Are fertiliser stocks primed for growth?

PORTFOLIO POINT: With phosphate prices showing few signs of rising, listed fertiliser stocks may not be the growth story investors are looking for.

The mining boom might be over, but that does not mean an agricultural boom is starting. This is an important point if you are thinking about investing in a fertiliser-focused company such as Paradise Phosphate, or any of the other dozen or so fertiliser hopefuls.

In principal there is nothing wrong with Paradise, which has lodged a prospectus with the Australian stock exchange seeking $20 million. It owns a number of phosphate deposits in north-west Queensland, and has a plan for their development.

In practice however, Paradise might struggle to achieve its goals, if only because phosphate prices are steady but relatively low, are showing few signs of rising rapidly, and the deposits Paradise plans to mine have a long and unimpressive history.

Paradise is not alone in seeking to develop historic phosphate prospects, and while it can’t be called a rush there seems little doubt that falling prices for conventional minerals, such as iron ore, has boosted the attraction of fertiliser minerals for speculative explorers and some of Australia’s best-known corporate entrepreneurs.

One-time nickel, gold and diamond explorer, Joseph Gutnick is the driving force behind Paradise, a project he has previously tried to develop through the US-listed company Legend International, which will be the major shareholder in Paradise once it floats.

John Kahlbetzer, one of Australia’s (and Argentina’s) biggest cattle owners, is backing UCL – a company trying to develop beds of marine phosphate off the coast of Africa discovered more than 30 years ago – but has found himself locked in a takeover tussle with its partner in the Sandpiper project, Minemakers.

Other phosphate stocks include Minbos, which is exploring in Angola; Aguia, which is exploring in Brazil; and Rum Jungle Resources, which is exploring in the Barrow Creek area of the Northern Territory.

All are seeking to cash in on a theory that global food demand will outpace global mineral demand over the next decade, triggering a sharp rise in the price of phosphate, potash and urea, the major sources of phosphorous, potassium and nitrogen that are essential elements for crop production.

The challenge is not so much finding phosphate but breaking into the fertiliser industry, which has traditionally been dominated by big companies with deep balance sheets.

Phosphate is a classic bulk commodity where transport economics play a dominant role in profitability and where location close to domestic consumers, or rail and port facilities for export, is critical to success.

While demand for all fertilisers is rising, the industry traditionally operates on fine margins and there is little evidence yet of a widespread shortfall in supply.

It was different back in 2007 when fertilisers joined the commodities stampede in the crazy months ahead of the Lehmann Brothers collapse and the onset of the global financial crisis.

Phosphate prices rose rapidly up to late 2007 amid speculation of a food shortage, but fell back just as sharply in 2008 thanks to supply from the major producers comfortably meeting demand.

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Over time an investment in fertiliser-related stocks could generate reasonable returns, but as a general rule it is a business best suited to a big mining or chemical company with a deep balance sheet and a proven track record of operating a bulk commodity business.

BHP Billiton has already discovered how difficult a fertiliser investment can be. It tried to buy one of the world’s biggest producers of potash, failed, and then set about developing its own potash mines, but has set itself a timetable measured in decades, not just years.

It is for those reasons that investors should treat emerging fertiliser stocks with caution and question not just the geology of what they have but its location, quality, marketing and transport logistics.

Paradise, the company attracting most attention in the current flush of interest in fertiliser, plans to make a quick start on production from the Paradise North project, the highest grade of a series of well-understood phosphate deposits located about 150km north of Mt Isa.

Discovered more than 50 years ago, Paradise phosphate was originally an asset of Broken Hill South, a member of the once-famous Collins House group of Melbourne-based mining companies.

At its peak, BH South had two highly-rated assets. A shareholding in the aluminium producer, Alcoa of Australia, and ownership of phosphate deposits in Queensland, including Paradise and another deposit called Duchess.

BH South, in what must rank as one of corporate Australia’s worst-ever business decisions, sold out of Alcoa to focus on phosphate, starting with the development of Duchess, only to discover the fertiliser demand was erratic, prices fluctuated widely, fuel prices rose sharply in the 1970s, and Duchess was a long way from customers in Australia or export ports.

To maximise its return, BH South also went down the road of value-adding, converting its phosphate into two major product lines – diammonium phosphate (DAP) and monoammonium phosphate (MAP), with both produced using sulphuric acid produced as a by-product of Mt Isa’s copper mines.

DAP and MAP sell for roughly three times the price of raw phosphate rock, but that’s largely because they are expensive to produce.

BH South, despite several attempts to make money from phosphate fertilisers, failed. The company eventually collapsed. Control of Duchess passed to Western Mining Corporation (WMC), which changed the project’s name to Phosphate Hill.

Soon after WMC was acquired by BHP Billiton it sold the fertiliser assets to the chemical and fertiliser specialist, Orica. Phosphate Hill remains Australia’s only source of domestically-mined phosphate.

In its prospectus Paradise notes the simple, flat-lying geology of the phosphate in its deposits, which should make it well-suited to simple bulk-mining techniques. Once mined, the highest quality material could be trucked and railed to Townsville for export.

But what investors should ask is that if it is so easy to develop a mine at Paradise North, or the other deposits in the company’s portfolio, why did that not happen when they were an asset of BH South in the 1960s, or more recently when an asset of Legend International?

The answer to that question is contained in the complex mix of remote location and the challenge of transporting a relatively low-value bulk commodity from inland Australia to the coast, and that’s before cracking into the specialist world of phosphate trading.

Gutnick, in his letter of invitation to investors, said that the $20 million being sought would be spent on delivering bulk samples to potential customers, advance project approvals and to complete a bankable feasibility study.

A decision on mining the high-grade material in Paradise North could be made in the third quarter of next year.

For investors with a high tolerance of risk Paradise might yield a reasonable return, and being involved in a stock led by Gutnick is always exciting.

However, the history of north-west Queensland’s vast beds of phosphate, and the challenges of entering the fertiliser world are very high, and have tripped up many earlier hopefuls.

Fertiliser is good for farms, but not that attractive for investment portfolios.