Potash - Take Advantage of the Cyclical Trough
Potash Corporation of Saskatchewan Inc. (POT) is one of the largest producers of fertilizers in the world. The company controls a large portion of the world's low cost potash deposits and has formed an industry cartel Canpotex with Mosaic (MOS) and Agrium (AGU). Potash is not just a potash producer, but also has significant operations in the manufacturing of phosphorous and nitrogen fertilizers as well. This makes the company a major producer of all 3 major elements used in fertilizers. The company gets approximately half of its revenues from potash, while nitrogen and phosphate contribute around one fourth each. The company has been generating billions of dollars in FCF as the price of potash has almost quadrupled in the last decade, from $100/ton to ~$400/ton now. It has used the cash to acquire strategic equity stakes in Sinofert, SQM and Israel Chemicals. We strongly believe that agriculture is going to be one of the most important sectors in the coming decades. Potash, being one of the most important fertilizer companies, is a great long term investment. Potash stock has recently come under pressure due to recent weakness in demand from its main markets in India and China. The prices have come down as these countries are sitting on big inventories. However, we see this as a good opportunity to buy Potash which remains one of the best ways to play the secular growth in the agricultural industry.
Why we like Potash
- Food Demand will outstrip Supply - Agriculture prices are set to keep increasing, due to limited supply and fast growing demand. The supply of new agricultural land has been almost exhausted, and yields in developed countries have hit a plateau. Even with technology breakthroughs, the demand for food will outstrip the growth in supply. Jeremy Grantham has written that he sees that potash and phosphorous will have constrained supply in the future. Potash with its massive reserves is one of the better ways to play this shortage theme. We think Deere (DE) is another good way to play the agricultural secular growth story.
- Fat Margins and Agricultural safety - Potash has one of the largest reserves of low cost potash reserves in the world. While potash prices have cooled from the $1000/ton reached in 2008 to about $400/ton now, Potash is still earning huge profits as its cost of production is around ~$150/ton. With the central banks showing no signs of slowing down the money-printing, Potash could zoom once again, if this money flows into potash. Unlike industrial commodities like aluminum, zinc, copper etc, Potash will also not be affected much if a Chinese hard landing occurs.
- Strategic Stakes - Potash has taken strategic stakes in key resource producers such as Sinofert which is the biggest importer and distributor of fertilizes in China. Canpotex has also signed a contract to supply 1 million tons of potash for $400/ton in 2013. The company has also taken a 14% stake in Israel Chemicals, which it is trying to increase. The company has also acquired an interest in Sociedad Qumica y Minera de Chile S.A.(SQM) which is a Chilean based producer of potash, lithium etc.
- Valuation is in line with the industry average - Potash is trading more or less at the same industry multiple with a trailing P/E of 16x and a forward P/B of ~3.8x. Potash gives a dividend yield of 1.65% and has a forward P/E of 13x. POT has a market valuation of $36.5 billion, which is around ~10% less than the $40 billion bid, which BHP Billiton (BHP) had made for Potash in 2010.
- Strong linear topline and bottomline growth - POT has managed to grow its revenues and profits in a strong steady manner over the last decade. Except for a fall in 2009, the increase in the topline has been impressive. The company's revenues have grown by almost 4 times in the last 10 years, from ~$2 billion in 2002 to $8.7 billion in 2011. Net margins have also increased quite spectacularly from ~2% in 2002 to 35% in 2011.
- Canpotex cartel backlash - Potash has formed a cartel with two of the other major Canadian potash firms called Canpotex. This Canadian cartel operates with the help of the former Soviet Union cartels to keep the prices high by keeping the production in check. This is similar to what OPEC does. This cartel is coming under increasing pressure from the regulatory authorities and even from competitors. Cartels are illegal in the western world and huge billion dollar fines have been imposed on those found guilty of distorting a market. US antitrust authorities are investigating whether Potash has broken the law. However, given that the Russian and Canadian governments find it in their interest to have their cartels maintain their power; it is difficult for US or major importers like India or China to do much against the global potash cartels. The Canadian government blocked BHP's bid to buy POT, as it feared that the cartel might be broken. This is one of the rare instances where a western government has blocked one western company from acquiring another western company, due to national interest.
- New Entrants - The high price of potash at $400/ton is attracting a number of new players who have acquired mining leases and rights in new potash rich areas. Though the costs are higher in these new areas, the lucrative margins being made by the current potash producers and the relatively stable prices of Potash, are making these new companies bet big. However, it takes a long time to get a mine running and takes a huge amount of investment. However, large buyers like India and China are willing to invest in these junior miners to reduce their dependence on the Canadian cartel.
- Recent weakness in results - Potash is suffering from weakness in fertilizer prices due to irregular weather and a slowing global economy. The company gave tepid Q412 results due to these reasons and we think that the 2013 will continue to be slow as well. However, we think that these problems are short term in nature and the company has great prospects over the long term.
POT stock has given a loss of 10% in the last one year and has underperformed its peer like Agrium (35% return) and Mosaic (10% return). However over the last 5 years, the company has given an average performance of -10%, compared to +~71% for Agrium and ~-34% for Mosaic. The stock is trading in the middle of its previous 52 week range at ~$42. The stock has seen it reach an all time peak of ~$77 in 2008.
Potash is the largest independent potash producer on the planet and has shown tremendous growth in the last decade. While the last 5 years has seen stock price turbulence, the long term future of the company seems bright. The company has invaluable asset in the form of its potash mines, which makes it a lucrative target in case the stock price ever goes down. The company does not face any technological threat and is a large cash cow that keeps growing. We would like to have seen a bigger dividend from Potash, given the massive cash flows it is generating. However, the company is still in the expansion mode buying up stakes in foreign companies. Potash is a better commodity investment as we don't think potash faces the prospect of sharp price declines like industrial commodities. The company faces risks from regulatory authorities in foreign countries against its cartel like behavior in conjunction with Canadian, Russian, Belarusian and Ukrainian producers. However, given the strong support that it enjoys from its home government, we see it having a limited impact on Potash.