Agrium Inc. $36 – Toronto symbol AGU

AGRIUM INC. $36 (Toronto symbol AGU; Aggressive Growth Portfolio, Resources sector; SI Rating: Average) is a leading producer of nitrogen, phosphate and potash fertilizers and crop protection products. It has 12 major production facilities in Canada and the United States, and one in Argentina that it operates through a joint venture.

Sales to farmers and other agricultural customers account for the bulk of Agrium’s sales. The company also sells its products to industrial companies. For example, forest companies use Agrium’s chemicals in the production of wood resins.

Agrium’s revenue grew from $2.1 billion in 2001 to $3.3 billion in 2005, or 12.0% compounded annually (all amounts except share price in U.S. dollars). It lost $0.06 a share (total $7.0 million) in 2001, but earnings rose to $2.11 a share ($283.0 million) in 2005. Cash flow per share rose from $1.07 in 2001 to $3.27 in 2005.

Nitrogen-based fertilizers account for about 75% of Agrium’s production. The company uses natural gas to make ammonia, which is the basic ingredient in fertilizers. Natural gas accounts for over 80% of its ammonia costs. Agrium extracts phosphate and potash ore from mines it operates, and converts it into commercial fertilizers.

Most of Agrium’s facilities are near large gas suppliers in Alberta. Long-term supply contracts help cut its price risk, and give Agrium an advantage over other fertilizer makers.

The company has had trouble in recent years securing steady gas supplies for its big plant in Kenai, Alaska. The company recently shut down the plant for the winter, but has secured enough gas to run the plant at 75% capacity in 2007.

Converting coal to gas

Agrium hopes a new facility that will convert coal into natural gas will solve Kenai’s gas supply problems. It aims to offset the plant’s construction and operating costs by generating electricity from its by-products and selling the power to local utilities. It also aims to sell the excess carbon dioxide to oil exploration firms. If Agrium decides to proceed, the new plant could begin operations within five years.

Agrium also aims to cut its input costs by replacing natural gas with cheaper hydrogen. It recently signed a deal to buy hydrogen for its Redwater plant in Alberta from a new oil sands processing facility. Although it would have to convert some equipment at the plant and build a new supply pipeline, the company feels this will improve this plant’s long-term profitability.

Retail operations cut risk

The company is using its strong earnings to build up its operations outside of its core bulk fertilizer business. In early 2006, Agrium paid $474 million for Royster-Clark Ltd., a leading distributor of fertilizers and agricultural products in the U.S. The purchase doubled Agrium’s retail operations to roughly 500 stores.

The retail operations now provide around 45% of Agrium’s revenue. That’s good news since the retail business gives it steadier revenue streams than wholesale fertilizer sales. Royster-Clark’s storage facilities also give Agrium more flexibility to expand or shrink production in response to demand.

Another area of growth is specialty fertilizers. It recently paid $86 million for certain operations of rival fertilizer producer Nu-Gro Corp., and $88 million for Pursell Technologies Inc. These deals enhanced Agrium’s line of controlled-release fertilizers, which generate higher profits than its regular products.

Balance sheet still strong

Agrium had to borrow the cash to complete these deals. Although long-term debt grew 52% in the first nine months of 2006, it rose from 0.4 times equity to a still reasonable 0.5 times. However, the company will probably use any excess cash to pay down debt before buying back stock, or increasing its $0.11 U.S. dividend, which yields 0.4%.

The stock dropped to $22 in June 2006, after the company warned that bad weather would hurt its fertilizer sales and earnings. Higher costs related to the Kenai plant shutdown and the integration of the new operations would also hurt its profit growth.

Agrium’s shares now trade at 36.4 times the $0.86 U.S. a share it will probably earn in 2006. But earnings should improve to $1.93 U.S. in 2007, which implies a more reasonable p/e of 16.2. The stock is also attractive at 9.1 times its 2007 cash flow estimate of $3.46 U.S. a share, and at 1.02 times its sales of $30.70 U.S. a share.

The long-term outlook for Agrium is bright. Some projections indicate that demand for food will double by 2050. Developing countries like China and India are using more fertilizers, which greatly increases their crop yields.

Biofuels should also drive growth

The company should also profit from growing interest in biofuels like ethanol from corn. Corn requires more fertilizer than other crops. Oil refiners add these products to regular fuels to improve mileage and cut harmful emissions. Ethanol use curbs oil imports, and some environmentalists say it also helps to reduce global warming.

The United States hopes that renewable fuels will supply 25% of its energy needs by 2025. Agrium is in a strong position to profit from this initiative.

Agrium is a buy.

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