Last summer, fertilizer stocks plummeted on fears that the Russia-Belarus potash dispute would flood the market with cheap potash. The issue sent shares of Mosaic (NYSE: MOS ) and Potash (NYSE: POT ) plunging and didn't help Agrium (NYSE: AGU ) either.
Fertilizer stocks have been interesting investments over the last few years with the long-term theme of demand from emerging markets not playing out. On the flip side, the dispute between Russia and Belarus brought to the surface the pricing structure in the potash market that might not be sustainable.
On one hand the marketing groups such as Canpotex in North America and Belarusian Potash in Eastern Europe provide strong margins and pricing stability for potash. The combined groups control around 70% of world potash production. On the other hand, it provides huge downside risk. If Russian producer OAO Uralkali decides to continue undercutting partner Belaruskali, it could undercut all the prices including the higher prices for the North America producers.
Signs already exist that Canpotex is losing market share in China with Uralkali increasing Oct. market share to 73% according to CIBC. Uralkali market share was only 26% back in May.
Ultimately though, global potash production hasn't increased much over the last ten years. According to this chart from the fourth quarter 2013 market analysis from Potash Corp, potash demand has only slightly ticked up during a period of explosive economic growth for emerging markets.
Potash Corp hit by declining prices
Despite all the expectations of higher global demand for crops, Potash Corp. saw a weak pricing environment during the third quarter with potash prices dropping to $307 per ton, down from $429 per ton in the same period last year. The total gross profit plunged from $554 million generated during the 2012 period to only $228 million during the recent third quarter.
The scary part of the equation is that total potash sales volumes for the first nine months of 2013 reached 6.3 million tons, a 7% increase over the same period last year. While Potash Corp also sells nitrogen and phosphate, the company was previously very dependent on potash for gross profits. The company obtained nearly 60% of gross profits from the key fertilizer though it plunged to only 47% during the third quarter.
Mosaic margin example
The mix of fertilizers sold by Mosaic is a prime example of the risk in the potash market. In the third quarter last year, Mosaic had phosphate sales nearly double that of potash. In essence, the company is focused on producing phosphates, but in reality the potash gross margins are so high that the gross profit for potash was actually over $100 million higher than the phosphate segment.
Even with the slump in the third-quarter potash market, the gross margins for potash were an astonishing 35%, down from 48% a year ago. These margins compare very favorably to the relatively low gross margins for phosphates, which have averaged around 15% to 20% in the last couple of years.
To hammer home the point even more, Mosaic had potash production at 73% of operational capacity. The phosphate production operated at 88% of capacity. In normal markets, the higher capacity division would operate at higher margins. Also, the huge slack in the potash division especially for a commodity would typically see gross margins significantly below 35%.
Agrium benefits from retail
Agrium gets the majority of its revenue from retail operations, which saw an increase in third-quarter revenues. While the company is part of Canpotex and typically listed in the potash trade, it only obtained $23 million in gross profit during a period of higher prices in the third quarter of 2012. Consequently the stock only saw minor dips during the summer when Russia made the decision to exit the partnership and lower potash prices. In fact, Agrium now sits at the same stock price as before the potash price collapse.
Investing in potash stocks remains a concerning proposition considering the high gross margins may not be sustainable. It is worth noting, however, that all potash stocks aren't created equal. Potash Corp. will be the most affected with Agrium relatively unscathed. The long-term demand equation for higher food demand increasing fertilizer usage in emerging markets might yet play out, but it could very easily do so without the potash segment benefiting. Even after the recent stock drops, shares of Potash and Mosaic carry significant risk of lower potash prices.
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