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Federico Flom
Federico Flom
Articles (110) 

Potash (POT) - Great Exposure to a Growing Indutry

May 10, 2012 | About:
Introduction – Potash Opportunity: Potash Corp. of Saskatchewan (POT) is the world's largest fertilizer company by capacity, producing the three primary crop nutrients: potash, phosphate and nitrogen. Potash is the worlds' leading potash producer and is responsible for about 20% of global capacity. It is the third-largest phosphate company in the world and has the phosphate industry's most diversified product line (liquid, solid fertilizer, feed and industrial). Potash has operations and business interest in seven countries and is a key player in the growing challenge of feeding the world. Potash products help provide the primary nutrients that crops need, in addition to nutrients that are used to make livestock feeds and industrial goods.

Millions of people with rising incomes want to feed their families better diets, with high quality fruits and vegetables and protein from meat. With pressure on global crop supplies mounting, the need to substantially increase production is clear. This demand is supporting strong prices for a wide range of crops grown globally. Farmers are responding by increasing yield by applying more fertilizer, especially potash.

World crop consumption is forecast to grow from 3.4 billion tones in 2000 to 4.9 billion tones in 2020. Each year, the global population is expected to grow by about 75 million; by 2020 the world population will have grown by almost 800 million. Most of this growth is occurring in developing countries, along with the priority for most people to improve their diets. Ongoing economic growth will continue to improve the affordability of and increase the desire for more and better food.

Management is Bullish on Potash Business

Potash Corp. is headed back to the top spot in Canada's markets — and soon — its ebullient chief executive, Bill Doyle, predicts.

Never mind that Potash is currently in 10th place, has just come off a dismal quarter that saw it blow past expectations — the wrong way, with a 33 percent drop in first-year earnings — and a cut to its full-year forecast. Its shares are down nearly 7 percent in the past month. It faces fertilizer buyers skeptical of demand amidst global economic turmoil.

Mr. Doyle has never shied away from a sunny look at the future. During his successful fight against the BHP Billiton (BHP) takeover bid, at $130 per share, he suggested Potash's value "far exceeds $170 per share."

During April, with the company trading pennies below $130, in split-adjusted terms, Mr. Doyle told a Calgary audience that big things are still ahead. "We were for about one nano-second in 2008, the largest market cap company in Canada, and we hope to get back to that level within the near term," he said at a local chamber of commerce event.

Asked in an interview whether that was likely to happen in the next half-decade, Mr. Doyle, who has long promoted the virtues of selling potash into a world with a rising appetite for food, and therefore fertilizer, said: "Oh, yeah." "It's really just growing earnings. Look at the capacity to grow — over the next three years, we're going to grow tremendously," he said. Potash is in the midst of a major $7.7-billion expansion, and Canada's potash industry expects to grow its exports from 9.8-million tonnes last year to 20 million a decade from now.

Mr. Doyle added: "We're the only producer that has five-fold leverage to our nutrient," pointing to the company's planned output increases, its international investments, its ability to spread fixed costs over more units as it grows, its belief that prices are on the rise and the fact that Potash doesn't have to pay profit taxes on production over 5.7-million tonnes. "It's tremendous, the levers," he said. "It's like dominoes, they just all start working together. And when it kicks in, we're off to the races."

Still, the immediate outlook for Potash, and the commodity it draws its name from, is more muted. Though second-quarter earnings are expected to be much stronger, the company is not counting on major price increases as it enters negotiations later this year with key buyers in China and India.

Signing a new contract with China, whose current deal expires at the end of June, should happen without much delay, Mr. Doyle said. India could be more difficult, given distortions in that market that have come from government subsidies of nitrogen. Overall, though, Mr. Doyle expects a "modest increase, but enough that it makes a difference to us."

"I think the Chinese are certainly aware of that," he said. "The Indians may not like it. But I think they're going to get themselves in the position where they're looking to higher prices."

Current Outlook for Fertilizers – Analyst Comments

Getting any respect in the fertilizer business has been pretty tough so far this year. Agrium Corp. (NYSE:AGU) reported first quarter results this morning, posting adjusted EPS of $1.32 on revenues of $3.63 billion. Analysts were expecting EPS of $0.99 on revenue of $2.98 billion. Agrium attributed its increased sales to higher volumes and higher prices for nitrogen. Last week, CF Industries Holdings Inc. (NYSE:CF) also blasted through estimates, but the company’s best seller was also its nitrogen products. Potash Corp. of Saskatchewan Inc. (POT) missed earnings estimates on lower potash sales and margins (gross margins fell -56% year-over-year). The Mosaic Co. (NYSE:MOS) also missed on earnings as potash volumes fell and phosphate costs rose. Monsanto Co. (NYSE:MON) pounded EPS estimates, but analysts believe that sales were all pulled forward due to the warm weather.

Agrium and CF are less dependent on potash and phosphates than are the others, and the rise in nitrogen is directly related to its ability to boost yields on the same amount of acreage. Potash fertilizer is needed to ensure healthy plants, but its contribution yields is less important.

Whether demand for nitrogen will continue through the Northern Hemisphere’s growing season remains to be seen, but as more people demand more food on the same amount of acreage, sales and margins on nitrogen are likely to keep pace.

Credit Suisse questioned potash groups' hopes of a revival in potash demand by forecasting a drop in world shipments this year and cutting price estimates, citing "extreme caution" among distributors.

The bank warned that it was "now skeptical over whether potash prices can regain the momentum seen last year."

Indeed, a "sharp" rebound in volumes, fostered by unexpectedly prompt deals to supply China, the top importer, look set to peter out.

"We believe that volumes could weaken again in the second half [of 2012]," Credit Suisse said, forecasting a fall to 52m-53m tonnes in world shipments this year, below last year's 55m tonnes.

The figure is also below the 56 million to 58 million tonnes forecast two weeks ago by Uralkali, the Russian potash giant, and an estimate of "up to" 58m tonnes from K+S, its German rival.

Credit Suisse's forecast reflected an observation that "distributors remain extremely cautious, given the uncertain grain price outlook, and are looking to defer new purchases until there is greater clarity around the U.S. crop size and grain prices."

Potash Corp. was also downgraded by Atlantic Equities from an “overweight” rating to a “neutral” rating in a research note issued on Monday.

POT has been the subject of a number of other recent research reports. Analysts at Stifel Nicolaus initiated coverage on shares of Potash Corp in a research note to investors on Thursday, March 29th. They set a “buy” rating and a $56.00 price target on the stock. Separately, analysts at Raymond James (RJF) initiated coverage on shares of Potash Corp. in a research note to investors on Thursday, March 29. They set an “outperform” rating on the stock. Finally, analysts at National Bank upgraded shares of Potash Corp. from an “underperform” rating to a “sector perform” rating in a research note to investors on Monday, March 26. They now have a $45.00 price target on the stock.

My view on the opportunity

Rising demand for food grain from emerging economies and adverse weather have pushed grain prices to record levels, boosting fertilizer prices. The scarce supply of potash is another factor for the rise in demand, and the company has already started preparing to meet this demand by investing in its ongoing potash operational capability. Potash Corp. expects to spend $1.6 billion on potash expansion projects.

It raised its full-year earnings forecast to between $3.40 and $3.80 a share, instead of $3.00 to $3.40. We have thus upgraded our recommendation to Outperform from Neutral with a target price of $63.00. US plantings of wheat and corn this year will be higher than the most recent US Department of Agriculture survey according to new survey results from Allendale Inc. cited by Bloomberg News. The firm forecasts that corn planting will rise to more than 95 million acres, higher than last year’s total of 91.9 million acres and higher than last month’s USDA forecast of 94 million acres. Wheat planting will rise to nearly 57 million acres..

Fertilizer stocks should be major beneficiaries of a rally in agricultural sector equities later this year. In fact, the declines in the sector over the past year have reduced valuations to levels last seen more than two years ago.

At these levels, fertilizer stocks are more than pricing in the recent decline in agricultural commodity prices, and further downside appears limited unless there's a new global economic recession.

POT is one of my top picks among fertilizer stocks because it offers exposure to all three major fertilizers. The company controls nearly a quarter of the world's total potash mining and production capacity and is by far the largest player in this market.

The potash market is an oligopoly, with the six largest players essentially controlling the market. These companies have proved adept at managing supplies in recent years, maintaining pricing and margins by shuttering production facilities following declines in demand.

And Potash Corp.'s mines in Canada are among the lowest-cost sources of this key fertilizer in the world.

The company suffered a weak fourth quarter, as Asian demand slowed and dealers and distributors delayed new orders because of economic uncertainty.

However, management suggested that despite a decline in its fertilizer sales during the fourth quarter, actual applications of fertilizer by farmers remained strong, an indication that producers and distributors have been drawing down their inventories.

The U.S. Dept. of Agriculture raised its estimate of last year's corn crop in recent months, but poor growing conditions throughout much of last season stressed crops and hurt yields.

Farmers are expected to aggressively plant acreage this year in an effort to offset that showing. The company expects that to lead to more robust sales as the year progresses and dealers restock their inventories."

The bad news about near-term potash demand appears to be baked into valuations, and Potash Corp. of Saskatchewan should be bought at current levels.

About the author:

Federico Flom
Equity Research Analyst

Rating: 3.7/5 (15 votes)


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