Is Potash Sowing Seeds of Discontent?

Typically, when companies forecast lower sales or profits, their stocks usually take a hit. It's not always easy to tell whether it's having a fire sale, or burning down. Maybe it is time to get out -- or maybe it's time to buy more!

Fertilizer giant Potash Corp (POT) recently said that its full year earnings were going to come in at the low end of the range of its previously issued guidance of $2.80 to $3.20 per share, as delays in supply contracts to emerging markets in China and India reduced sales. The stock pulled back on the news, as it marks the second time in three months that it cut guidance. But don't blindly follow those selling (or buying); you still need to do some research. We need to use the announcement as a jumping off point for additional research.

Potash Corp snapshot

Source: FinViz.com

Sowing the seeds of doubt
Record prices for potash in late 2008 and 2009 that hit around $900 a ton had analysts forecasting they could continue their parabolic run, and top out north of $1,500 a ton by 2020. While that's always a possibility, prices have fallen back sharply, and are currently near $500 per ton. Of course, potash cost less than $200 per ton before it began its meteoric rise during the recession.

Nowadays, though, supplies are plentiful, and Potash will have to cut production again to meet the current state of slack demand. It recently idled its biggest mine for a month and, while it just reopened it last week, it's widely expected that Mosaic (MOS -0.69%) will be forced to cut output, too, as North American inventories remain 39% above the five-year average.

Potash, Mosaic, and Agrium (NYSE: AGU) have been cutting production all year long to try to catch up to falling demand. The prices that were set last didn't anticipate that lack of growth that's being experienced this time around. In India, for example, producers didn't expect the currency weakness that raised spot prices further for farmers, nor the subsidy cuts that hit them hard. India's largest potash producer says its sales have been halved as a result.

Reaping the whirlwind
As troubling as the indications are for the immediate future, the long-term outlook remains as strong as ever.

It's no less true because it's often cited, but the fact that people have to eat is a tremendous catalyst. Corn production in the U.S. is forecast to hit 10.7 billion bushels as of Oct. 1, down slightly from September, and off 13% from last year. Yields are forecast at 122 bushels per acre, much lower than the year ago figure. With lower crop forecasts and corresponding higher prices -- corn currently trades at $7.60 a bushel, well ahead of the $6.25 it realized last year -- farmers are expected to try and maximize harvests.

Fertilizer stocks from nitrogen producers, like CF Industries (CF 0.91%) and Terra Nitrogen (NYSE: TNH), to the potash and phosphate producers, like Potash Corp, are going to benefit from the trends. The global need for fertilizer will ultimately outweigh whatever the local conditions are. Yes, China and India are huge consumers of potash, as is North America, but Brazil is also a major user, as well. (It's the third largest market.)

Lying fallow for a time
To me, while I see share price weakness representing opportunity, I'd still like to see Potash's stock pull back more. While it's size and scope should give it the valuation premium it commands over Mosaic and Agrium, with its enterprise value trading at 34 times its free cash flow, it's not quite cheap enough for me. Even Mosaic, at 26 times FCF, is rich. I like Agrium the best, as its enterprise value is just 12 times its free cash flow.

I'll pass on rating Potash on Motley Fool CAPS, the 180,000 member-driven investor community that translates informed opinion into stock ratings from one to five stars. Instead, I'll be rating Agrium to outperform the market indexes based on its valuation; but tell me in the comments box below if you think Potash Corp will be able to seed enough demand going forward to drive profits higher.

Looking under rocks