Why I'm Buying PotashCorp, Once Again

As the grandmaster Putin undertakes his latest, confounding, and seemingly illogical round of diplomatic chess, you might be forgiven for failing to notice several very positive developments underlying an investment in the potash industry and PotashCorp  (NYSE: POT  ) . I first bought shares of PotashCorp (and again) for my Real Money Portfolio six months ago, on the heels of Russian potash powerhouse Uralkali's move to dissolve the Eastern European chapter of the global potash cartel, Belarusian Potash Corporation (BPC). The market seemed to think that PotashCorp's mammoth cash-generating capacity was headed the way of BPC, but I thought otherwise.

My rationale was simple: Foremost, I thought Uralkali's move greater parts bluff than substance. Whether the cartel existed in name or practice, the global industry's prospects remained strong, because potash producers would pursue their best economic interest—which meant the industry-at-large needed to maintain relatively robust prices. Amid subsequent management shuffles at Uralkali, and Mother Russia's (read: Putin's) reported displeasure at BPC's dissolution, its resurrection seemed at very least possible, if not probable. Last, I also figured that, in light of PotashCorp's relatively conservative leverage and a fairly cheap stock, the company could employ its cash flow and a bit of debt to repurchase a hefty chunk of stock.

That meant a solid secular growth profile and assets ranking among the industry's jewels came on the cheap. With the prognosis looking bright on both fronts, I'm allocating 1.5% of my Real Money Portfolio to PotashCorp again. And I expect to harvest gains.

The Potash Cartel Tango Continues
It all seemed an odd case of happenstance. When Uralkali announced intentions to leave BPC, pursue a volume-over-price strategy and, basically, dragoon their competitors, the company's former CEO landed in a Belarus jail and its senior leadership were replaced amid rumors Putin was displeased. By any stretch, indications were that Putin was hoping to reconcile the estranged lovers.

And even if that didn't transpire, I figured potash prices would converge on a market-clearing price—one where all parties earned a reasonable return—which I estimate at $325/ton. Anything less, and by my math, players like Mosaic's  (NYSE: MOS  )  and Agrium's  (NYSE: AGU  )  potash-specific returns on invested capital would look pretty ugly. In that case, which I deemed most likely, PotashCorp shares looked pretty cheap. Should BPC make nice, it was a bonus.

A few months hence, and it seems likely that BPC's ready for a tour on the reunion circuit. An exec at Onexim, Uralkali majority owner Mikhail Prokhorov's investment vehicle, recently mused: "If cooperation were to be resumed, it could be beneficial to us and Belaruskali." Somewhat coincidentally, this quote reached the press just as Sergey Chemezov, head of Russian state behemoth Rostec, and Kremlin beloved, was rumored to be joining Uralkali's board.

In short, it looks like the cartel's back on. And if so, things are better than ever. It starts with the obvious: The big five potash players—PotashCorp, Mosaic, Agrium, Belaruskali, and Uralkali—should resume the previous mutally beneficial arrangement, a variety of cartel capitalism that emphasized limited supply and high prices. More significantly, Uralkali's keenness to upset the status quo—by producing at 100% capacity, and introducing significant uncertainty—should discourage new entrants investment plans. In that regard, the cartels' clout is now greater than ever. Most notably, I'd expect development in BHP's  (NYSE: BHP  )  Jansen mine to progress at a crawl.

All of this is very good for the potash industry.

The Potash Buy
The Eastern European cartel's reconciliation, on its own, would be very positive for an investment in PotashCorp. There's also a pocket ace. PotashCorp and Mosaic management both mused about their desire to aggressively repurchase shares during their respective fourth quarter conference calls. If nothing else, I found this interesting, because I'd figured they wouldn't move on share repurchases without some assurance that a return to stability (in the potash market) was forthcoming.

In the time since, a few nuggets point to a higher likelihood of share repurchases by PotashCorp. For one, they offered $750 million worth of debt at 3.5% earlier this month. Two-thirds went to retiring $500 million of more expensive debt, but it wasn't clear how management intended to spend the rest. PotashCorp doesn't need the cash, and if forced to guess, I'd say it's for repurchases. For my part, I'd like to see Potash take on a lot of debt, expressly for repurchases.

A few numbers go a long way to showing the prospective impact. At current, PotashCorp's debt burden is fairly conservative next to its massive cash generation. Were management to increase its leverage to a still sensible 2 times debt/EBITDA (based on my 2014 estimate), they could scare up $1.5 billion worth of debt. Between that, current year free cash flow, and existing cash balances, I estimate that management could repurchase about 10% of shares outstanding. Dependent on the timing, that could add $5 to $10 to my $47 estimate of fair value. And that's not bad.

The Foolish Bottom Line
Things in the potash patch seem brighter than ever, and Potash Corp, as one of the industry heavyweights, is poised to benefit. Shares remain very reasonably priced, and that's why I'm back for more.

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8/29/2014 4:03 PM
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