these sorts of breathers are healthy. I think
it's important to recognize, however, that when we talk about risk to the
downside versus upside, we are talking about the current cycle; we still have
a bullish view for a secular uptrend in Ag commodities.
TER: Where can investors get an advantage?
RW: Well, interestingly enough, Allana Potash (TSX.V:AAA) put out a press release recently and
announced another strategic investor. It's the International Finance
Corporation (IFC), which is a member of the World Bank. IFC is putting $10
million into Allana; obviously, the company has
done due diligence and likes what it sees there. Allana
is developing the Dallol Potash project in
Ethiopia, and we're quite keen on it because it's got some interesting
advantages versus some of the other junior potash plays. Apparently, IFC has
done its homework and has a view similar to ours.
TER: What does IFC's investment mean for the
company?
RW: It's an interesting development for Allana because it provides credibility. In other words,
it's not just an analyst saying it's a good project—it's a
sophisticated investor saying it's a good project. And, it also helps
mitigate finance risk. All of these junior fertilizer companies have to raise
a tremendous amount of capital; for example, we believe Allana
has to raise somewhere in the neighborhood of $800–$900 million (all
in) for the total project. So, you want to be able to secure financing over
time to make sure that it gets built.
When someone like the IFC steps up and puts $10 million of equity
into a company, it's got some skin in the game and, arguably, will be around
when it's time to raise more equity and/or debt capital. So, we think a
development like this is a positive and, on the back of that development,
raised our target on Allana nominally to $2.25 from
$2.15. But, we do have a strong buy rating on that stock. Frankly, it's one
of those stocks that could double or triple over the next two or three years
as this theme plays out.
TER: Could that IFC investment have any
negative implications, in terms of a potential takeover?
RW: I would say no. I think that, at the end
of the day, IFC wants to help facilitate this project to help stimulate the
Ethiopian economy. And if the company is taken out, it definitely would be by
a bigger and better-capitalized company that should be able to ensure the
project gets built. I think it'd be a win/win situation if there was to be a
takeout.
TER: Your $2.25 target price has an implied
+40% upside from here.
RW: Yes. It doesn't seem all that compelling
but we had a $1.00 target on AAA when it was $0.40. This company is one
that's gone very far, very fast and was due for a pullback.
TER: In a note, you compared Allana to the German fertilizer company K+S Aktiengesellschaft (Fkft:SDFG.F) acquisition of Potash One Inc. for CAD$434,
I believe.
RW: Right. The interesting thing was that the
Potash One multiple was estimated at 0.45 of the enterprise value (EV) to net
asset value (NAV). But that was before grain and food prices had risen so much. It was closer to the bottom of the current
cycle. As I said, these stocks are cyclical and I feel that we're closer to
the top of the current upcycle here.
TER: Sounds like that $10 million investment
from IFC really derisked this play.
RW: It helps for sure; it definitely helps.
There's a long way to go yet—a lot of capital to be raised; but when
you've got a partner like that working with you, that's impressive. That's
well done.
TER: Allana's market
cap is in the $265M range, which is high enough for mutual funds to buy the
stock. You recommended AAA when it was a penny stock. Congratulations on that
call, by the way.
RW: Thank you.
TER: You've seen Allana
go from a level at which mutual funds couldn't buy it to where they can now.
Is that where the next leg up is coming from—more institutional
investors coming in?
RW: Well, that's a part of it; but I think the
biggest part will come over time as the company meets and fulfills its
milestones. Then, as you pointed out, when the market cap gets through
certain thresholds, you can bring a new list of investors into the mix. A
number that's often used here in Canada that many fund managers look at is
CAD$100M market cap. When a stock gets through that level, they can start to
look at it.
TER: You rate Allana
a Strong Buy. Are there any other strong plays that you can mention?
RW: Yes. Another one that we follow is IC Potash Corp. (TSX.V:ICP; OTCQX:ICPTF). It's looking to develop an operation to
produce sulfate of potash (SOP) from polyhalite in New Mexico in the U.S. Now, the company
is working to confirm that the polyhalite-to-SOP
conversion process can be done. About 50 years ago, Potash Company of
America, which was acquired by PotashCorp (TSX:POT; NYSE:POT) in 1993, did some work on converting polyhalite to SOP that showed it could be done. Now, IC
Potash is going back and duplicating those tests and getting favorable
results.
It's early days yet and some pilot test work needs to be done, but it
looks like the conversion operation will work—making it the lowest-cost
(or among the lowest) SOP production in the world. It could be in the bottom
10% on the cost curve, and that's one of the reasons we like that project.
Anytime a company can get costs that low, I'm intrigued; so, that stock is
coming along nicely. It, too, has come off in the last three or four weeks
and is not immune to the selloff in the space—but, that's one stock we
like a lot.
TER: I see that IC Potash raised
$20M in equity, recently. Is that enough to derisk
the project?
RW: Well, it goes a fair way to derisking it. Again, the company will likely be looking
at spending $600–$700 million. We estimate this recent capital raise
will get IC Potash through its prefeasibility study (PFS) and into 2012. So,
the company has at least a year's worth of capital to complete the milestones
it plans. Then, it would have to come back to market at some point.
TER: You rate ICP a strong buy with an implied
75% upside from here.
RW: That's right, $2.50 target. We use
12-month targets.
TER: Is there a phosphate opportunity that you
like?
RW: MBAC Fertilizer Corp. (TSX:MBC) is developing a phosphate project in Brazil. We
like this one because, from a transport-cost perspective, it's advantaged
logistically. Brazil is a large Ag-based, or Ag-centric, economy and about
25% of its GDP is driven by this sector. The country has a tremendous amount
of arable land that can be expanded to help feed the world and also has an
enormous amount of fresh water. So, it's got the fresh water and the land. We
think agriculture will drive that economy for years and years to come. So,
that's the macro view and the overlay on why we like Brazil.
Now keeping that growth in mind, consider that Brazil imports half of
its phosphate and 90% of its potash. So, the country is beholden to imports
for its fertilizer even though it's an Ag-centric economy. MBAC's phosphate
deposit in the Cerrado is next door to the growing
region that's like the Brazilian breadbasket. With this project, the company
is looking at mining phosphate ore and converting it to single super
phosphate (SSP)—a type of phosphate fertilizer that has sulfur in it.
In phase one, MBAC is looking to bring on 500,000 tons of production by
summer 2012; so, we're less than 18 months away from that. There also are
prospects for phases two and three (in other words, not just 500,000 tons),
but it could go up to 1.5 million tons (Mt.) of single super phosphate or
other phosphate fertilizers over the next five years or so.
We estimate MBAC has a transportation advantage in the neighborhood
of $60–$90/ton because, right now, the brunt of the phosphate rock that
comes into Brazil comes from Morocco. Once it's on vessel in Morocco, it has
to cross the ocean, land on the coast of Brazil and be offloaded and import
duties will be paid. After the material is put on a truck or rail, it must be
transported all the way up to the Cerrado. That
whole transportation-and-logistics situation costs a tremendous amount. MBAC
can eliminate that cost because it has this deposit right in the Cerrado. So, we think that advantage is competitive and
sustainable. We expect MBAC to drive significant economics with this project.
We're looking at about $65 million of EBITDA for phase one, and we believe
that can grow to north of $200M of EBITDA with phases two and three.
TER: With that transportation advantage, it
wouldn't take a lot of capital to double.
RW: Well that's the other thing. Unlike a lot
of these junior stocks we talk about, the financing (on phase one) is largely
done. MBAC recently raised a little over $40 million
of equity and now has about $90 million of cash on the balance sheet. Now,
the company's securing debt facilities with IFC and the local banks in
Brazil. So, we're looking at the company just dotting the "Is" and
crossing the "Ts" on these agreements. It has a bit of due
diligence to do but it's very close to being done. We've got a $6 target on
the stock. It's trading at around $3 now. We believe MBC could be a
$15–$20 stock inside four or five years.
TER: I've enjoyed meeting with you. Thank you
for your time.
RW: Thanks very much.
With a lifelong interest in geopolitics and the financial issues that
emerge from these relationships, Chris Berry founded House Mountain Partners in 2010. House
Mountain firmly believes that the emerging quality-of-life cycle emanating
from Asia is a "game-changer" that will affect everyone throughout
the world for decades. With that in mind, the firm focuses on the intersection
of three topics: 1) The evolving geopolitical relationship between emerging
and developed economies; 2) The commodity space; and 3) Junior mining and
resource stocks are positioned to benefit from this phenomenon. Chris spent
13 years working across various roles in sales and brokerage on Wall Street
before founding House Mountain Partners. He holds an MBA in finance with an
international focus from Fordham University and a BA in international studies
from the Virginia Military Institute. Chris is also a member of the Canadian
American Business Council. He invites readers to receive a complimentary
subscription to Morning Notes, which provides analyses of emerging
geopolitical, technological and economic trends. Go to www.discoveryinvesting.com.
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DISCLOSURE:
1) Karen Roche of The Energy Report conducted this interview.
She personally and/or her family own shares of the following companies
mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of
The Energy Report: Strathmore Minerals and Mawson
Resources.
3) Mickey Fulp: I personally own shares of
the following companies mentioned in this interview: Strathmore, Mawson and Uranium Energy. I personally am paid by the
following companies mentioned in this interview: Strathmore Minerals and Mawson Resources.
The Energy
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