It’s not all that difficult to find stocks trading at prices well below fair value and historical norms. The problem is “guessing” if and when they will rebound. The result is investors fuming at “value traps” while advisors and gurus preach “patience”.
Is there a lesson here? Yes, It’s dangerous to catch a falling knife but mere child’s play to catch a bouncing ball. Let me illustrate my strategy with a stock that I’m tracking as part of my “Value Bounce” stock recommendation service..
Let me begin by highlighting that farmers all over the world have a daunting task ahead of them. Over the next 50 years they must produce more food than they have in the past 10,000 years.
The combination of a growing global population, a rising middle class hungry for more protein, fruit and vegetables, and less productive land has many asking how on earth we are going to feed everyone.
This chart sums up the challenge quite nicely:
As a leading agricultural company aptly put it:
1 pound of chicken requires 3 pounds of corn, 1 pound of pork requires 4 pounds of corn, and 1 pound of beef requires 7 pounds of corn.”
A Darling Turns into a Millstone
The Sociedad Quimica Y Minera De Chile (Chemical and Mining Company of Chile) (SQM) produced last year more than $2.5 billion worth of specialty plant nutrients, iodine, lithium, potassium chloride and potassium sulfate, industrial chemicals, and other commodity fertilizers. SQM has long been a darling of global investors looking for plays on the “Singapore of Latin America” as well as the need for more productive farmland.
But the SQM darling has turned into a millstone as SQM has lost 54% of its value so far in 2013.
Ouch! What the hell is going on? In short, a perfect storm of political intrigue and uncertain and turbulent markets.
The root of the problem appears to be bad blood between Russia’s Mr. Putin and the president of Belarus. Leading fertilizer companies in both countries have worked in tandem to stabilize fertilizer prices at high levels but a recent power play has resulted in a sharp pull back in price that, in turn, has led to weak fertilizer markets and weak quarter of sales and earnings for SQM, (-17% and 44%, respectively).
The key question is how long before prices get back to normal levels? I don’t think it will be that long because this Russia-Belarus flare up is just noise to cover up a bigger threat to both from down under.
Australia’s mining giant BHP had announced moves to develop a sizable phosphate mine and export the product in markets now essentially in the hands of the Russia-Belarus “informal” cartel. The recent plunge in phosphate prices has had a chilling and perhaps fatal effect on BHP’s expansion plans. Well played, Mr. Putin but what about the collateral damage to SQM shareholders?
Given the strong trends underpinning this story, I think it’s only a matter of time that SQM will bounce back with the catalyst being a return to normalized pricing and earnings.
After all, the company has a strong balance sheet, $900 million plus in cash reserves and a dividend yield of 3.8%. Farmers need its products to continue to boost productivity with some believing that fertilizers account for more than 40% of increased agricultural yields over the last decade.
In addition, SQM is known for its hefty operating margins and still delivers a 10.8% return on assets and a 25% return on equity.
The stock is currently trading at only ten times trailing earnings but there is one other part of the story that intrigues me. SQM is a big producer of the highly prized lithium used in many industries including hybrid batteries. In fact it accounts for 29% of annual world production, more than all of China.
This chart looks even better than the earlier one on population growth.
Now Wait for the Bounce
You could off course jump into the fire by buying SQM right now and hope for the best. My guess is that this would probably work out over time. But the risk of loss from current prices is high.
Is there a smarter way?
Yes, be patient and wait for an upturn supported by a catalyst(s) before you invest in SQM. And be wary of a “dead cat” bounce, which is normal after a big selloff.
This increases the probability that the “bounce” will develop into an uptrend.
To sum up the value bounce strategy; scour the world for deep value, study the situation carefully to find out what’s wrong, identify catalysts that should lead to a rebound, and then wait for the “bounce”.