The potash market imploded in turmoil on 7/30/2013 when Uralkali, one of the largest potash producers in the world, announced that it will leave the BPC cartel. In the financial markets, fortunes are made and lost amid chaos. Thus, the recent chaos in the potash market has made potash companies very interesting to fortunate seekers. This article evaluates how the new potash landscape will impact companies like Potash (POT), Agrium (AGU), Mosaic (MOS), and Intrepid Potash (IPI).
Potash Market 101 - Long-Term Predictable Demand
Potash is used primarily (~90% of current use) as an agricultural fertilizer (plant nutrient) because it is a source of soluble potassium, one of the three primary plant nutrients. Potash is a mined product and have no substitutes, but low-nutrient-content, alternative sources of plant nutrients, such as animal manure and guano, bone meal, compost, glauconite, and "tankage" from slaughterhouses, can be used.
If prices are too high, smaller farmers may substitute potash with low-nutrient-content fertilizers - we saw evidence of this in emerging markets when potash prices skyrocketed in 2008. However, there is evidence that larger farmers must pay the market price:
'"First the price doubled, and then it tripled,' says Brian Willott, who farms soybeans and corn near Palmas in Brazil. 'You feel kind of trapped because there's nothing else you can substitute for it."'
Some analysts spend an inordinate amount of energy trying to predict next year's demand by forecasting crop yields, prices, etc. However, as a long-term investor, I do not worry about small year-to-year fluctuations unless it will materially impact the company over the long-run. In the long-run, fields need to be fertilized, storages must be filled, and people will always eat.
Potash Market 101 - Long-run Predictable, Short-run Volatile
Long-term, supply will meet demand. Effectively, as far as I'm concerned, there is enough potash in the world to supply the world forever. If current mines cannot meet supply, price will increase and production capacity will expand to meet demand. New production capacity, however, takes years to bring to market since conventional Greenfield projects take a minimum of 7 years to complete and Brownfield projects usually take over 2 years to complete (of course, this can vary significantly depending on the extent of the construction and existing infrastructure). Bottom line: in the long-term, supply will meet demand and world-wide production capacity is highly predictable.
However, short-run supply can be volatile. Potash deposits that are economically minable are concentrated in only a handful of countries and dominated by a handful of producers. Big potash players formed cartels to support potash prices and reduce competition. As a result, potash companies that belong to one of the two large cartels have been producing below capacity. If any of these companies decides to produce at full capacity in order to capture market share (i.e. leave the cartel), then the market may be temporarily flooded with supply, driving potash prices down significantly. This is exactly what Uralkali is threatening to do.
Will Potash Prices Really Tank?
If you take the Uralkai CEO's words seriously, then yes, prices will most definitely tank in the near future to as low as $250/t. If prices actually do reach $250 per ton, the marginal producers will bleed money, and Greenfield and Brownfield projects will get shelved. Will prices go as low as $250/t? It is definitely possible, and maybe even lower. If Uralkali maximizes production, than Belaruskali Potash will as well. If both Uralkali and Potash maximizes production, global supply will increase significantly since both companies are producing under capacity and currently represent 43% of all global exports (source: my estimates based on various public disclosures). This changing landscape will force Cantoplex to reevaluate its current strategy as it faces decreasing market share by following the price-over-volume strategy. Remember, the average potash price in 2005-2008 lingered around $150/t.
What Are the Long-Term Impact of Uralkali - Belarusian Fallout?
Again, if we take Uralkali's CEO's words seriously, then potash prices should collapse in the short-run. Depending on how long the low-price environment will persist, marginal players will bleed money and some will face the risk of going out of business. Brownfield and Greenfield projects expected to hit the market in 2018 will get shelved, reducing the medium-term global capacity.
However, I highly doubt that Uralkali will pursue the new volume-over-price strategy for long. Why? The volume-over-price strategy simply doesn't make sense for anyone in the long-term. I believe Uralkali has three strategic reasons for maximizing volume in the short-run:
1. To discipline Belaruskali Potash and the Belarusian government. Uralkali's unilateral action to dissolve the BPC will show the Belarusian party that the cartel setup is extremely valuable to both parties and that without a cartel, both parties will suffer. After Belaruskali Potash suffers financially, the Belarusian government will likely reconsider the decree allowing Belaursian Potash to trade outside of the BPC. Per the interview cited above, Uralkali's sees consolidated trading sometimes in the future, which will push potash prices up to current levels - we just don't know when this will happen.
2. To grab market share. Uralkali is very sour on two facts: 1) Belaruskali Potash is cheating, and 2) they are losing market share to Cantoplex. Since Uralkali is a low price potash producer and since it geographically closer to China, a huge and growing market for potash, this new volume-over-price strategy will allow the company to grab market share and hopefully hold on to it after the future consolidation.
3. To clear the fields of capacity expansion and marginal players. Uralkali's actions won't put any of the big, low-cost producers out of business. However, since 2008, high potash prices have attracted outsiders, including the resource giant BHP Billiton (BHP). High-cost producers like K+S are also considering huge Greenfield projects. The logical question is "why maintain high potash prices that will attract new capacity and players, leading to more competition in the future?" Low potash prices now will "clear the field" before competition becomes a problem in the future. I estimate $300/t potash will do the job just fine.
After the three above goals are achieved, I believe Uralkali and Belaruskali Potash will form another cartel, one that is similar to the current BPC cartel. Prices will rise again and outside players will look to come in and marginal players will look to expand - history will repeat itself.
Is This The Right Time to Invest in Potash Companies?
Yes, but only if you have the three following attributes:
1. You have a long-time horizon - and I mean really long, like over 10-years.
2. You have a strong stomach.
3. You are willing to study the fundamentals of potash companies like POT, AGU, MOS, URALL, and IPI to determine who will come out stronger and who will come out weaker in the low potash price environment. (This article will not cover this since each individual company deserves an in-depth treatment. If there are any interests, I will cover a few in follow up articles.)
The way I see it, potash companies are currently trading at historically low P/E multiples. The reason for this is that the E of the P/E ratio is expected to drop significantly in the near future, which is probably a safe assumption. I believe most analysts out there are forecasting $300/t potash, which is what is driving current potash company valuations.
I believe potash companies were overvalued two months ago for the same reason I believe they are somewhat undervalued today:
1. Two months ago, potash companies are priced as if the historically high potash prices will persist indefinitely, ignoring all the potential competition that high prices are attracting.
2. Two months ago, potash companies are priced as if cartel members will never have disagreements and cartels will continue indefinitely.
3. Now, potash companies are priced as if potash prices will be $300/t forever, and as if potash prices will certainly drop to $300/t.
4. Now, potash companies are priced as if Uralkali and Belaruskali Potash will never speak to each other again, and that there is no possibly that Uralkali is just bluffing.
I don't think the market's reaction to Uralkali's announcement was too extreme, but the reaction leans towards the panic side of the spectrum, thus leading to somewhat - but not greatly - undervalued potash companies. As a result, I have personally taken a small position in Potash Corp , which is the low-cost producer and market leader in the world of potash. I believe there is risk of significant downside price movement for the stock, which is why I have taken a small position with room to increase my holdings as shares drop from the current $30/share to, say, $25/share and $20/share, effectively allowing me to average down during market turmoil. This is my current strategy, one that might not fit your profile, so please do not view this as an investment recommendation.
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