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For Potash Corporation of Saskatchewan Inc. (POT), one farmer's bad luck represents another one's opportunity. The drought in the U.S. is severely impacting the production of corn and could represent "enormous repercussion for global food supply" as noted by William J. Doyle, CEO and President of Potash Corporation, in the company's Q2 2012 earnings call held on July 26, 2012.

Due to the drought, the USDA, which initially estimated corn production at 166 bushels per acre, has reduced the estimate for this year's corn production at 146 bushels per acre. With U.S. production negatively impacted, other geographic regions, such as Brazil and parts of Latin America, stand to benefit. Farmers in other regions can take advantage of the U.S. shortfall by planting more acreage and adding more fertilizer, and adding more fertilizer is where Potash Corporation comes into the picture.

Potash Corporation is the world's largest fertilizer company by capacity and produces potash (K), phosphate (P) and nitrogen (N), the three primary crop nutrients. Potash Corporation is a large global player in fertilizer, as the company is responsible for 20% of global capacity.

In the company's Q2 earnings release, Potash Corporation indicated it would have reported record revenue for the quarter, had it not been for a non-cash impairment charge related to an investment in Chinese fertilizer company Sinofert. Potash Corporation owns a 22% stake in Sinofert, and while Sinofert's performance improved last year, the company's results are at 80% of revenues for 2008.

Also on a negative note, Potash increased its cost estimate for the company's New Brunswick project by $500 million, due to under-appreciating the scope of work required in developing a new ore body.

Potash Corporation indicated demand for potash accelerated in most major markets in the most recent quarter. In addition to Brazil and other parts of Latin America, purchases of the company's products also increased in China and other Asian markets.

Potash Corporation indicated it expects demand and prices for fertilizer products to increase in 2013 and 2014 due to the U.S. drought, as fertilizer demand has historically been very resilient following a poor growing season. The company also expects India to resume purchases of potash and also phosphate next year, since India has under-applied fertilizer for the last two years.

Potash Corporation revised its full year 2012 earnings estimate to between $2.80 and $3.20 per share, due to the Sinofert impairment charge.

Potash's stock price is down for the year, but appears to have put in a double bottom around the $38 price as shown below:

The second downward-leg for the double bottom was slightly lower than the first downward-leg, which is a little troubling, but is probably okay.

With Potash's earnings release behind it and with its rosy outlook for 2013 and 2014, a bullish position is considered for the company. A potential bullish position to entertain is a bull-put credit spread that may be entered by selling one put option and purchasing a second put option further out-of-the-money.

Using PowerOptions tools, a variety of bull-put credit spread positions are available as shown below:

Click to enlarge

The 2012 Sep 35/37.5 bull-put credit spread could be considered, as it has a potential return of 5% (40% annualized) and a stock/strike price separation of 13.3%, however, the 2012 Sep 37.5/40 bull-put credit looks a little more attractive with a potential return of 13.1% (104.1% annualized) and a 7.5% separation between the stock price and the strike price of the short put option. The 2012 Sep 37.5/40 bull-put credit spread may be entered by selling the 2012 Sep 40 put option for $0.55 and purchasing the 2012 Sep 37.5 put option for $0.26.

Bull-Put Credit Spread Trade

  • Sell POT 2012 Sep 40 Put at $0.55
  • Buy POT 2012 Sep 37.5 Put at $0.26

A profit/loss graph for one contract of the Potash bull-put credit spread is shown below:

For a stock price at expiration above the $40 strike price of the short put option, the position will return 13.1% (104.1% annualized). For a stock price at expiration below the $37.5 strike price of the long put option, the position will see a total loss, however, the position should be exited or rolled prior to experiencing a loss.

A management point of $42 is set for the Potash bull-put credit spread. For a stock price below $42, the position should be managed for an exit or a roll.

Source: Potash Corporation Looking Bullish