Fundamental, Industry, Thought Leading, Thematic
Deutsche Bank Company Research's Research Product Committee has deemed
this work F.I.T.T for investors seeking differentiated ideas. Potash and phosphate
fertilizer prices have increased five-fold over the past 12 months while agchem
volumes have increased dramatically. Here we analyze the drivers behind the
improvement in sector fundamentals in order to assess this boom.
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DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1
FITT Research
Top picks
Israel Chemicals (ICL.TA),ILS66.20 Buy
Makhteshim-Agan Industries
(MAIN.TA),ILS32.75 Buy
Companies featured
Israel Chemicals (ICL.TA),ILS66.20 Buy
2007A 2008E 2009E
DB EPS (USD) 0.42 1.35 1.62
P/E (x) 19.7 14.5 12.1
EV/EBITDA (x) 13.0 10.0 8.3
Makhteshim-Agan Industries
(MAIN.TA),ILS32.75 Buy
2007A 2008E 2009E
DB EPS (USD) 0.40 0.59 0.65
P/E (x) 18.5 16.4 14.9
EV/EBITDA (x) 9.4 9.6 8.6
Fundamental: A detailed look at supply/demand dynamics
We look at both short and long-term fundamental trends and potential risks of
sector drivers and their potential impact. We examine both fertilizers and
agchems, as well as agriculture – crop prices and farmer income are key demand
drivers. We then assess the sustainability of price demand and price rises.
Industry: Key drivers should continue to support sector in long-term
We conclude that the long-term secular drivers are enduring enough that we
expect the current agricultural cycle to sustain through 2011. US subsidization of
corn ethanol may have added some bubble-like characteristics to the agricultural
boom, but we see this outweighed by the need to replenish record low grain
inventories. We expect a focus on increasing crop production to drive higher
demand for fertilizers and agrochemicals in order to improve yields.
Thematic: Price rises and margin expansion not priced in
The sharp rise in potash prices goes straight to ICL’s EBIT. We calculate that the
stock currently prices in a sustainable potash price of c$550/ton, which is 25%
below current spot prices of $750/ton and 45% below the $1,000/ton mark that
has already been achieved on some small deals. We do not see downward
pressure on potash prices over the next two years, with near-term rises more
likely. At MA we expect high volume growth to drive margin expansion, and do
not believe that investors have accounted for this as margins had eroded since
2005. The 1Q08 improvement in gross margins marks a watershed, in our view.
Thought Leading: Fertilizer sector more compelling than agchems
While underlying demand drivers are similar, the fertilizer sector (especially
potash) benefits from a benign supply structure. Potash sources are scarce,
barriers to entry high and producers maintain a tight supply strategy that gives
them considerable pricing power. By contrast, the agchem market is highly
fragmented and pricing power limited, so volume is the main determinant of
earnings growth – not prices.
We view ICL and MA as core holdings in Israel
Both ICL and MA are leading companies in their respective global sectors with
their growth outlook determined by trends in global agriculture rather than local
factors. We expect both stocks to outperform the TASE, and we recommend
them as core holdings in Israel.

Table of Contents
Investment thesis .............................................................................. 3
Israeli fertilizers and agrochemicals – Is the boom sustainable?...............................................3
Valuation ..................................................................................................................................5
Risks ........................................................................................................................................5
Rising crop prices driving input use ................................................ 6
Why high crop prices are key....................................................................................................6
Low inventories, strong demand support crop prices ..............................................................6
Higher income, improving diets – the key secular driver............... 9
Inherent link between meat consumption and fertilizer demand ..............................................9
Soft grains used mainly as animal feed for meat production ....................................................9
The need for yield............................................................................ 13
Limited land supplies require high fertilization rates ...............................................................13
Limited land availability drives fertilizer and agchem usage....................................................13
Ethanol adding fuel to the fire, but… ............................................ 16
Biofuel crops amongst highest fertilizer consumers...............................................................16
Rapid biofuel growth driving crop and fertilizer demand.........................................................16
Risks – Beware the cycle................................................................. 20
A reverse of crop prices is the major risk................................................................................20
Specific drivers for fertilizers and agrochemicals......................... 23
Fertilizers – supply structure determines pricing power .........................................................23
Agchems – fragmented supply makes it a volume, rather than price story ............................26
A focus on Brazil .............................................................................. 29
Strong fundamentals, but not without challenges ..................................................................29
Israel Chemicals............................................................................... 33
Outlook ..................................................................................................................................33
Valuation ................................................................................................................................33
Risks ......................................................................................................................................33
Company background .............................................................................................................35
Fertilizers................................................................................................................................39
Industrial products ..................................................................................................................42
Performance products ............................................................................................................45
Comparative valuation.............................................................................................................51
Makhteshim Agan............................................................................ 52
Outlook ..................................................................................................................................52
Valuation ................................................................................................................................52
Risks ......................................................................................................................................52
Company background .............................................................................................................54

Investment thesis
Israeli fertilizers and agrochemicals – Is the boom sustainable?
Cycle to sustain through 2011
Potash and phosphate fertilizer prices have increased five-fold over the past 12 months and
agrochemical volumes have dramatically increased. In this report we analyze the drivers
behind the improvement in sector fundamentals in order to assess whether the current boom
is sustainable. We conclude that the long-term secular drivers are enduring enough to
suggest that the current agricultural cycle will sustain through 2011, with low grain
inventories and improving diets as the main factors. However, biofuels in the US have added
fuel to the fire, and since they are supported by subsidies they have added bubble-like
characteristics to the agricultural boom.
Fertilizer and crop protection demand closely tied to crop prices
High crop prices are, in our view, the single most important factor in the fertilizer price rises
of the past year and the increase in crop protection volumes. With crop prices high since late
2006 farmers have more incentive to ensure that yields are high (through optimal fertilizer
application) and that crops are protected from pests, fungus and weeds (through applying
agrochemicals). Farmers have increased planted acres by using incremental land of lower
quality, on which they need to apply more fertilizer than usual, while the high crop prices
have enabled fertilizer companies to push through price increases without negatively
impacting farmer income. With stocks-to-use ratios close to all-time lows we expect crop
prices to remain high on a 2-3 year view since the inventory rebuilding process will take at
least 4-5 years. The stock-to-use ratio is total available stocks divided by daily consumption.
Improving diets the key secular driver
The key secular driver is that higher income, especially in emerging markets, continues to
lead to an improvement in diet and increased meat consumption. Since the majority of soft
grains globally are used as feed for meat production there is an inherent link between meat
consumption and agchem demand. This is especially the case since feed grains tend to be
produced by large commercial farms that are the most intensive consumers of fertilizer and
agchems. The drive for higher living standards is a powerful and long-term force that starts
with food. Will food inflation spoil the party, leading to cutbacks in consumption? We’d
advise keeping a close eye on the Chinese pork sector as a test case. Prices are up 70% YoY,
yet initial data from Q1 suggests that consumption has increased rather than contracted.
Improve yields or increase acreage? Both routes positive for agchems
Farmers have two main ways to increase production – improve yields or increase acreage.
The way to improve yields is through optimal fertilizer application, which particularly in India
and China means applying more fertilizers. Increasing acreage by definition means that the
farmer will require more agchems, but since new or recovered land is usually of lower quality
and thus needs more fertilization, the incremental effect is substantial. In Europe and the US
this is being played out as land is brought back from historic set-aside programs, while in
Brazil the nutrient quality of unused arable land is lower than that of cultivated land.
Biofuels – more of a risk now than an opportunity
The increase in corn consumption for ethanol in the US has created a demand shock, with
the USDA estimating that 60% of corn consumption growth globally last year was
attributable to the US ethanol industry. To give some perspective, about a quarter of US corn
production is used for producing ethanol, representing 7-8% of global corn output. We are
witnessing a growing backlash against ethanol in public opinion, but it is worth noting that US
biofuel targets are mandated to 2012, and rolling back the legislative framework would likely
be a lengthy process. Nevertheless the corn crop accounts for more than 40% of US fertilizer

consumption, and a lowering or removal of biofuel subsidies could have both a rapid and
negative impact on crop prices and fertilizer demand.
Benign supply structure in potash provides pricing power
Beyond growing demand, the attractiveness of the potash sector stems from a benign
supply structure. Potash sources globally are scarce with a limited number of producers and
a significant barrier to entry, in that the investment required for a greenfield site is in excess
of $1bn and takes time. Pricing is determined on a regional basis by three main marketing
organizations (Canpotex and BPC in Latam and Asia, K+S in Europe) that have considerable
pricing power especially in times of booming demand. Historically, producers have
responded to periods of weaker demand with discipline by sacrificing volume for price. We
expect producers to continue this policy in coming years to endeavor to keep potash prices
high, and so we are not concerned that capacity expansions will alter the fundamental
supply/demand balance.
ICL benefits from potash trends, phosphates too…but to a lesser extent
Even though Israel Chemicals is a price taker, it benefits from these trends and has two key
advantages in potash: proximity (in shipping terms) to the fast-growing Indian market and a
low cost source of production at the Dead Sea. ICL is also active in phosphate fertilizers, and
while prices in phosphates have risen more dramatically than in potash we place less
emphasis here as input costs have also risen, the supply structure is more fragmented, and
new capacity poses a long-term threat to prices.
Crop protection market highly fragmented…gains come from volume
The crop protection chemical market is highly fragmented, with the market share split
between 7-8 leading players. As a result pricing power is low, and profitability gains stem
from higher volumes or lower costs. MA understands this well, and has positioned itself as
the fastest growing player for a number of years, through a mix of organic growth and
acquisitions. The secular drivers noted above are leading to higher application rates of crop
protection chemicals, and so we expect robust industry growth through 2011. We see MA
benefiting from these trends, though overall we view ICL and the fertilizer sector as more
compelling.
Input inventories at low levels
Fertilizer inventory is scarce, as customers are buying up inventory in the spot market.
Additionally, farmers, particularly large operations in Brazil, bought much of their fertilizer
requirement at the beginning of the year, and production has had difficulty in keeping up with
the limited supply and increasing demand. Even in a sector such as crop protection
chemicals, which is driven by volume, certain chemicals such as glyphosate are in short
supply.
Israel Chemicals: Despite strong run, substantial upside potential remains
Although Israel Chemicals has rallied close to 40% YTD following an 88% gain in 2007, we
believe that the full story is not yet priced in. The sharp rise in potash prices goes straight to
EBIT, while the even sharper increases in phosphate prices, while somewhat offset by a
corresponding rise in sulfur prices, will further contribute to earnings growth. In the past
month there have been reports of some sales of potash to Asian and Latin American markets
for US$1,000 ton for 3Q08 delivery. We are currently modeling an average price of
US$567/ton in our forecasts for 2008 and $661/ton for 2009. While we feel it may be
premature to incorporate the US$1,000 ton in our model, if this price is sustainable long-term
it would imply 50% upside to our valuation.

MA Industries: Strong fundamentals not yet priced in
MAIN's record 1Q08 results point to strong sector fundamentals, as the company increased
profitability despite rising input costs. High demand and rising prices for its products helped
offset higher energy costs. We view the results as an indicator of the general positive trend
in the sector, and believe the strong fundamentals are not fully reflected in the share price as
some negative sentiment lingers from the company reporting lower than expected 4Q07
results.
Let’s not forget that agriculture is a cyclical sector
While we expect that the current agricultural cycle will sustain through 2011, it is important to
bear in mind that agriculture is a cyclical sector with a history of highly volatile prices. We can
identify seven crop price cycles since 1972, of which the current cycle (that commenced in
Oct 2006) is the most intense on the upside. Each previous cycle ended after 2-3 years with
crop prices returning close to pre-cycle levels. We are wary of ‘this time it is different’ type
arguments as we recall similar arguments during the tech and real estate booms. However,
we believe that the secular drivers and especially the low global grain and corn inventories
are powerful enough to keep demand for fertilizers and agchems at high levels over the
medium term.
Valuation
We use DCF models to derive our price targets for Israel Chemicals and MA Industries. For
both companies we use a blend of US and Israeli long-term bond rates to determine the RFR.
This is in order to reflect their dollar-based accounting and export focus on the one hand, but
Israeli domicile on the other. We use a WACC of 9% based on 5% RFR, beta of 1x and 4.5%
ERP. In the case of MA Industries we apply a 1.5% terminal growth rate, whereas we apply
3.0% terminal growth at ICL, which is in line with the differing growth rates of the agchem
and fertilizer sectors.
Risks
The major risk that we see for the sector would be a reversal of crop prices, especially given
that prices have more than doubled in recent months, the sharpest price movements in over
30 years. Lower crop prices would lead to lower farmer income and as a result fewer
resources to acquire agchem and fertilizer inputs.
Food inflation represents a risk since it could lead to declines in consumption of meat and
even basic food products, driving down demand for raw crops. In such a scenario crop
inventories could rebuild quicker than expected forcing down crop prices. While food is a
non-discretionary item, the quantity of food consumed is discretionary (certainly in developed
countries), as is the amount of meat consumed.
As noted above, the backlash against biofuels is a risk for agchem and fertilizer stocks,
especially if legislative action follows.
Finally, we note that fertilizer prices have never risen quite as sharply as in recent months, so
price elasticity is largely untested. While in the short term demand has not been impaired by
higher prices, it is not unlikely that some farmers will choose to lower their usage of fertilizer
inputs. Farmers in developing countries have historically under-applied potash in relation to
nitrogen and phosphates. Will they choose to increase potash application now that prices
have tripled? Higher prices could therefore affect long-term fertilizer demand growth just as
new capacity is coming on line.

Rising crop prices driving
input use
Why high crop prices are key
􀂄 High crop prices are in our view the single most important factor in the fertilizer price
rises of the past year and increase in crop protection volumes.
􀂄 With crop prices high since late 2006, farmers have more incentive to ensure that yields
are high (through optimal fertilizer application) and that crops are protected from pests,
fungus and weeds (through applying agrochemicals).
􀂄 Farmers have increased planted acres by using incremental land of lower quality, on
which they need to apply more fertilizer than usual.
􀂄 The high prices have enabled fertilizer companies to push through price increases
without hurting farmer income.
􀂄 With stocks-to-use ratios close to all time lows we expect crop prices to remain high on a
2-3 year view, though we caution that crop prices have been cyclical historically and that
declining prices would be very negative for both the fertilizer and crop protection sectors.
Low inventories, strong demand support crop prices
Inventories at historically low levels
Several factors have combined to deplete global grain inventories over the last several years
to levels not seen since the early 1970s for corn and wheat. These include:
􀂄 Growing demand for food, particularly by developing markets such as China
􀂄 Growing demand from the fledgling biofuel industry
􀂄 Poor climatic conditions in some regions (such as drought in Australia) that have reduced
harvests in the last few years