Conventional underground mining accounts for almost 80% of global potash capacity. Image: PotashCorp.
Hopes for recovery from PotashCorp (NYSE: POT) were already bleak after the Canadian province of Saskatchewan enacted changes to its royalty scheme that the fertilizer producer warned could swipe $100 million from this year's profit. But prospects for a turnaround were all but dashed when the potash marketing group Canpotex finalized a pricing agreement with China to deliver 1.8 million tonnes of the fertilizer component at an estimated $315 per tonne.
Fractured future
The potash market was thrown into turmoil in 2013 when Russian potash producer Uralkali ended its distribution agreement with Belaruskali, its joint venture partner in Belarusian Potash Corp., or BPC, a cartel that controlled roughly 43% of global potash exports.
The division caused the price of potash to plunge from nearly $400 per tonne to $305 last year. Both BPC and Canpotex, which represents PotashCorp, Mosaic (NYSE: MOS), and Agrium (NYSE: AGU) in world market negotiations, had looked to score higher prices this year -- BPC specifically was aiming for a $30 per tonne increase while Canpotex was hoping for $25 per tonne more.
Potassium Chloride (Muriate of Potash) Spot Price data by YCharts.
However, Belaruskali last week announced it had signed an agreement with China, the world's largest importer of potash, for $315 per tonne. That was significant for several reasons.
Market share power grab
First, and most obviously, it undercut the negotiating power of its rivals. Immediately after Belaruskali's announcement, Uralkali said it had few options left and made its own deal with China for the same price. Canpotex then said it had finalized supply agreements with its Chinese customers, merely saying pricing was at "current competitive levels."
Second, it also shows the divisions that still exist between the Belarus and Russian trading partners, diminishing the chances of the two ever reuniting. That's somewhat problematic for Canpotex, as the cartel had helped keep potash prices high.
Now the two companies are trying to outdo one another for market share, and that brings up the real problem for Canpotex, and ultimately PotashCorp, which is the largest of the three companies in the marketing group.
Waning influence
Canpotex used to be the first group to settle negotiations with China, followed by BPC. Last year Uralkali led the way in coming to agreement with its Asian trading partner, and now Belaruskali has gone first. This indicates Canpotex is losing not only market share, but also influence in directing market pricing.
That could pose further problems for PotashCorp. While North America accounted for 51% of the fertilizer producer's revenue last year, sales to Canpotex represented 44% of its total potash sales for the year, and China represented a growing percentage of the marketing group's sales volume, 16% last year, up from 12% in 2012. The depressed pricing will likely hamper its further recovery.
PotashCorp's stock won't be rolling anywhere as competitive difficulties undermine its recovery. Image: PotashCorp.
Also, the lower pricing is having a ripple effect as India now wants special consideration for its imports. India, which imports all of its potash supplies, paid $322 per tonne last year; in the wake of the Belaruskali agreement with China it now wants to keep the price flat in 2015.
India suffered a potash demand deficit because the country is very price sensitive. There are additional costs involved in shipping potash to the country, which is one reason it pays more than China, but with spot prices for the fertilizer component going for about $330 per tonne, producers might be loathe to increase the price much for fear of driving demand in India lower.
Not getting the royal treatment
PotashCorp's recovery is further jeopardized by changes made in Saskatchewan regarding when producers can take tax deductions for expansion and maintenance spending.
Potash companies can claim capital expenses as tax deductions in Saskatchewan, and while the size of their potential deductions didn't change, the amount they can deduct each year from their taxes was reduced.
PotashCorp says it's spent some $6 billion on expansion activities in the province, but they were based on the royalty scheme remaining stable. It estimated the new changes could cost it anywhere from $75 million to $100 million pre-tax .
While the provincial government is also willing to look at the taxes imposed on the producers -- it admits it has the highest anywhere in the world -- that revision would be in the future and is not guaranteed.
Climbing the hill once more
PotashCorp's stock had rallied from a low of $31 a share hit in October, nearly reaching its 52-week high achieved last summer. But the blows it has received in the past month have sent its shares tumbling.
No one figured PotashCorp to reach the heights it did in 2008 when commodity prices were soaring and its stock topped $78 a share, but investors have expected better than a mild recovery. However, the new tax plan, along with lower potash prices and increased competition, puts that comeback in jeopardy.
Where PotashCorp shares are valued at 18 times earnings and 16 times estimates, in line with the multiple for peers Agrium and Mosaic, it's trading at more than four times its estimated earnings growth rate, or three times greater than that of either of its rivals.
So a $100 million hit to pre-tax earnings may not seem like a lot to a miner that generated more than $1.5 billion in profits in 2014, but because PotashCorp's stock also goes for at least twice what its peers are selling at in terms of sales or book value, and that valuation was based on a better pricing environment for its primary fertilizer ingredient, the miner still looks overpriced and investors may find it tests new lows once more.
