Urea!

On Oct. 29, Agrium reported its strongest quarter in more than five years — and said next year looks even better. We caught a whiff of the company's strong growth prospects relative to its share price thanks to our Bargain Growth screen.

The centerpiece of our Bargain Growth screen is the price/earnings-growth, or PEG, ratio. Price, earnings and the rate at which earnings are growing are the three most important things to consider when sizing up a stock. The PEG gives a quick snapshot of the relationship between all three.

We generally consider stocks with PEGs below 1.0 cheap. That means their price/earnings multiples (numerator) are less than their earnings growth rates (denominator). What's the mathematical basis for the 1.0 cutoff? Let's see: take the square root of the reciprocal raised to the power of the sine of the adjacent angle...OK, there is no basis, mathematical or otherwise. In fact, your former math teachers would frown on dividing a P/E ratio by a growth percentage in the first place. Still, the PEG is one of the most useful valuation measures in an investor's tool kit, particularly when comparing one company with another. You can change the 1.0 cutoff if you like, but we encourage you to include the PEG in all of the screens you run yourself with our stock-screening tool.

The search we performed showed that low PEGs are getting rarer. Of the 8,300 companies in our database, we found just 395 with PEGs less than 1.0. That's down from 544 in our Feb. 7 Bargain Growth screen. We also looked for operating margins that were above their industry medians and growing. Debt for each of our companies had to be manageable, and we insisted that 2003 earnings estimates hadn't been cut within the past four weeks. Analysts' recommendations, on average, had to be Buy or Strong Buy, the kind of popularity growth stocks should have.

We made other demands; see the recipe to the right for all of them. Our search yielded 13 companies, including Agrium.

Agrium makes nitrogen-based products like anhydrous ammonia, urea and ammonium nitrate that are chemically identical to products made from manure. It also offers a portfolio of phosphate, potassium and sulfur products.

Some products are useful for more than fertilizer. Urea liquor, for example, may sound unsettling, but it's actually a common supplement for livestock feed, glue and even cosmetics.

The company's profits have been strong. Earnings for the third quarter ended Sept. 30 reached $25 million, compared with $1 million a year earlier. Per-share earnings of 17 cents topped Reuters Research's six-analyst consensus by eight cents. Sales rose 20% to $592 million, yet tonnage of products shipped rose just 1%. Nitrogen pricing was the key.

Average prices for ammonia and urea are up 38% and 40%, respectively, over year-ago levels. And analysts don't expect supply to start rising significantly until 2005. Grain prices are on the rise, leading to increased demand for fertilizer as farmers try to produce more. But costs have been rising, too — particularly for natural gas, a key ingredient in the production of nitrogen products. Still, industry watchers say natural-gas prices have leveled in recent weeks, and should fall long before fertilizer prices do. That's good for nitrogen producers.

Agrium has the most exposure of its group to nitrogen supply and demand; more than 70% of its profits come from nitrogen products. Such specialization, of course, makes it a somewhat risky stock. National Bank Financial analyst Steve Laciak, though, is undaunted. "We have a [1.90 Canadian dollars] EPS forecast for 2004, but our one-in-three probability of EPS soaring to [C$2.50 to C$3.00] is increasingly looking likely," he wrote on Dec. 3. One Canadian dollar equals 77 U.S. cents. (Laciak doesn't own shares of Agrium; National Bank has an investment-banking relationship with the company.)

Agrium's extra cash flow, meanwhile, is being put to good use. The company has paid down $168 million in debt in the past year, and it will likely pay off $125 million more that comes due in the next three months. That will leave long-term debt of about $500 million. Managers recently declared a 5.5 cent quarterly dividend, which gives the stock a yield of 1.4%.

Rising earnings expectations — the 2003 consensus is up to 82 cents from 68 cents two months ago, and the 2004 consensus is up to $1.26 from $1.15 — have made shares look rather cheap. The stock's P/E ratio of 18.7 is well below the chemical-manufacturing industry's average of 27.1. And earnings for Agrium are projected to increase by a whopping 50% annually over the next three years, compared with 9% for peers. That makes for one of the lowest PEGs we've seen in a while, just 0.37, well below the group's 3.0 or the S&P 500's 1.8.

The 50% growth consensus, we should point out, is aggressive. Visibility for 53% earnings growth in 2004 is pretty good, but beyond that it gets sketchy. So you might want to mentally discount that figure a bit, and then cut it a bit more to account for the company's above-average risk. Even so, this fertilizer producer smells like a bargain to us.

For the full list of our Bargain Growth survivors, click here.