Potash: Still Not Liking Market Fundamentals

Aug. 7.14 | About: Potash Corporation (POT)


Potash Corp generally exceeded Q214 estimates based on strong cost controls.

The potash market to remain under pressure even if new growth targets are hit.

Investors should consider the recent rebound in Potash Corp a gift that is contrary to the long-term fundamentals in the main fertilizer.

The latest quarterly report from Potash Corp (NYSE:POT) shows some improvements in the fertilizers markets. In a previous article, the question was whether any value existed in the potash stocks going forward. The real concern is that large miners like Rio Tinto (NYSE:RIO) and BHP Billiton (NYSE:BHP) have sights clearly on establishing potash mines and expanding market in this area due to historically higher margins.

If the glory days are over for potash, does Potash Corp have any upside left?

Q214 Numbers

The Q214 numbers were generally better than expected for Potash Corp. The company provided the following highlights for the quarter:

  • Revenue for the quarter of $1.9 billion, compared to $2.1 billion in the prior year period.
  • EPS dropped to $0.56 for Q214 from $0.73 last year.
  • Gross margin fell to $747 million from $979 million in the previous Q2.
  • Operating cash flow hit $788 million.

The numbers slightly exceeded estimates with EPS projections of analysts sitting at $0.45 versus the $0.56 reported. The numbers were solidly better than expected, but the big picture remains a mixed bag with lots of uncertainty. Based on those numbers, the company guided towards EPS of $1.70 to $1.90.

The company guided towards full-year potash gross margin of $1.2 to $1.4 billion. The amount equates to a potential decline from the 1H14 rate of $695 million. To hit the lower-end forecast, potash margins would actually decline to only $500 million in 2H14.

Growth Forecasts

To make all the capital expenditures in the past couple of years, Potash Corp needs potash demand growth. The company continues to forecast growth that hasn't really happened in the past.

The recent forecast is for 2014 sales of 56.5 to 58 million tons, up from a the previous forecast of 55 to 57 million tons. The growth from actual shipments of 53.3 million tons in 2013 equates to the market expanding by a rather surprising 7.5% at the mid-point of the new guidance.

The above picture from the investor presentation perpetuates a strong market with continual growth, but anybody reviewing the previous article would notice that world potash supply continuously exceeds demand. In fact, demand has made limited gains in the last decade.

Ironically though, Rio Tinto and BHP Billiton are plowing ahead with establishing mines for later in the decade.

Valuation Proposition

With the stock rebounding in the last year, it doesn't offer much in the way of value. Potash trades at roughly 17x forward earnings and the long-term prospects for potash aren't really changing unless demand actually increases… and it hasn't in the last few years unlike forecasts.

The real key is that reaching the earnings estimates of $2.09 in 2015 requires roughly 15% growth from the forecasted 2014 mid-point of $1.80. The new 2015 estimate is also similar to what the company earned in 2013 back when pricing was strong for the first half of the year.

Potash Corp has successfully reduced cash costs for potash mining and expects to further reduce levels to reach the stated goal of up to $30 per tonne in 2015, compared to 2013 levels. The fear has to be that these reduced costs eventually become absorbed into lower prices.

According to the below chart, the stock trades at an interesting level after having rebounded from the Belarussian crisis this time last year. Ironically, with potash prices much lower, the stock actually traded remarkably close to the levels prior to the collapse. The below chart is interesting from a technical perspective contrary to the fundamentals.

Click to enlarge


The real key for Potash Corp is how the dynamics in the market work out. Higher prices in the short-term could lead to more price cuts from Russia hoping to gain market share. Also, Rio Tinto and BHP wanting to build large-scale mines continues to make the fundamental story unappealing. The opinion is that the stock eventually retests the lows of last summer.

Disclosure: The author has no positions in any stocks mentioned, but may initiate a short position in POT over the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.