Potash Corp. Facing Uncertainty

In life, a broken relationship is rarely fully repaired. In business the same often holds true. In either situation, caution is warranted.

This past summer, the Russian-Belarussian potash cartel BPC broke up, throwing the global fertilizer market for potash into disarray. Many potash producer stocks have been beaten down. One company that has taken a significant thrashing is Potash Corporation (NYSE: POT  ) , which has seen shares fall from its 52-week high of $44.30 to recent prices near $32.

This price drop has caught the eye of would-be value investors. I am here to tell you that there is no way to know whether Potash Corp. is a value play or a value trap at this point.

Here's what we do know. Uralkali's decision to break up its marketing and distribution agreement with Belaruskali, the jilted partner, has driven spot prices for potash down to about $325 per ton in China according to Bloomberg. Because China is a key player in global potash flows due to its geographic positioning and size, it, along with India, will be key to driving the profits of potash producers. 

The impact of what is going on in Russia has been swift. Potash Corp., according to its reporting, was on pace to export 6.4 million tons of potash in 2013, excluding U.S. sales. 71% of those exports, or 4.5 million tons, were expected to go to China, India, and other Asian nations, with most of the balance going to South and Central America. However, according to ICIS, Canpotex, the Canadian potash cartel which Potash Corp. is a 55% owner of, has not renewed some of its contracts with Asian customers.

The importance of the goings on in Russia cannot be underestimated. Over the years, BPC has worked in tandem, if not in cooperation, with Canpotex to maintain higher than market clearing potash prices. However, Uralkali has made a move, for now at least, to use all of its capacity, which is both low-cost and abundant, sacrificing unit price for higher exports.

According to recent corporate reports, Uralkali has quickly increased exports with 800,000 tons just in August, which compares favorably to the 1.9 million tons in the entire first quarter. For the third quarter, its year-over-year production is up 5%. It appears that virtually all of the increase in Uralkali's sales has come at the expense of the Canadians. 

Uralikali Director of Sales and Marketing Oleg Petrov has made it very clear they are aiming for a 2 to 2.5 million increase in annual production:

"We have a target to sell all the volumes we produce and this is possible by winning markets from international players in some regions who earlier had taken our market share."

A major disadvantage to competing in Asia for Canpotex and Potash Corp. is the high transportation costs for shipping potash across the Pacific. According to ICIS research, it costs about $67-$75 per ton to transport Canadian potash by Panamax freighter to China and India. Uralkali, with a cost of production near $100/ton and rail transport significantly less expensive than ocean freighter, is in position to take most Canpotex business in Asia. 

Further complicating Potash Corp.'s business outlook in China is that CIC, a Chinese sovereign wealth fund, has taken a 12.5% interest in Uralkali.

While Canpotex partners, Mosaic  (NYSE: MOS  ) , and Agrium  (NYSE: AGU  )  all stand to lose volume in Chinese, Indian, and Asian markets, Potash Corp. stands to lose the most as it derives 45% of revenue from potash sales. With a likely export miss and lower pricing, consider it already had a second quarter price received of $356 per ton, which was down year over year from $433, and it might be set up for a significant earnings miss. On October 10, the company revised guidance downward.

What is most relevant to investors is whether reduced exports and lower pricing portends a longer-term trend. If it does, then Potash Corp. is a value trap. If it is merely a short-term market adjustment, then Potash might indeed be a value play.

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