The fertilizer industry continues to struggle as the long-term demand thesis is under pressure. Investors are learning the lesson that price matters in the commodity business. In the case of potash fertilizer, the substantial gross margins of the past may never return after to the breakup of the Belarusian marketing arrangement.
First quarter earnings for The Mosaic Company (NYSE:MOS) were mostly disappointing, with declining prices for phosphate and potash pushing down operating income. The numbers follow those of PotashCorp (NYSE:POT), where analysts continue to forecast a substantial drop in earnings for this year.
First quarter earnings
The headline operating earnings tell the story, with Mosaic only generating $267 million during the first quarter compared to $491 million a year ago. The company saw profits plunge despite higher sales volumes of both key nutrients, suggesting the market is currently oversupplied.
For the quarter, the company generated $1.3 billion of phosphate sales with a gross margin of 17% of sales. Both numbers were down roughly 16% over last year. Potash sales rang in at $733 million for the quarter with gross margins of $212 million, or 29% of sales. Both numbers were down from last year, but the major hit took place with gross margins dropping from a substantial 48% last year. This drop led to a $185 million decline in gross margin and a nearly 50% decline in operating earnings to $166 million from $306 million.
PotashCorp saw a similar impact with the gross margin plunging from $504 million in the first quarter of 2013 to only $300 million this year, or nearly 45% of sales. The significant drop in sales price and consequently gross margins has made it to where nitrogen is nearing a similar level of importance.
Mosaic projects an optimistic tune regarding the rest of 2014 and the future. The long-term demand equation probably isn't a huge concern with plenty of consumers in China and India demanding higher quantities of food. Those consumers aren't exactly able to pay the nearly 50% margins that Mosaic previously produced in the potash segment, however.
For the second quarter, the company forecasts higher phosphate sales to the tune of 3.1 to 3.4 million tons, compared to 2.9 million tons last year. Potash sales are expected to roughly match those of the second quarter last year, but the key is that gross margins will remain in the same range as the first quarter.
Another sign that margins are attractive at the current levels is that the company continues expansion projects that will lead to capital spending of over $1.2 billion for the year. In addition, BHP Billiton (NYSE:BHP) is moving forward on the Jansen Project in Canada with a further $2.6 billion investment due to the attractive economics of the project. The company recently announced that potash was one of the pillars of its growth.
The general perception exists that long-term global demand for fertilizers is bullish for the stock of fertilizer companies such as Mosaic and PotashCorp. However, the high margins of the past may never return in order for that demand to materialize. The future appears a lot cloudier with the prospects for potential further gross margin erosion in the potash segment. The likelihood of the Belarusian marketing arrangement returning to prop up prices is not very plausible considering the Russian aggression in Ukraine.
With the potash market oversupplied and BHP Billiton moving forward with a major mine expansion, investors should expect further margin erosion despite the market participants being bullish regarding long-term demand.
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Mark Holder has no position in any stocks mentioned. The Motley Fool owns shares of PotashCorp. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.