The surprising decision by Rio Tinto (NYSE:RIO) to move forward with a new potash mine has negative implications for the sector. The commodity already faces an oversupply issue, and BHP Billiton (NYSE:BHP) desperately wants to move forward with a massive mine in Canada that would further pressure the commodity.
The news continues a bearish trend for PotashCorp (NYSE:POT), which continues to face increasing threats from competition that wants a share of the high margins for the commodity. The stock has seen a sharp rebound to the levels it traded at prior to the collapse of the Belarusian marketing arrangement about a year ago. Does the recent news from Rio Tinto portend a trend of supplies ready to pounce on any increase in potash demand that will halt the rise of potash stocks?
Rio Tinto enters market
One of the biggest concerns with Rio Tinto moving forward with developing the potash mine is that the company isn't currently active in the sector. The company is a giant in the mining sector, with revenue forecast to reach $55 billion this year, placing it slightly below the $71 billion from BHP Billiton. In comparison, PotashCorp pales in size with revenue of only $6.2 billion.
According to Russian fertilizer producer Acron OAO, the joint venture with Rio Tinto is moving forward with the development of the Albany potash prospect in Saskatchewan, Canada. Acron stated that the project area contains 1.4 billion tonnes of inferred resources, with the recoverable amount at 329 million tonnes of potassium chloride (KCI).
The development is small in compariosn to the Jansen Project being undertaken by BHP Billiton. Jansen has 5.3 billion tonnes of measured resources, with 25.7% of KCI providing for 1.3 billion tonnes of recoverable resources. BHP made potash part of its five pillars of growth and had agreed to move forward with the project at the beginning of the year before recently pulling back. Just last week, the miner allowed the right to develop a port facility for exporting potash to expire. The company had planned to move forward, with a goal of reaching annual production of 10 million tonnes of potash. But it is now reviewing the entry into the market.
Despite a compressed pricing market in the last year, one only needs to review the financial statements of PotashCorp to understand why both Rio Tinto and BHP Billiton want to aggressively enter this market. The Canpotex and Belarusian marketing arrangements have artificially kept the prices (and hence potash margins) high for a long time.
For the first quarter, PotashCorp generated a gross margin of 44.7% from potash and only 41% from nitrogen and negligible amounts from phosphates. The potash margin declined from an impressively high 56.9% in the prior-year period.
With those huge gross margins from mining potash, especially if prices were to return to prior levels, there is no doubt that BHP Billiton and Rio Tinto want to enter the market in full force. The biggest concern for PotashCorp is that not only do these miners want to expand at a time of oversupply in the market but also the companies have the size and cash flows from other commodities to handle compressed margins from this commodity going forward.
In the short term, the major saving grace for PotashCorp is that the proposed mines from BHP Billiton and Rio Tinto won't reach production for years. Long term, though, large miners entering the sector will have negative implications for margins, which ultimately will hit profits and the stock price of potash producers.
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.