Potash Corp.: Is Another Dividend Cut Around The Corner?

| About: Potash Corporation (POT)

Summary

Potash Corp. will report its quarterly earnings on April 28.

I provide my checklist for the company's upcoming earnings.

I argue that another dividend cut might provide a good buying opportunity.

Potash Corp. (NYSE: POT) will release its first-quarter results on April 28. Inevitably, the main topic will be the sustainability of Potash Corp.'s dividend. The company has recently suffered a flurry of downgrades, and each analyst cited poor market conditions as the reason for the downgrade.

The stock ignored the downgrades, although it did not join the same wave of optimism like other commodity-related equities in gold, silver, oil or iron ore.

Recently, I covered the bigger picture for potash supply fundamentals. I started with projects that are about to hit the market and the perspective projects in Canada, and followed with discussion of potash mining prospects in Africa and a very interesting project in the UK.

My general take is that short-term outlook for supply/demand balance is challenging, but that it gets better with time. This is true especially in the case where potash prices stay lower for longer, as upcoming projects will likely have trouble receiving financing.

The previous dividend cut did not provide any flexibility for Potash Corp. A 100% payout ratio leads to zero room for error. And this error is already there. With no news from China, it looks like the additional pressure on potash prices is still present.

Previously, Potash Corp. guided for 2016 sales of 8.3 million-9.1 million. I expect that this figure will have a downward revision. Also, I expect that Potash Corp. will revise its 59 million-62 million expectations for global potash shipments. In my view, the upper end of this guidance was too optimistic.

Also, costs may rise together with the strengthening Canadian dollar. Back in January 2016, the U.S. dollar cost 1.45 Canadian dollars, but now it takes only 1.27 Canadian dollars to buy the greenback. This was a major and fast move that took the Canadian dollar to levels last seen in July 2015.

A weakening Canadian dollar mitigated the impact of falling fertilizer prices in the previous quarters, but now Potash Corp. lost almost half of the previous exchange rate advantage.

Potash Corp. still has flexibility regarding production levels and it might use this leverage to provide support for market prices. However, if we take into account the upcoming projects, such actions may ultimately lead to the loss of market share.

Back in November, I wrote an article explaining why Potash Corp.'s dividend was not sustainable at potash prices of $200 per ton. In its calculations, the company used sales estimates of 10 million tons. Fast forward two quarters, and this estimate looks like a science fiction.

The company already cut the dividend announced production cuts, and is arguably heading to the lower end of its 2016 production guidance. Meanwhile, the stock is supported by the strong dividend yield and the "people have to eat" long-term thesis.

In my view, an ideal entry point in Potash Corp. may arise after the company cuts its production guidance and cuts the dividend for the second time. Such a combination of news might put the ultimate bottom behind the price of Potash Corp.'s shares.

As the company left itself no room for error regarding the dividend, the fear of the dividend cut will always be present unless we see a sustainable upside in the fertilizer market. The yield greed puts a price floor for the stock, while the fear of the cut serves as a ceiling. As a result, Potash Corp.'s shares are range bound and trade in a waiting mode until a decisive catalyst shows up.

Here's my checklist for the company's earnings report:

  1. The dividend. As I stated above, a solid cut will make me look for an entry point in the company's shares. If the dividend is not cut, I would like to see the reason for the decision. In my view, the possibility of borrowing for the dividend will be a negative sign.
  2. Sales estimates. The current range is too big. I expect that it will be cut to the downside.
  3. Costs. Was Potash Corp. able to mitigate the impact of stronger Canadian dollar? It's always easy with costs - the lower, the better.
  4. Realized fertilizer prices. How big is the drop in comparison with the fourth quarter?
  5. What happened with China this year?
  6. World shipping outlook for potash. Is the company still expecting 59 million-62 million tons? How about the emerging competition?

Other news will also be helpful, but these are my main points of interest for the company's report. Until the report, I still view Potash Corp. as a long-term hold. In case the market reacts negative to the report and the stock opens near February lows, I might consider a range-play in Potash Corp. If the dividend is cut together with production estimates, I will take a closer look to consider Potash Corp. for a longer-term play.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in POT over 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.