- Agricultural inputs mean industry faces challenges.
- The demand is expected to stabilize in the coming days.
- Potash is not a good dividend pick.
Potash Corporation of Saskatchewan Inc (NYSE:POT) is an integrated fertilizer and related industrial and feed products company. It operates in an industry that is facing hard times from the unbalance between supply and demand. Consequently, the industry that produces fertilizers, helps to grow food corps and provides resistance from diseases is facing some headwinds from the low prices of potash and phosphate that have occurred over the past few quarters.
The Indian region, traditionally a major purchaser of food fertilizers, is now domestically producing sufficient potash and phosphate for its usage. As a result, major overseas fertilizer exporting companies like Potash and Mosaic see low demand for their products in the country. Whereas China also has the potential to generate a significant amount of fertilizers for its domestic use, demand in China is modest and not as good as it was. Amid all this, the increasing population and need for food offers underlying growth opportunities for food fertilizers in these two countries. Thus, Potash is expecting nearly huge shipments this year led by recently signed contracts with Canpotex.
Latin America and other Asian countries besides India will create demand for all of Potash's key nutrients because these regions are aggressively pursuing a new supply to meet the needs of growers. In North America, the company has a strong order book in place, and it is expecting additional product needs to appear as the season opens. Still, the prices of fertilizers continue to decline as most producers are offering very low prices in order to capture limited demand. Recently, Uralkali, a Russian based company, agreed to a 24% cut in the potash price for China.
The pricing pressure and lower demand are impacting Potash's three key nutrients: nitrogen, potash and phosphate. This further impacts its revenues and profits. As a result, its revenue has kept going down over the past three years from $8.7 billion to $7.3 billion by the end of 2013. Margins are compressed, and they have been lowering down each year over the past three years. Thus, earnings were also on a downward trend. Since 2012, its earnings per share came down from $3.51 to $2.04 at the end of last year.
Potash, though, is a well-diversified company with good product diversification. Last year, it started ammonia capacity, which helped it lower pricing pressure and increase sales volume. Diversity in phosphate products also offers some relief, and its feed and industrial business helped it overcome pricing pressure. However, the company will probably generate lower income this year compared with the past year. Potash is expecting to generate earnings per share of around $1.40 and $1.80 in 2014.
The downward trend in earning is impacting Potash's cash flow generating potential as well. The company's operating cash flows fell from $3.4 billion in 2011 to $3.2 billion in 2013. Its cash flows will reduce further as the company is expecting to again generate lower income this year compared with the past one. While looking at the supply and demand dynamics, the company has reduced its capital investments. This initiative allows the company to keep generating better free cash flows to cover dividend payments. Therefore, the company has made a huge increase of 950% in dividends. At the end of this recent year, its free cash flows were at $1.5 billion, and dividend payments are at $997 million. Here, its dividends look safe as free cash flows are proving complete cover to them.
However, going forward, I believe it might be difficult for Potash to sustain its current dividend growth momentum. Its payout ratio based on income is going up over the past few years from the constant downward trend in its income. Its payout ratio went up from 6.9% in 2011 to nearly 59% in 2013. This year, it is expected that the company will post lower profits than the previous one, so its payout ratio will go up more. In the first quarter of 2014, Potash is likely to generate earnings per share in the range of $0.30 to $0.35 while the company is paying quarterly dividends of $0.35/share now. This downward trend in earnings will take its payout ratio to more than 100%.
In the short-term, I'm expecting headwinds to continue for fertilizer companies. The Indian region has sufficient potential to meet its domestic demand, while China offers some growth potential for these companies. China has a large population and, therefore, it will be 75% dependent on imports. However, fierce competition will keep potash and phosphate prices lower. Looking at these circumstances, I do not recommend initiating a position in a company with a main product line facing difficulties. Consequently, earnings growth is at risk. Further, it is difficult for the company to sustain dividend growth with the constant fall in earnings as dividend payments are going above its earnings per share, and cash flows are also going down each year.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.