Monday, August 3, 2009

Capital & Crisis Hotline -- Earnings Updates!

Agora Financial
Agora Financial's Capital & Crisis

Capital & Crisis Hotline -- Earnings Updates!
July 31, 2009

"We must prepare ourselves for waves of higher resource prices and periods of shortages unlike anything we have faced outside of wartime conditions. In fact, I believe we are already several years into this painful transition but are still mostly invested in denying it."
-- Jeremy Grantham, GMO, in his latest quarterly shareholder letter

"Smokey, my friend, you are entering a world of pain."  
-- Walter Sobchak, The Big Lebowski

Dear Capital & Crisis Reader,

Food, water and energy demand all come together in a sort of nexus. We need water to make energy. We need water to make food. We need energy to make water and we need energy to make food. We need food to… well, we need food to eat.

These connections are becoming more important these days because they are increasingly in competition with one another. I like to remind people that before the financial crisis hit, the headlines were rife with talk of a food crisis.

Yet the papers and politicians prattle on about reforming health care. And we continue to empty the national treasury on bankrupt financial companies. All the while, a tsunami makes its way toward the beach.

This week, I got to circle back and listen in on Potash's (POT:nyse) conference call. It's always a worthwhile call for all the color you get about what's going on in the world of agriculture.

The fertilizer business has just gone through a soft period. In fact, it was the longest period of demand deferral on record, according to CEO Bill Doyle. Farmers just waited. In the U.S. alone, potash use fell to the lowest level in 40 years. Meanwhile, the crops draw down the potash levels in the soil and the supply chain grows depleted. The storage bins are about empty and farmers will have to restock.

That's because all the factors that set this fertilizer bull market in motion in the first place are still here. Populations are still growing. Diets are shifting toward more fruits, vegetables and meats -- all fertilizer intensive. As Doyle says, "This will continue to put pressure on global grain supplies, as farmers are being challenged to produce more with land and water resources that are shrinking on a per capita basis."

Fertilizers are a key part in meeting that challenge. And the farmers are financially in good shape to buy more. The debt-to-equity ratio for the U.S. farmer is only around 10-15%.

Overseas, farmers are subsidized directly. In India, the government picks up the tab of higher fertilizer costs. As Doyle pointed out: "With low grain stocks and low yields and 1.2 billion people, they're not going to drop the ball. They'll continue to support the Indian farmer." China has also started to subsidize the Chinese farmer, helping out with seed, machinery and fertilizer.

But since fertilizer application rates fell around the world this year, it is hard to imagine a strong harvest. We will see. As grain inventories are already low, I expect we'll need a strong planting season in early 2010. That means a strong demand for fertilizers.

At current pricing for potash, there is no incentive to boost production by investing in new capacity. The financial crisis also laid low any plans for more potash. A greenfield project -- that is, one started from scratch -- needs a higher price to make it work.

As Doyle pointed out, the cost for a 2-million-tonne facility in Saskatchewan is approaching $3 billion. That doesn't include the infrastructure you need around it. Plus, it would take nearly a decade to get that new project generating a return on investment.

So from an investment point of view, potash still looks very good.

Doyle summed it up well:
"A year ago at this time, we were in headlines of a global food crisis. And what I would tell you is that that really hasn't gone away. It's been overshadowed by the economic crisis. And as you know, I've said this before, we can't seem to focus in on more than one thing at a time. But the food crisis hasn't gone away."
Hang onto Potash Corp.

*** Flowserve

Flowserve (FLS:nyse) is a classic example of the kind of company that keeps civilization a going concern. It keeps the lights on, the water flowing and fuel available with its pumps, valves and sealants.

Flowserve reported solid results and the stock rose as much as 12% on the day of its release. I think what the market liked best was that the company actually raised its guidance for the year. You just don't see many companies doing that these days. Flowserve now expects earnings per share of $7.15-7.75 for the year.

Flowserve operates in that ever important water-energy nexus. It makes pumps, valves and more for moving fluids -- such as oil or water. It's really a global infrastructure play. I am always amazed at the number of pies it has its fingers in.

It also puts together a comprehensive quarterly report. The slide presentation for the second quarter had 41 slides. This is the importance of the "D" -- for disclosure -- in our CODE system. We like companies that make good disclosures, so we know what is going on.

Flowserve has all kinds of opportunities in power generation -- coal, wind, solar, nuclear and whatever else. During the conference call, management put out some good data on projects in the pipeline.

They pointed out that there are over 500 gigawatts of new capacity planned over the next five years. Even in recent weeks, over $400 billion in power projects have been announced, including:
  • China plans $88 billion in nuclear power developments
  • Saudi Electricity plans $28 billion investment to meet increasing demand
  • U.S. electric utilities plan to over $250 billion over the next 3 years.
Management also talked about some exciting things going on in water. I've told you before about all the investment in desalination -- turning seawater into fresh water. During the call, management said there were 195 projects under construction globally and another 135 planned. Altogether, there is $64 billion planned spending for desalination alone through 2016. There are many opportunities on that front.

That's just a snippet of what's going on. So far, I'm very pleased with Flowserve's fundamentals. It is well above my buy price now, as we're up about 80%, but hang onto your shares.

*** Northwest Pipe

The results here were pretty light. It's not too surprising really. We are, after all, in a deep recession, and industrial companies like Northwest Pipe (NWPX:nasdaq) are going to feel that pain. Business is off across the board.

It's still making money, earning 26 cents per share in the quarter and 55 cents so far this year. The balance sheet is in good shape. And the company has a good future in its water pipe business. We've ridden this horse for a long time, it seems. We've owned it since 2006. It's one of our oldest holdings. We doubled our money on half, and we've kept our foot in on the other half, in which we are up 40%.

I'm taking NWPX down to hold. I wouldn't buy more here just yet. I suspect we may get a better price to pick it up. I could be wrong and it's worth hanging onto as a longer-term holding because of all the water pipe work still in the hopper. The recession has affected that, as it has affected everything else. But my bet is that it is more of a deferral than a permanent cancellation.

You really don't have much choice with water pipes. You have to replace them or they break or leak and all kinds of bad things can happen. Also, growing populations raise the need for new water systems.

Hang onto your shares.

*** Astec Industries -- and Highway Spending

I had a chance to listen in to Astec's (ASTE:nasdaq) conference call and its always informative CEO and founder, J. Don Brock.

As I wrote last week, the quarterly results here were not good, though close to what people expected. As Brock points out on the call, this was the first time in company history that second-quarter volumes were lower than first-quarter volumes. The industrials are soft, as I mentioned above. It's just the way it is for now. You buy these things and hang onto them with the idea of waiting for a recovery.

Anyway, on to Brock's comments. I was interested to hear what he'd have to say about the effect of the stimulus spending. One unintended consequence of the government's stimulus plan is that it's actually curtailed spending, because people are simply waiting to see what the government does before they buy anything. So stimulus talk is actually making things worse.

As Brock says: "Everyone buys only what they must have, waiting to see how the law will change and what the new rules will be."

But if and when the spending does kick in, it could be boon to Astec. Federal highway spending runs at about $40 billion per year, plus about $14-16 billion in stimulus money. The highway bill expires on Sept. 30, 2009. The trust fund is already broke and will need another $8 billion in August for work to continue.

Brock laid out what he thinks will happen. Either we get an 18-month extension with spending levels of $41 billion plus whatever stimulus money is left, or we get a brand new six-year highway bill that will be much larger -- maybe $450 billion.

Brock handicaps this latter possibility as having a 50-50 chance of passing, but adds: "We will really know more about which occurs in the next two weeks."

Obviously, the latter, a fat new highway bill, will be better for Astec. This is the most frustrating aspect of this holding. It's clear we need the highway money, based on the work of any number of independent engineers on the condition of our roads and bridges. Everyone seems to agree, but the political process to get that money is slow and uncertain. It seems inevitable, though, that we've got more spending in some way.

So we'll wait and see.

Astec is also an international story and this may be a bright spot in future quarters. As Brock said:
"Looking forward to the third quarter, we have seen a pickup in international business
in other countries that have previously been quiet. The weakening of the dollar has helped, along with lower oil prices and infrastructure stimulus money in these countries."
All the big countries, especially India, China -- but also Canada -- have stimulus plans with good chunks of money going toward building or fixing roads.

Anyway, that's a little more color on the latest earnings report. It could break either way, but let's hang onto our shares of Astec and see how it plays out.

*** Methanex

Methanex (MEOH:nasdaq) is our producer or methanol, which I dubbed the "Chinese ethanol." Methanol is an energy source, and its prices track oil prices pretty well.

The latest earnings report was what the market expected. The company reported a loss, but understand that on a cash flow basis, Methanex made money. Things are improving. CEO Bruce Aitken reports strong demand from Asia. Methanol prices are now averaging about $235 per ton for July, compared with $211 for the second quarter. I think the bottom is in for methanol prices.

Methanex has the ability to generate substantial cash flows over the next several years, which I think the market completely overlooks. The valuation of Methanex is most stark when you look at it from a replacement value point of view, as I did in my initial write-up of the company.

In other words, I start with the question of what it would cost to build the assets Methanex has. When you do that, it's not hard to get $20-30 per share. That excludes the 1.5 billion-ton facility in construction in Egypt. This facility should start producing methanol in the first quarter of 2010 and is another catalyst for the stock price.

In the meantime, we own a company that pays us a nice dividend and has plenty of cash and a smart team, with a very good track record, running the show. We're up about 50% as I write, but the biggest gains are still ahead of us on this one.

Have a great weekend, and I'll write you again soon.


Chris Mayer

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