Before the global economic downturn of 2008, a clear investing theme had emerged. Rising incomes across the world were leading to richer diets and triggering a boom for all kinds of stocks that helped farmers be more productive. This emerging trend helped enrich shareholders of Mosaic (NYSE: MOS), the world’s largest producer of phosphates and the third-largest producer of potash — a pair of essential fertilizers and ingredients used in animal feed.

Shares of the company shot up from $30 in the spring of 2007 to more than $150 in the summer of 2008 — a 400% move in just 13 months. Investors began to see profits can soar when demand spikes along with the price of phosphate and potash.

Of course, the eventual economic downturn highlighted the risk of Mosaic’s business model. Demand slumped and a price drop made things even worse, pushing shares down to $35 just seven months later. These days, the boom-and-bust phases appear to be in the past and the farm belt has settled into a more predictable, smoother cycle.

Shares of Mosaic had rebounded all the way back up to $85 this winter, yet have sold off anew and now once again trade below $70. In light of projections for rising global farm output, the pullback creates a solid entry point. [My friend Nathan Slaughter agrees. Read his recent take on Mosaic.]

 
Good, not great
Mosaic just released reasonably impressive fiscal fourth quarter results. The company generated $2.9 billion in revenue, and EPS (earnings per share) of $1.45 were $0.06 ahead of the consensus forecast. (Potash, with gross margins in excess of 50%, is the sexy part of the business. Phosphate, with margins closer to 25%, is not quite as impressive.) Operating cash flow in the fourth quarter of $973 million was especially impressive, from $532 million a year earlier.

Free cash flow was just above $600 million in the quarter, which the company has been steadily using to pay down its debt. Long-term debt has shrunk from $3.4 billion a year ago to a recent $790 million. All that free cash flow has also enabled Mosaic to “attain an investment grade rating, undertake a sizable potash capacity expansion and build up a considerable liquidity cushion,” note analysts at UBS.

The key for this business model is the company’s own production capacity, along with potential output at key rivals. Right now, the company is operating at about 85% capacity at both its phosphate and potash mines, right in-line with the industry average. In years past, when this number has crept north of 90%, it’s become a seller’s market because producers can hike prices and customers can do little about it.
 
Mosaic is actually embarking on a bit of a balancing act. The company is boosting capacity at its lucrative potash segment in anticipation global demand will rise at a fast pace as emerging economies continue to boost agricultural output. Rivals in Saudi Arabia and China are also boosting output, though that shouldn’t wreak havoc on industry supply/demand dynamics, at least in the all-important potash segment. “Longer-term, we believe favorable potash fundamentals should more than offset potential phosphate oversupply conditions,” note the UBS analysts.

The trends appear to be working in the right direction. Mosaic sold potash for $404 per ton in the fiscal fourth quarter and expect this figure to rise to a range of $430 to $455 in the current quarter. The company sold phosphate for $574 per ton in the last quarter and could see the figure move up to $590 in the current quarter.

Action to Take –> Demand for potash and phosphate has improved in recent quarters, but is still not at the peak levels of a few years ago. Shares of Mosaic deserve to trade at a slight premium to its average five-year price-to-earnings (P/E) multiple of 13. Assuming shares trade up to 14 times projected fiscal 2012 profits, then the stock should move from a recent $68 up toward the $88 mark — at least that’s the logic behind Citigroup’s $88 price target.

Analysts at Merrill Lynch also think a P/E of 14 is warranted, though they apply it to projected EPS for fiscal (May) 2013 of $6.75, yielding a $94 price target. This is nearly 40% above current levels. If the global economy starts to get back on its feet and demand for potash phosphate climbs a bit higher, then shares could eventually move past the $100 mark. This is a far cry from the $150 level seen in 2008, but still a solid gain from current prices.

P.S. — I don’t know if you’re aware of this or not, but a 20-year energy agreement between the United States and Russia is about to expire. The problem is, this deal supplies 10% of America’s electricity. When the Russians refuse to renew the agreement, the U.S. will face an entirely new kind of energy crisis. This disruption could send a handful of energy stocks through the roof. Keep reading…