A few days before Potash Corp (NYSE: POT ) announced earnings, I discussed why the company was likely to face difficultly going forward. The earnings and outlook that Potash Corp released Thursday have confirmed my concerns about the company's future.
Potash reported a massive 45% drop in year-over-year profits for the third quarter. They pointed out that lower pricing of potash (the mineral used in fertilizers), falling sales, and general market uncertainty were all to blame for their change in fortunes. The company also lowered guidance for the full year to between $2.00 to $2.20 per share.
Looking to Russia
Potash Corp's major foil appears to be Russian competitor Uralkali. This past summer, Uralkali decided to abandon its pricing strategy and instead compete more aggressively for market share in the fast-growing Chinese and Indian markets. Uralkali has a significant competitive advantage in Asia versus Potash Corp because it enjoys a lower cost of production and a cheaper cost of delivery since Potash Corp must ship overseas.
Uralkali recently reported increased production and sales last quarter of 5%, as well as, gave a rosy outlook. That outlook will likely continue to come at the expense of Potash Corp as they have yet to come to terms on a new contract to export potash to China after their first half of the year contract expired. Interestingly, that contract expiration roughly coincided with a Chinese equity firm's recent deal to invest in Uralkali. Given Uralkali's aim to take market share in Asia, I believe that Potash Corp will need to temper 2014 expectations significantly.
Those who have recommended Potash Corp. in the past few months believe that Uralkali will reverse course and once again focus on higher potash prices. Neither Uralkali, nor the Russian government which wields considerable influence, have given any indication this is true to happen soon-although I agree, it might happen eventually, after competition is reduced and Asian markets are secured by Uralkali.
Growth and Valuation
According to the USDA, American potash use is growing at slightly under 3% per year. The International Fertilizer Industry Association's (IFA) "Fertilizer Outlook for 2013-2017" pegs growth at under 2% in coming years. The IFA expects demand for potash from Central and South America, which are important markets for Potash Corp, to be between 3% and 4%. The IFA pegs European growth for potash slightly above 1%.
Placing a roadblock in front of improving growth rates is that according to the International Plant Nutrition Institute (IPNI), potash inventories are about 30% above the five-year average. Thus, although demand from farmers for potash could marginally increase, it might not improve growth rates anytime soon. Potash Corp has in fact had some of its mines shuttered for longer than usual this year to help reduce inventory, which is not supportive of growth.
Potash Corp's reported third quarter earnings were only $0.41 per share. Presuming that Potash sales increases in the Americas and Europe offset losses in Asia, and Potash Corp capital expenditures continue to trend down, we can expect earnings in 2014 to drop to around $1.60-$1.70 per share. A low growth rate of course implies a low valuation in general. Currently Potash Corp's price/earnings multiple stands in the middle teens based on its projected range of earnings for the full year.
Helping to support the stock is a significant share repurchase program and hefty dividend. If market conditions for potash remain weak for an extended period however, either or both the buyback and dividend could be threatened, which would be negative for the stock price.
One of Potash Corp's competitors, but also fellow member in the Canadian fertilizer marketing organization Canpotex, Agrium (NYSE: AGU ) also faces pressure from falling potash prices. However, Agrium is less exposed as it makes only 11% of revenue from potash sales versus over 40% for Potash Corp. Agrium's revenue mix relies more heavily on nitrogen-based fertilizers which have benefited from lower natural gas prices. With natural gas prices in the Americas projected to stay low for an extended period, this should benefit Agrium. In addition, Agrium is well diversified into phosphate-based fertilizers and other lines of business.
I reiterate that investors should stay away from Potash Corp until there is more certainty in the potash market. For those wishing to take advantage of the lower pricing in fertilizer stocks, I suggest looking at Agrium.