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Potash Pricing Quietly Holding Up, But Commentary Has Vanished (POT)

Posted on | November 25, 2008 Time: 1:59 pm |

Potash Corp. of Saskatchewan (POT) has seen a lot of its commentary drop along with its stock price. One need look no further than the sparse listings for Potash Corp. within the Seeking Alpha pages to realize that bullish interest in the company has largely burst along with commodity prices.

Now that POT shares are down more than 75% from their summer peak, postings come in with about half the frequency. And the majority are now bearish, further proof that it’s so difficult for most to avoid the tired cycle of “bullish at tops and bearish at bottoms”. I’ll purge out all the bearish news first, then move on to the pricing environment for potash, the commodity surprise of the year.

Fertilizer Prices Falling Precipitously

The price of phosphates, urea, and nitrogen - three of the largest fertilizer inputs - have gone off a cliff in the past month. Consider that less than two months after Mosaic (MOS) reported an ASP of over $1,000/tonne for diammonium phosphate (DAP) in the 3rd quarter, current prices for DAP are now less than $550/tonne according to trade resource Fertilizer Index. Grain futures have also fallen dramatically from their summer peaks, with corn, wheat, and soybeans all down 40% or more. But recent weeks have seen short month futures stabilize (especially in wheat & soy), while longer-dated grain contracts continue to price in expected strength in the future.

In addition to drops in the all-important grain prices, Potash Corp. has been hurt by the rapidly declining value of its stakes in other agriculture and chemical makers. A truly undiversified portfolio, the company’s equity holdings were worth just $3.7 billion as of September 30th, down from $5.3 billion in the second quarter. Judging from the underlying stock prices of the holdings, these investments are down another 30-40% in the 4th quarter.

Mine Strike to End

Potash Corp used a strike at several of its largest mines this fall as an opportunity to “organically” cut production at a time when demand was weakening. This has partly helped to keep potash prices high, as have planned 50% production cuts by Uralkali, a large Russian producer. A tentative deal to end the strike was signed by union workers earlier in the month, and the company can now take full advantage of the supply cuts by competitors and low inventories in the global market.

Potash Corp. still plans to increase overall capacity by an audacious 80% over the next five years, from 10 million tonnes annually to 18 million. But they’ve stated repeatedly that they won’t just do it because they have the cash; they continue to guide production levels in response to global demand. The capex required to keep on track with the capacity growth is expected to be $2 billion in 2009, a number the company will have no problem allocating given the run-rate operating cash flow of $3.8 billion.

Potash Prices Holding Ground

While Potash Corp. also deals in phosphates and nitrogen, potash sales continue to drive net earnings and the share price, as the company is the world’s largest producer. And despite the trend in nearly every commodity to the sharp downside, potash prices are not only holding steady, but ticking upward. In the 3rd quarter, average realized prices for offshore potash (sold through the Canpotex subsidiary)  were $601/tonne, which was up 262% year-over-year. Total production volumes were even down by 14%, making the company’s five-fold growth in earnings per share all the more extraordinary. If potash prices were to even go down mildly, the company would still be a cash generating machine.

I can’t speak to whether shares have reached their lowest levels - irrational markets still reign the day - but the time to be bullish is now. I was shocked to discover that Canpotex just signed a deal with Japan to supply potash at a price north of $900 per tonne in 2009. We’re not supposed to be seeing prices this high anymore; we’re supposed to see potash prices drop along with all the other agriculture commodities, along with all the grains, along with the rest of our deflationary world.

But they’re not, thanks to a unique set of supply constraints, some of them temporary (mine strikes, Uralkali cuts, Chinese export tariffs) and some long-term (capacity upgrades can take 5 years or more to implement, and come quite expensively).

Earnings Forecasts

As of October 23rd, Potash Corp. is still guiding toward $12/sh in EPS for 2008, which puts a P/E of 5x around this stock. In another day and time I’d say that’s the most attractive number ever, but in truth you can find valuations like that in many sectors. The difference here is that EPS isn’t clearly headed off a cliff in coming quarters….it could even (gulp) rise. Reuters has the current consensus EPS estimate for 2009 at $20/share, which even if due for a haircut implies continued strong growth. The company’s balance sheet remains pristine and underlevered.

If the potash industry can prove that sustainable prices above $700-$800/tonne are possible, POT shares are due for a major revaluation. Given the strong secular trends promoting A) higher protein consumption, B) lower arable land, and C) constrained potash supplies, I continue to see an extremely positive risk/reward proposition for Potash shares. It remains a top 5 holding in the Secular Trends Portfolio.

disclosure: Author does not hold a position in the companies mentioned.

More on this topic (What's this?)
Andrew Snyder Says Potash Corp (POT) Still Has Further to Fall (Contrarian Profits, 10/10/08)
Bookkeeping: Starting to Rebuild Potash (POT) (Fund my Mutual Fund, 11/20/08)
Potash Corp (POT) (Stocks Today, 11/7/08)
Read more on Potash Corporation of Saskatchewan at Wikinvest
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