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Mosaic Co. (MOS), the largest U.S. fertilizer producer, reported Q3 profit that beat analysts' estimates due to strong Asian demand for potash. By reducing the cash and increasing the leverage, more upside is expected for Mosaic with increased efficiency for its balance sheet.

Management Calls

Despite Q3 typically being the slowest quarter, Q3 this year is a solid quarter for MOS as net income rose to $344.6M (81 cents a share) from $273.3M (64 cents) a year earlier. Profit, excluding other one-time items and cost of an antitrust settlement, was 90 cents a share (beating analysts' estimate of 88 cents per share). Q3 sales increased 2.3 percent to $2.24B, trailing $2.3B as estimated by analysts.

For the total operating earnings of $419M, the potash business unit contributed $216M and the phosphate business unit contributed $197M. For Q3, the company generated $371M in operating cash flow and continues to maintain a strong cash position with $3.3B of cash on hand.

Stronger Demand

Commodity prices have declined modestly as futures markets recognize the potential for a large 2013 crop. However, the prices remain high relative to historical norms. For Potash, the shipments are expected to reach the higher end of the 55M-57M ton range. The demand is boosted by the contracts with India and China, as well as the expectation for a strong spring planting season. The operating rate of potash mines is expected to increase in Q4 (from 78% of Q3) with better-than-expected demand from China and India. The 3M tons of ongoing potash expansions are proceeding as planned.

More Efficient Balance Sheet

The management is working on a more efficient balance sheet, which means less cash and more debt. The company will return excess capital to shareholders through share repurchases, which become possible when tax restrictions expire in late May. The priority for cash flow is to seek organic growth like current committed potash expansions, aiming strong long-term returns for shareholders. Strategic investment opportunities like the joint venture with Ma'aden are also considered.

Strong Guidance

For Q4, potash sales volumes are expected to be in the range of 2.3M-2.6M tons (vs. 2.0M tons for Q4, 2012). A new quarterly record will be set if the top range is achieved. The average realized potash prices are expected to be in the range of $350-$380 per ton, which reflects a substantially higher mix of lower priced standard product. The gross margin rate for the potash segment is expected to be in the range of 40%-45%. Year-over-year margins are being impacted by higher depreciation as the company brings new capital investments online and higher labor costs for a new capacity. The operating rate in potash for Q4 is expected to be above 85%. The management expenses are expected to be in the range of $245M-$260M for 2013.

As for phosphates, sales volumes are expected to range from 2.6M-2.9M tons for Q4, (in line with last year's volumes). The realized prices are expected to range from $475-$505 per ton (in line with Q3). The gross margin rate should be flat (in line with Q3). Mosaic's phosphates operating rate is expected to exceed 85% of capacity for Q4.

Ma'aden Join Venture

The outlook for the phosphate business is positive in the longer term. The joint venture with Ma'aden will support the company's growth strategy and partially meets the growing demand from the company's international distribution operations, as well as giving the company access to exceptionally low cost phosphate and more cost-effective access to India and other Asia markets. This project does not change the management's plans for Florida and Louisiana phosphate business. Ma'aden operations are expected to be in production in late 2016, and by then, the company will be able to allocate more domestic production to North America and South America.

Readers are suggested to review Mosaic's CEO Discussion on Q3, 2013 result here at Seeking Alpha.

Fundamentally, a quick comparison will be made between Mosaic, Potash Corporation of Saskatchewan, Inc. (NYSE:POT), and the industry average.

Mosaic

Potash

Industry Average

Revenue growth (3 year average)

2.6

25.8

4.9

Operating margin (%, ttm)

22.4%

38.1%

27.1%

Net margin (%, ttm)

18.9%

26.2%

18.3%

ROE, ttm

16.2

23.4

27.6

Debt/Equity

0.1

0.3

0.3

P/E

13.8

16.6

17.1

P/B

1.9

3.4

3.2

By improving the efficiency of its balance sheet, MOS could expand its growth and increase its ROE as compared to POT and other competitors in the industry of agricultural chemicals. By increasing its growth rate, MOS can catch up with its P/E and thus lead to a higher valuation.

Bottom Line

Investors should expect a solid Q4 for MOS with a possibility of record potash sales. In the long term, the Ma'aden deal will improve the fundamentals on the phosphate end. More efficient balance sheet, faster growth, and stronger ROE will lead to higher valuation. MOS remains a long-term buy at current valuation (Forward P/E of 11.9). Investors can also review the following ETFs to gain exposure to MOS:

  1. Global Agriculture Portfolio (PAGG), 7.65% weighting
  2. Fertilizers/Potash ETF (SOIL), 5.17% weighting
  3. MSCI Global Agriculture Producers Fund (VEGI), 4.47% weighting
  4. Dow Jones U.S. Basic Materials Index (IYM), 3.54% weighting

Note: Investors and traders are recommended to do their own due diligence and research before making any trading/investing decisions.

Source: Mosaic: Expecting Strong Potash Sales And Expanding P/E