You may not know much about potash, a type of salt used primarily in fertilizers. You may not know about the potash cartels. You may want to know about these things, though, considering that a rogue cartel member threatens the price of potash, which is battering these companies' stock prices.
Are potash producers a profitable pick for your portfolio? Let's take a look.
In the potash industry, there are two cartels: the Belarus Potash Company, made up of Uralkali and Belaruskali, and Canpotex, made up of Mosaic (NYSE:MOS), PotashCorp (NYSE:POT), and Agrium (NYSE:AGU). Together, these cartels controlled 70% of the potash market. But now, for a number of potential reasons, Uralkali is quitting the cartel. Speculation ranges from the move being a negotiating tactic for a more favorable agreement with its partner Belaruskali, to Uralkali believing the potash market is out of whack and this move is to grab share and push quantity at lower prices. Analysts see potash falling to $300 per ton, down 25% from current prices.
Of course, over the course of history, even $300 is high:
Analysts make their valuations based on future prices, and a fall back to $300 was a surprise to most investors, causing PotashCorp and Mosaic's stock prices to fall nearly 20%. It also dragged down related companies' stocks, such as Sociedad Quimica y Minera (NYSE:SQM), which only has 3% of the potash market but makes 25% of its revenue on the commodity, by a similar percent.
The future of potash
Will these stocks spring back like the crops they help fertilize? This depends on, obviously, the future price of potash.
If Uralkali follows through and trades outside of the cartel, there's little other companies can do but match lower prices. This could mean delayed investments in increased production, cost cutting, further consolidation, and cuts in dividends. Expansion projects, like Agrium's $1.5 billion investment in an extra 1 million tons of capacity scheduled to be completed in 2014, likely won't meet the return on investment targets when the company first calculated potential profits. Potash prices will likely stay above the average $100 per ton cost of production, but pricing power may never be as strong for the producers as it once was under the cartels. And market sentiment for the companies may take awhile to turn around.
But, in the long term, these companies benefit from plenty of trends and industry dynamics. One, their moat is fairly unbridgeable. Starting a potash mine is complicated and costly, as PotashCorp explains:
In Saskatchewan, we estimate it would cost CDN $4.2 billion to bring into production a new conventional 2-million tonne per year greenfield potash mine and mill, which would take a minimum of 7 years lead time to bring to production. This figure does not include infrastructure outside the plant gates, such as rail, road networks, utility systems, port facilities and potential fees to purchase reserves, which could increase the cost to more than CDN $6 billion.
Two, a growing world population needs more food and desires more meat, all of which requires more fertilizer. Global fertilizer consumption increased 27% from 2001 to 2011, and the Food and Agriculture Organization estimates demand growing at 1.9% per year through 2016.
Planting the seed
The out of favor fertilizer stocks were blindsided by industry relationships outside of their control, but they still make money. While a future fall in potash prices will hurt, once market sentiment turns around, I believe the battered stocks will be a safe place for a steady return. The only question is when this will happen.