Tough Times Ahead For Potash

| About: Potash Corporation (POT)

Summary

Potash reported weak Q1 results.

The company also lowered outlook for 2016.

Another dividend cut a possibility.

Consolidation is the only near-term solution for producers.

Potash Corp. (NYSE:POT) this week reported its first-quarter results. The company saw nearly an 80% drop in its first-quarter profit as it continued to grapple with low prices. POT also lowered its earnings guidance for 2016, highlighting the challenging environment the company is facing. While potash imports to India are expected to rise, POT and other potash producers will continue to face challenges due to pricing pressure.

Potash reported earnings of $0.09 per share for the first quarter, down from $0.44 per share reported for the same period in the previous year. The substantial drop in profit can be attributed to weaker potash and nitrogen prices. Potash prices tumbled in mid-2013 following the breakup of Belarusian Potash Company (BPC), one of the two cartels operating in the potash market. The breakup of BPC has changed the dynamics of the potash market and producers such as Potash Corp. have become price takers from price makers. While the long-term outlook for potash, driven by the need to feed the ever-increasing global population, remains robust, the breakup of BPC has given major buyers such as China and India negotiating power.

Potash's revenue for the quarter dropped 27.4% to $1.21 billion. Post the first-quarter earnings release, Jochen Tilk, Potash Corp.'s President and CEO, said:

"Lower prices for all nutrients weighed on our performance for the quarter and contributed to a more subdued outlook for the year. In potash, the deferral of new contracts in China led to cautious buying patterns in other regions, resulting in a weaker demand environment and lower prices."

Just like last year, China has deferred signing new contracts as it looks to negotiate on price. All other major buyers, including India, remain on the sidelines until China has struck a deal, as the world's second-largest economy usually sets the benchmark. In fact, India expects a surge in potash imports due to an anticipated strong monsoon season that should boost crop outlook. In a recent article, Bloomberg, citing Indian Potash Ltd.'s P.S. Gahlaut, noted that India's purchases may increase by as much as 29% in the fiscal year ending March 31, 2017. However, the report further noted, citing Mr. Gahlaut, that buyers in India will seek a further cut in prices. Importantly, Indian buyers will come to the negotiating table only when China has finalized its contracts and set a benchmark. So despite strong demand, Potash Corp. and other producers will, in fact, see a negative impact on pricing.

Not surprisingly then Potash Corp. has cut its 2016 outlook. Potash lowered the upper end of its 2016 sales forecast to 8.8 million tons from 9.1 million tons. The company also lowered its 2016 earnings forecast from $0.90 per share and $1.20 per share to $0.60 per share and $0.90 per share.

Despite the challenging short-to medium-term outlook, Potash Corp. has attracted income investors mainly because of its yield. Despite the 34% cut in its dividend yield, Potash still offers a yield of almost 5.70%. However, as I had noted in my article last month, further dividend cuts are likely, especially now that the company has lowered its earnings outlook for 2016. Based on the mid-point of the revised 2016 earnings guidance, Potash will have a payout ratio well above 100%.

As I have noted before, the only solution to the challenging near-term environment for Potash Corp. and other potash producers is consolidation.

Disclosure: I am/we are long POT.

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.