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These four have long-term appeal

These four resource stocks are more risky than, say, Imperial Oil or EnCana. Still, we feel that their large reserves and low-cost operations put them in a good position to take advantage of rising demand for commodities as the global economy recovers. However, only three are buys right now.

POTASH CORP. OF SASKATCHEWAN $96 (Toronto symbol POT; Aggressive Growth Portfolio, Resources sector; Shares outstanding: 295.6 million; Market cap: $28.4 billion; Price-to-sales ratio: 3.6; SI Rating: Average) is the world’s largest fertilizer producer. The company operates six potash mines in Saskatchewan and one in New Brunswick. The reserves of five of these mines should last between 60 and 97 years. The other two mines have minimal or undetermined reserves.

The stock hit an all-time high of $246 in June 2008, but fell to $62 last December. The drop was caused by lower prices for crops, which hurt demand for fertilizers like potash. As well, farmers in North America and Australia are seeing better-than-expected crop yields this year, even though they applied less fertilizer. This is mainly because of good weather and large amounts of residual fertilizer in the soil from last year.

In an effort to stabilize prices, Potash Corp. will cut its production by 60% this year. Still, global inventories remain high. That’s because many customers stockpiled fertilizers during last year’s boom, in anticipation of continued rising demand. Prices will remain weak until they start using up their inventories.

The company’s earnings will probably drop to $3.51 U.S. a share in 2009 from $11.01 U.S. in 2008. The stock trades at a high 25.7 times this year’s estimate. The $0.40 U.S. dividend yields 0.4%.

Potash Corp. is a hold.

AGRIUM INC. $53 (Toronto symbol AGU; Aggressive Growth Portfolio, Resources sector; Shares outstanding: 157 million; Market cap: $8.3 billion; Price-to-sales ratio: 0.7; SI Rating: Average) makes fertilizers from natural gas at 11 plants in North America and Argentina. The company also makes other fertilizers, such as potash and phosphate, from mines in Alberta, Saskatchewan and Idaho. Agrium sells its products to industrial users and farmers through over 800 stores in the U.S., Argentina and Chile.

The company continues to pursue a hostile takeover of U.S.-based fertilizer maker CF Industries Holdings Inc. (New York symbol CF). If successful, this would cost it $4.4 billion U.S. in cash and stock. Adding CF would triple Agrium’s phosphate and urea and ammonium nitrate (UAN) fertilizer-production capacity. The company has extended this offer several times. It now expires on October 22.

Despite recent weakness, the long-term outlook for fertilizer is strong. Rising populations will continue to drive demand for food. This should prompt farmers to use more fertilizer to raise their crop yields, and the quality of their products.

Agrium’s attempt to buy CF adds to its uncertainty. However, the stock trades at a reasonable 14.2 times the $3.52 U.S. a share that the company will probably earn this year. The $0.11 U.S. dividend yields 0.2%.

Agrium is a buy.

PENGROWTH ENERGY TRUST $11 (Toronto symbol PGF.UN; Aggressive Growth Portfolio, Resources sector; Units outstanding: 258.4 million; Market cap: $2.8 billion; Price-to-sales ratio: 1.2; SI Rating: Average) produces oil and natural gas, mainly from properties in western Canada. Natural gas accounts for 60% of its production; oil supplies the remaining 40%.

In October, the trust cut its monthly distribution by 30%, to $0.07 a unit from $0.10. The new annual rate of $0.84 yields 7.6%.

The lower payout should save Pengrowth roughly $93 million a year. That will help it pay down its $1.4-billion long-term debt, which is equal to 50% of its market cap.

Aside from debt repayments, Pengrowth wants to spend more on developing its properties in western Canada, especially those with longer-term potential. These include its Lindbergh oil-sands project, where the trust aims to begin producing oil in 2016. Pengrowth also plans to develop its properties in the Horn River shale-gas field in northeastern B.C.

Lower debt and greater production from these new projects will put Pengrowth in a better position to sustain its current distributions, particularly now that it plans to convert to a dividend-paying corporation by 2013.

Pengrowth is a buy.

PRECISION DRILLING TRUST $6.70 (Toronto symbol PD.UN; Aggressive Growth Portfolio, Resources sector; Units outstanding: 275.6 million; Market cap: $1.8 billion; Price-to-sales ratio: 1.3; SI Rating: Extra Risk) provides contract-drilling services to oil and gas producers. Its clients are located in western Canada, the U.S. and Mexico. The trust owns a fleet of 388 drilling rigs.

Precision has been able to avoid cutting its rates to attract new business. That’s because rising oil prices have spurred demand for its drilling rigs. As well, many of Precision’s customers are locking in new contracts now because drilling services may become more expensive in the next year or two.

The trust is also building new rigs for specific purposes and types of terrain. Demand for these models is growing strongly, so Precision can charge more for them than for its general-purpose rigs.

Moreover, Precision is benefiting from a stronger balance sheet. Last year, its long-term debt jumped to $1.4 billion after it paid $2 billion for U.S.-based contract driller Grey Wolf Inc. In April, Precision issued new units to help pay down the additional debt. Its $868.9-million long-term debt is now a manageable 47% of its market cap.

The trust will probably keep using its excess cash flow to pay down debt instead of resuming distributions. Precision should convert to a regular corporation once Ottawa starts taxing income trusts in 2011.

Thanks to its improving outlook, Precision’s units have shot up by 166.9% since they fell to an all-time low of $2.51 last February.

Precision Drilling is a buy.