Sociedad Quimica y Minera de Chile (NYSE: SQM) is the final company in the top ten stocks and as an agriculture play offers something different to the other stocks. Translated literally, SQM stands for the “Chemical and Mining Company of Chile”. It is an integrated producer and worldwide distributor of specialty and commodity fertilizers (mainly potassium chloride derivatives), iodine, lithium and industrial chemicals. Sociedad Quimica y Minera de Chile, according to 2011 figures, is the world’s largest producer of potassium nitrate (49% market share), iodine (37% market share) and lithium (31% market share).
SQM has two main production sites, one located in the Caliche Area, where it obtains its nitrates and iodine, and the other in the Atacama Salar, where potassium chloride and lithium are extracted. Using an inorganic chemistry process, it produces potassium nitrate using the sodium nitrate of the Caliche Area with the potassium chloride of the Atacama Salar. In 2011, exports represented 89% of sales to more than 100 countries. The company is legally controlled by Julio Ponce, via a series of investment companies, three of them listed in Chile (Pampa Calichera, Norte Grande, and Oro Blanco).
SQM, headquartered in Santiago, Chile, was founded in 1968 and re-privatized in 1988. The company has an international presence with commercial offices in more than 20 countries. Shares of SQM began trading as an ADR in the international markets in 1993. Series B shares trade in ADR form on the NYSE with a 1:1 exchange ratio.
According to the broker, Santander, Iodine and potash should continue driving SQM’s growth. They expect iodine prices to be in the range of US$50-55 per ton in 2012-14, as demand is increasing and new supply takes time to come on stream and will be late. The historical range is $25-$30 per ton. SQM should also contribute more than half of the new iodine supply. For potash, the exposure to Brazil and the granulated mix should keep prices high, while the expected new contracts in China and India should relieve the Latin American market of supply from Canotex – the Canadian potash producer. Iodine accounts for 36% of gross margins, whilst Potash accounts for 25%.
Demand for Iodine, despite the world economic crisis, continued to increase 5-7% in 2012, while supply is constrained by the lack of significant projects coming to the market. Regarding the supply side, SQM should add 2,000 tons of capacity by 2014; Algorta, another Chilean company, 1,000 tons; Cosayach has halted production due to water right problems; and Japanese production is falling due to the country’s limited and finite capacity. It is becoming more expensive and tougher to develop new projects in Chile due to water and energy scarcity and increasing labour costs.
SQM trades on a 2014 PE of 17 and whilst this might look at expensive at first, it has historically traded at a PE of 25. The current rating seems an attractive entry point for what I believe is one of the best ways to play the agriculture sector. The company has consistently generated a high Return on Equity (ROE) of around 30%, is on a Free Cash flow (FCF) yield of 8.5% for 2014 and a respectable dividend yield of 2.8%. Although SQM has a market capitalisation of around $15bn, it is capable of growing around 10% pa for the foreseeable future. Another positive, is that SQM only has a small amount of debt.
Over the last ten years we have seen regular bursts in food prices and supplies have become depleted. As the global population grows and becomes wealthier, demand for food will continue to rise. Whilst rising prices impact consumers and poorer nations, higher prices encourage farmers to increase food production. This will result in more investment in increasing farm productivity. One of the prime beneficiaries is likely to be Latin America, where conditions for growing crops are perfect.
SQM is a play on the growth of Latin American agriculture. According to the Inter-American Institute for Cooperation on Agriculture (IICA), Latin America has 42% of the world’s potential for agricultural production and it still isn’t using all of its farmland. The UN’s Food and Agriculture Organisation has said Brazil has around 350 million hectares of arable land that is not being used to produce food.
The World Bank has estimated that around a third of the world’s spare farmland is in Latin America. Some existing farms are dependent on old style techniques and machinery and have not invested much in R&D but this might now be changing due to higher prices. Farmers are realising that higher food prices will lead to opportunities for exporting countries. Latin America now supplies a third of China’s agricultural imports and as their population grows their demand for agricultural imports is also likely to keep growing.
There are several ways of getting exposure to the growth of the agriculture sector. It is possible to buy direct holdings in farmland but there is the risk of fraud and even expropriation, particularly given the situation in Argentina at present. Investors can also buy shares in large listed landowners but again there are risks with this. Therefore, SQM is the safer and more diverse way to gain exposure. Brokers estimate that around 30% of SQM’s sales go to Latin America, although this is expected to increase once farmers start spending more on production.
SQM is a company operating in a sector that has excellent potential for long term growth. It is a global business that should benefit from growth in the global population and the increasing demand for food. The share price is some way off the 52 week high of $65, so the current price looks to be an attractive entry point for long term investors.