Potash Corp. (POT) and The Mosaic Company (MOS) are currently more-or-less in a tie in terms of how they are rated on the Street. Both fertilizer producers have a "buy" rating, but come with a good amount of risk given their low dividend yields and high betas. Over the last twelve months, Potash and Mosaic are down by 10.8% and 25.4%, respectively, while the S&P 500 is down by only 1.2%. Exposure internationally hedges against domestic stagnation, but the risks inherent in both companies are holding back significant value.
From a multiples perspective, Mosaic is the cheaper of the two. It trades at a respective 8.7x and 8.8x past and forward earnings, while Potash trades at a respective 12.9x and 9x past and forward earnings. In addition, Mosaic has a cleaner balance sheet than its competitor's with a net cash position of $3.2B, 13.9% of market value. Potash, meanwhile, has net debt of $4.2B, which stands at 11.7% of market value. Despite this, Potash trades at a premium to competitors given its strong operational performance and pricing power. Its gross margins of 41.1% are nearly 1,000 basis points higher than its peer, which enables it to derive greater returns to equivalent increases in scale.
On the third quarter earnings call, Potash's CEO, Bill Doyle, noted the challenges and opportunities ahead:
"These are uncertain economic times as debt issues in several European countries and questions about global growth rates have caused many investors to reassess risk. The impact was evident in commodity markets as prices for a number of key global crops fluctuated during our third quarter. Despite this volatility, crop prices remained at historically high levels, and farmers continued to strive for increased production to capitalize on the economic opportunity in agriculture.
As a result, demand for our potash, phosphate and nitrogen products remain strong. Tight supply-demand fundamentals supported higher prices. This is especially true of potash as our shipments were up 14% compared to last year's third quarter, September bringing the highest monthly volumes in our history."
Despite earnings per share of $0.94 being roughly in line with expectations and gross margins doubling compared to 3Q11, guidance came across as eery. Management lowered expectations for potash volumes both on the low and high ends due to a forecast of overly warm weather. In addition, inflationary pressures from ammonia and sulphur will cut into margins - most likely materializing a meaningful effect by the fourth quarter. The fourth quarter will be additionally challenged by slowing demand in India and China. Finally, a shift towards lower margin sMOP will further contribute to limited profitability.
Even still, I anticipate improvements in phosphate prices and positive trends in the feed market. A limited supply of potash, coupled with impressive international demand, will set the stage for a brighter future in 2012. Management has guided global demand to be as high as 60M tonnes next year, which will drive better pricing.
As for its overly high multiple, Potash merits a premium to peers given its high gross margins. This reduces the amount of risk the firm faces relative to competitors in the challenging quarters ahead. In the past, the firm has been successful in growing production while lowering costs and I expect this to be the case in the future.
Consensus estimates for EPS are that it will increase by 80.9% to $3.69 in 2011 and then by 20.3% and 2.5% more in the following years. Of the 20 revisions, 14 have gone down. Assuming its multiple holds steady and a conservative 2012 EPS estimate of $4.30, the rough intrinsic value of the stock is $55.47. This implies around a 33% margin of safety, meeting the threshold of what I consider to be a value stock. Despite the discount, a shadow nevertheless lingers over Potash that will unfortunately keep plantations from flourishing.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
