Potash Corporation of Saskatchewan (POT), the world's largest fertilizer producer by market value, reported a large decline in quarterly profits as potash prices slumped 28% after the breakup of Belarusian Potash Co. ("BPC") and Uralkali's (OTC:URALL) decision to raise output.
Although the Saskatoon, Saskatchewan, based company pre-announced on 10 October that due to the challenges the fertilizer industry is facing quarterly EPS will decline to $0.41, still the updated guidance came in worse than expected. The company now expects annual EPS of $2.00-$2.20, down from previous range of $2.45-$2.70. The global potash markets remain weak and it is reflected in POT's updated volume guidance of 8.0-8.4 million tons (from 8.5-8.2 million tons). The weak updated guidance means that POT is not only looking at a difficult 4Q13 but also 2014 even after buyers, particularly China and India, return to the market.
The global potash industry remains under pressure. We think the equity market remains overly optimistic about a potential BPC resolution and a subsequent improvement in pricing. The resolution of the Uralkali-Belarus dispute might result in a new BPC or BPC 2 but the potash industry is unlikely to return to pre-BPC breakup era anytime soon.
The near-term demand for both potash and phosphate remains weak. Falling fertilizer prices, a narrow U.S. application window due to a late harvest, and lower grain prices are likely to defer some fertilizer use into the first half of 2014. Much of the outlook of the global potash industry depends on the outcome of the Uralkali-Belarus dispute; however, as of now there is little visibility on that front.
We expect POT's shares to remain under pressure until there is a complete reset of operating environment. A potential resolution of the Uralkali-Belarus dispute may take a form of no reconciliation at all or a new BPC; however, now the global potash markets need more than just a resolution surrounding BPC to improve substantially. For the operating environment to improve substantially, markets also need a settlement with China for 2014 and price adjustments in major Northern Hemisphere markets during spring 2014. Finally, and most importantly, markets need some certainty about where demand will be at lower prices. While the Russians argue that demand will increase with lower prices and they have lowered the prices, the Canadian Potash Exporters ("Canpotex") disagree and they still prefer price-over-volume strategy. The whole situation might become clear in the coming months but as of now uncertainty remains and we still prefer to remain on the sidelines.
Brazil A Positive But India Still A Challenge
Fertilizer demand in Brazil remains solid. Total fertilizer shipments to Brazil, the seventh largest economy in the world and the largest in Latin America, increased 5% Y/Y to 3.6 million tons in September. Potash and phosphate both remain strong, with demand increasing 7% and 10% respectively. YTD fertilizer shipments are up 7%-8% for all three major nutrients (potash, phosphate, and nitrogen). Expectation of a strong total acreage (+3%) this season is driving the demand.
India, on the other hand, remains challenged and a near-term noteworthy improvement is also unlikely. The country is renegotiating prices for half of the contracted shipments that haven't been delivered yet. The contracted prices was $427 per ton while the new price would likely be about $375 per ton, according to Suresh Krishnan, managing director of Zuari Agro Chemicals, India's second largest importer of potash.
Indian Potash Ltd, India's largest potash importer, already got a discount of 12% to the contracted price of $427 per ton. India is the second largest buyer of potash after China and meets all of its potash demand from imports. The subsidy imbalance and depreciation of the Indian rupee have made imports more expensive for the Indian importers. India will hold its sixteenth general elections in summer of 2014 and it is unlikely the subsidy issue will be addressed before the country goes to polls next year, till then we think the Indian market will remain tough.
Dividend Remains Safe - That's A Positive
Despite of the difficult operating environment, POT's dividend, which is an important component of its valuation, remains safe. POT has a dividend yield of 4.5%. The company reiterated that it will maintain its current dividend. Potash Corp. is even willing to use debt markets if needed to maintain its dividend, but the company said that it will not need to do so not at least in 2014. POT's capex is also expected to drop by $400-$500 million next year, providing the company with additional flexibility.
Potash Corp. is bleeding and there should be no two opinions about it. The stock has been hit hard by the events of the summer and is down more than 18% since Uralkali's decision to part ways with its Belarusian partners. The market for POT's namesake nutrient remains challenged and it is unlikely prices will reverse anytime soon. We think market remains overly optimistic about a potential BPC resolution and a subsequent recovery in prices. A resolution of the Uralkali-Belarus dispute may result in a new BPC but it is unlikely to improve capacity utilization, which is the main price driver.
POT's assurance to investors that it will maintain its current dividend and is even willing to take up debt if needed should be seen as a positive. Nitrogen segment, POT's second biggest revenue contributor, reported better than expected results, which is another positive in the current price environment. Brazil demand also remains solid; however India and China still remain a challenge.
Despite of a few positives, the bigger picture is that the global potash industry remains challenged following the events of the summer and now these challenges are stretching into 2014. The uncertainty caused by the BPC breakup has caused investors to exhibit extreme caution and delay purchases in anticipation of weak prices. We expect POT's shares to remain under pressure until there is a complete reset of operating environment. Until then we prefer to remain on the sidelines.
Those who want to take a position in potash or a fertilizer company should have a good look at Agrium (AGU). The Calgary, Canada, based company's retail business, its high dividend yield, and its growth potential offer investors both safety and long-term value. You can read our article on Agrium on the following link.