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Are Monsanto and CF Industries the Best of the Best?

Saturday - 4/6/2013, 5:48pm  ET

Imagine owning a business producing something every single person in the world has to have to survive! Not only that, imagine it is a product that has to be supplied by your business every year. Do you think a business like that would be worth owning?

The product everyone must have to survive

The product everyone in the world must have to survive is food, and not only does everyone need it to sustain life, as the population grows, more of it is required each year than was needed the previous year. As the less developed world becomes more developed and prosperous, people will demand more and better food as well. But as more land is developed into residential and industrial applications, less land is available for agricultural use.

Producing more food within the same amount of space requires increased yields and that requires better methods. Today, we are identifying businesses that increase food production by improving the soil and reducing the amount of loss experienced from pest infestation and disease. However, to truly be of interest, they must provide investors with the opportunity for substantial profits as well.

Better dirt and just dirt cheap

Producing food requires a lot of dirt; but not just any dirt. Efficient use of land for agriculture requires that the soil possess the characteristics necessary to sustain high crop density and healthy plants. Very few places have these conditions naturally, and even those that do can be depleted by constant use, but the right fertilizer can make the dirt better and it seems you can make a lot of money making dirt better.

CF Industries , Mosaic , PotashCorp  make fertilizers designed to improve soil conditions and crop yields. They seem to be pretty good at making money as well. Fertilizers tend to fall into one of the three broad categories of phosphates, potash, or nitrogen. Without these products, it is inconceivable that the world’s agriculture industry could come close to feeding the population as effectively as it does today.

PotashCorp spreads its products across all three of the major fertilizer types. At 2 times its projected 5-year earnings growth rate of 6.6%, it is somewhat expensive, but it pays a dividend that produces a very respectable yield of 2.85%. With a somewhat conservative payout rate of 29% for the dividend, it should be considered safe at the current level and investors have a reasonable expectation for increases, given the 700% increase since April 2008 when it was only $0.03/share.

Mosaic focuses its production in the phosphate and potash product arenas. It carries a slightly lower valuation than PotashCorp at 1.56 times the 5-year projected earnings growth rate of 8.9%; but a lower dividend yield of 1.72%. However, given the fact that it has a price to cash flow valuation that is 20% lower, it is probably somewhat more attractive than PotashCorp in terms of potential returns.

CF Industries focuses its product offerings in the nitrogen and phosphate fertilizer offerings, and appears to be by far the most attractive opportunity for investors today in terms of valuation. It currently trades at a PEG ratio slightly below 1, and has a five year projected earnings growth rate of 8.1%. While the current dividend yield is only 0.86%, CF has increased this payout from $0.50/share in 2008 to $1.60/share last year.

In addition to the increased dividends being paid, the payout ratio is only 5%, allowing ample room for increases and management is building a history of doing just that. Since the shares are currently trading at only 5.1 times cash flow (less than half that of PotashCorp or Mosaic) CF Industries is just dirt cheap.

Good food takes more than good dirt

Once the dirt is ready, we must have something to plant. Monsanto provides the world’s best seeds that have been engineered to be resistant to diseases, insects, droughts, and all sorts of other maladies that used to decimate yields in the agriculture industry.

We all think of biotechnology in terms of developing cutting edge treatments for maladies affecting the human condition, but Monsanto takes the same approach and applies it in the realm of plants.

Through the science of genetic engineering, they have taken production of food to levels not thought possible just 30 or 40 years ago, when widespread famine and starvation were being predicted due the looming inability to produce enough food to feed a growing population. Monsanto has played a major role in helping avoid those dire predictions.

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