So much for mitigating risk across a diverse business. PotashCorp (NYSE: POT ) delivered dismal earnings, reduced its full-year outlook by $0.30, and announced that it would cut production at two mines to balance supply. Potassium sales volumes were solid for the quarter, but weaker than expected Indian and Chinese markets muted what is normally the strongest quarter of the year for the industry.
Weakness was observed in all three major nutrients -- nitrogen, phosphate, and potassium -- which doesn't bode so well for the peer group, either. All around it wasn't a very strong quarter for PotashCorp. Is there any positive news that investors can take away? What, if anything, changes in the long-term outlook for the company and industry? Let's dig in.
Shares dropped over 5% in intraday trading on the bad news, but recovered to close down just 1.3%. Still, investors have good reason to be shocked. PotashCorp earned just $0.73 per share on revenue of $2 billion, whereas expectations called for earnings of $0.80 per share and revenue of $2.15 billion. That prompted management to cut full-year earnings guidance from $2.75-$3.25 per share to just $2.45-$2.70 per share. I'm not the biggest fan of Wall Street predictions, but slashing guidance is not a best-case scenario.
On a brighter note, management announced a $2 billion share repurchase program -- representing about 5% of outstanding units -- that will be completed in the next 12 months. You may not be thrilled about that allocation of capital, but you'll like the fact that a focus on efficiency has paid off dramatically. In fact, only 12% of major capex projects are incomplete. The portion of completed projects allowed PotashCorp to rake in a record $1.9 billion in the first six months of the year from operating activities.
Even with year-over-year improvements, the total gross margin came in at $220 million, or 18%, lower than last year's second quarter. In other words, if the recent push to upgrade production capacity and efficiency coincided with higher market prices for nutrients, then the company would be staring at record profits and revenue right now. That's good news for investors down the road.
Foreign market mystery
Despite growing consumption in India and China -- two of the world's most important agricultural markets -- the industry is having a difficult time selling to farmers in both countries. Indian woes could continue to weigh heavily on producers, with falling subsidies and currency depreciation resulting in fewer purchases by domestic farmers. It is important to note that farmers in emerging markets still view potash as an expensive luxury, which is not great news for exporters such as PotashCorp. Meanwhile, China has been subsidizing the overproduction of fertilizers, which has left massive amounts of nutrients at ports destined for export. The industry wants trade to go in the opposite direction.
PotashCorp is responding to oversupply by cutting production at its Lanigan and Rocanville mines. Management "expects to exit the third quarter with inventories at their lowest mark in years". That will likely ensure that mines run full schedules in 2014, unless prices fail to pick up and India and China retain their current policies.
Will international worries spook the earnings out of peers such as CF Industries (NYSE: CF ) , Mosaic (NYSE: MOS ) , and Agrium (NYSE: AGU ) ? Well, the pressure on potash prices isn't good news for Mosaic's expansion plans. The company is currently spending $6 billion increasing potash capacity to 11.6 million metric tons by 2015 and to 15 million metric tons by 2021. That could become a major cause for concern from investors who are skeptical that market forces are not headed for the predicted rebound.
Additionally, phosphorus nutrient prices have been weaker this year, which will hurt Mosaic even further. Nitrogen remains strong this year, but prices have wavered thanks to overproduction in China. That has weighed more heavily on products that are less value-added than nitrogen and ammonium derivatives, however. That alone could cushion the blow for Agrium and CF Industries, although the latter deals extensively in phosphate.
As you can see, the entire industry will have to respond to market conditions. I expect to see other companies announce dismal results or production cuts when they report in the coming weeks. Brace yourself.
Foolish bottom line
Investors got a reminder of just how cyclical and unpredictable the fertilizer industry can be. This was the worst second quarter -- i.e. growing season -- for the company in years. However, there are plenty of positives for long-term investors. The company's dividend has increased 950% in the last 10 quarters, efficiency remains at near record levels, major capex projects are nearly complete, and worldwide demand for nutrients continues to grow. Competition from China and less than friendly policies in India both may pose bigger risks than previously thought, but PotashCorp isn't exactly facing a doomsday scenario. I cannot guarantee that shares won't sink if selling prices continue to dip, but I think long-term investors have good reason to stay the course.
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