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Potash: Cost Advantages Are Your New Best Friend

By Daniel Segundo - Jan 21, 2014 at 12:18PM

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An industry recession offers investors a unique opportunity to pick up a wonderful business at a bargain.

Potash Corp. (POT) has recently been under fire due to the breakup of cartels Belaruskali and Uralkali. As a result of this, analysts have forecasted potash prices falling to around $300 per ton, which obviously puts pressure on all of the players in the potash industry. While a pick-up in profitability is likely, I would argue that the hammering that Potash Corp. has taken (in addition to the other producers within the industry) is a complete overreaction. Although some of the potash producers deserve to have been beaten up, Potash Corp. is an exception

So what?
What most people seem to be forgetting is that Potash Corp. has one of the widest moats in the industry. Despite the fact that the company has little to no pricing power, having a cost advantage is the next best thing. Potash's geographically advantaged assets throughout North America are widening the cost differential between Potash's production costs, and those of its competition. Therefore, Potash can produce the same product as its competition, but at a fraction of the cost. Not only does this cost advantage yield a fatter profit margin, but it also helps protect the company from problems within the cartel.

The cartel serves as a way for potash producers to adjust their production output in order to incrementally increase the price of the commodity, similar to what OPEC does with oil. I don't see the problems within the cartel being a long-term headwind for Potash's profitability, as its cost advantage really saves the firm a lot of headaches down the road. In industry recessions such as these, it's always important to assess whether the underlying economics of the business remain intact. In no way has the breakup of the cartel had an effect on Potash's mining assets, and therefore the firm still maintains its cost advantage.

How can it be then, that the market has overlooked this and is giving us the opportunity to buy a great business for sixty cents on the dollar? It's because the market is very efficient in the short term, but very inefficient in the long term. While throwing firms with weaker competitive positions such as Mosiac (MOS 0.96%) and Intrepid Potash (IPI 2.02%) out the window, Potash went out as well. And these are the opportunities for money to be made, by buying shares of a great company with a margin of safety. 

Now what?
Shares of Potash have already rebounded from their lows, but significant upside potential remains. Shares currently offer a generous 4.3% yield, while trading at 15 times earnings. The outlook for the company is certainly beginning to improve, as there are already signs out of Europe hinting that Uralkali and Belaruskali may mend their broken bond. Uralkali recently appointed Dmitry Osipov as its new CEO, and it seems as though he is diligently seeking reconciliation.

That being said, Potash is in a great position to benefit from the oligopolistic nature of the potash industry down the road, and until reconciliation occurs, profitability will be pressured. Despite placing a near-term headwind on gross margins and earnings capability, this is a scenario where a fantastic company is on sale for a bargain price. Indeed, Potash Corp. serves as a classic example of how an economic moat can become your portfolio's best friend.

Fool contributor Daniel Segundo is long POT. 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.

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