Potash Corporation of Saskatchewan (POT), the world's largest fertilizer producer by market value, citing emerging markets where growth has been less robust than expected, announced a number of layoffs, production reductions, and facility closures across the company's locations in the U.S., Canada, and Trinidad. POT will cut more than a 1000 jobs and reduce potash operating capacity to 9 million tons. The company said in a note:
"Despite confidence in the long-term drivers of our business, a significant portion of fertilizer demand comes from developing markets where growth has been less robust than expected. This sluggish environment has been most visible in our potash and phosphate businesses, and has contributed to challenging market conditions."
For potash, the company expects to reduce costs by $30 per ton by 2016, and by $15 per ton next year. In the phosphate segment the company expects to cut costs by $10 to $15 per ton at the gross margin level i.e. costs savings and product mix improvement. By early next year, the Saskatoon based company will reduce company-wide headcount by 18%. In the potash segment, the company will suspend a mill at Lanigan and reduce production at Cory by year-end. In addition, POT will cease production at the Penobsquis, New Brunswick, mine early next year. In the phosphate segment the company will cease production at the Suwannee River chemical plant, one of two plants at the White Springs, Florida, in the second half of 2014.
We think in the present environment these moves are good for the company and were needed in the face of the problems the fertilizer industry in general and the potash industry in particular is facing. Even as the supply expansions have moved forward, demand levels are still disappointing. Moreover, this doesn't change the bigger picture either, the potash prices outlook still remain challenging and the competition among the potash producers of Canpotex, Russian, Israel, and Belarus remains high particularly for the key markets of India, China, Brazil, and the Southeast region.
Other than the Russian-Belarussian dispute which has engulfed for potash industry for months, we think these announcements by Potash Corporation are also an acknowledgement on part of the company that demand, particularly the emerging markets demand, has not grown as fast as the company had anticipated. With or without a BPC resolution and regardless of the price levels, with the current demand trends it is unlikely Potash Corp. would be able to sell its constructed capability of 13 million tons of potash next year. According to the company after the current operational and environmental changes it will have the capability to sell 10 million tons in 2014, including operational capacity of 9 million tons and 1 million ton of inventory.
POT is positioning itself to be leaner as a hedge against the ongoing uncertainty in the potash market. If BPC is unable to resolve its dispute, POT is working to move down the cost curve and is positioning itself for an extended period of potash trading more like a pure commodity. If the market dynamics change favorably for the company in terms of higher than expected demand or a favorable resolution of the Russian-Belarussian dispute, the company will be able to capture the upside through higher prices given less available supply.
POT's meaningful employee reduction and operational changes at its various mines and production facilities should be seen favorably as it will increase earnings and cash flow. But at the same the cost cutting actions are yet another acknowledgement by the Saskatoon based company that industry headwinds are not short-term and that the persistent oversupply in coming years is unlikely to be absorbed by a recovery in the emerging market demand, particularly India, China, and Brazil.
While on one hand, POT is using the shutdowns to make a case that the overcapacity will be less than the market expectations, on the other hand company will have the potential and ability to increase market share when the demand returns. However, as mentioned earlier, while these cost cutting actions are positive, the biggest picture remains the same. There is still uncertainty and the market needs contracts and base-load tons to provide price signals to encourage buyers to come back to the market. These actions alone are unlikely to offset the magnitude of pricing headwinds. We remain neutral on POT shares, whereas we have a buy rating on Agrium (AGU).