Most observers seem to agree that the potash market is going to get better as the year progresses, but just how much better is the $64,000 question for Potash Corp (NYSE:POT) and investors in competitors like Mosaic (NYSE:MOS) or Intrepid Potash (NYSE:IPI). Nobody's talking about another repeat of 2009, but the market continues to play a game of chicken with shipment numbers and second-half restocking assumptions.
A Bad Quarter Was Expected, But This Was A Little Worse
Given the ongoing updates from industry participants like Mosaic, nobody had great expectations for this quarter. Still, it proved to be worse than the Street was expecting.
Overall revenue at Potash fell 20%, paced by a 46% drop in potash sales. While phosphate revenue was up 13% and nitrogen revenue was flat (and all three came in within about $50 million of each other), nobody really cares about the non-potash operations right now. With potash, the price improved 19% from last year and slightly from the fourth quarter, but year-on-year volume dropped about 55%.
Given how profitable potash is, however potash sales go, so goes the company. As a result, gross profit fell more than a third as the potash gross profit declined 56%. Likewise, operating income dropped about one-third.
Still A "When, Not If" Calculation?
Pretty much all of Potash Corp's shortfall can be tied back to lower-than-expected potash shipments, and while the company did cut back its guidance for the year, the market still expects improving results throughout the year.
With corn plantings up about 4% from last year in the U.S., the expectation is that demand has to pick up at some point. While it's true that farmers can skip a year, there wouldn't seem to be an economic reason to do so. Potash prices are well off the 2010 lows and more than double the sub-$200/mt level of the pre-boom years, but also well below the peak of 2009.
What's more, corn prices are quite healthy relative to the levels of the last four or five years. It's also worth noting that farmers don't seem to have trouble finding the money to pay for more advanced (and more expensive) seed traits from Monsanto (NYSE:MON) and DuPont (NYSE:DD).
The issue is the dealers. A lot of dealers got absolutely creamed in 2009 and those who survived are very cautious with their inventory stock levels now. So while potash is probably going to start moving in April and May (the peak of the application season in North America), they're going to be careful about reordering and restocking likely won't start in earnest until the second half of the year. Consequently, I don't read the fact that inventories are above five-year averages as much more than a sign that the dealers are going to wait to see stocks decline before buying more.
Longer Term Mixed, But Likely Irrelevant
It's always interesting to me to see when discussions of long-term fundamentals enter into the discussion around commodity names. Certainly future production/supply levels are relevant, as is the fact that the industry is looking to add about 20% more capacity by the end of 2013. Not only is the expansion of existing players relevant, but also that of relatively new entrants like Vale (NYSE:VALE) and BHP Billiton (NYSE:BHP) which are spending a lot of money on greenfield projects.
But here's the flip side. Demand continues to increase, and we've all heard the reasons why ad nauseum - more people, more meat consumption, less arable land, and so on. Moreover, economic potash deposits are relatively concentrated around the world and prices are largely controlled by two cartels. Moreover, there's a very large institutional ownership of Potash Corp shares and long-term in the institutional world often means two quarters.
Said differently, if shipments start picking up in the second quarter and restocking commences in the second half, this stock will do well.
The Bottom Line
The replacement value of Potash Corp's assets are well above the current market price, but the next time fertilizer stocks trade on replacement value just might be the first time. For better or worse, forward multiples of P/E and EBITDA are popular methods, and I favor the latter.
The trick here is the right multiple. Potash used to routinely trade at 12-15x forward EBITDA, but since the 2009 industry bloodbath (when about 50% of production was idled) that has dropped to about 9x.
I expect a 5-10% EBITDA year on year decline for 2012, and am wiling to go with a 10x multiple. That suggests a fair value of close to $50, whereas the current price seems to harken back to terrible industry conditions that I just don't believe are applicable today. Investors should shop around and consider other ideas like Mosaic and Yara International (OTCPK:YARIY), but PotashCorp is still looking like an interesting high-risk trade for 2012.