Rising population and middle class standards in developing countries, easy monetary policies in developed countries, and less than optimal agricultural conditions in the U.S. (drought), India (weak monsoon season), Russia (drought), and Australia (drought) are leading to higher food prices. Potash Corp (POT) is well-positioned to alleviate this problem by being the number one producer of potash in the world, which is used to fertilize soil. Potash is also used in feeding farm animals and in a variety of industries. Potash Corp shares appear to be reasonably priced and the company is dedicated to providing long-term shareholder value. In addition, the political situation in India is likely to improve and depletion of dealer inventories in the U.S. bodes well for the company in 2013 and beyond. Finally, Potash Corp recently instituted a 50% dividend increase, which should smooth the volatility of its shares and somewhat limit any downside.
BHP Billiton (BHP) made an offer to acquire Potash Corp in 2010 for $130 per share, which was unsuccessful after Potash Corp demanded $170 per share. The shares are down about 5% from mid-November of 2010, when Potash made it clear that BHP offer was inadequate, while the S&P 500 is up over 22% for the same period. Currently, Potash shares trade at about $43 (the shares split 3 to 1 on February 25, 2011) and the company has about 860 million shares for a market capitalization and enterprise value of $36.5 billion and $40.3 billion, respectively, making it the largest company in the fertilizer field. For comparison, Mosaic (MOS), Agrium (AGU), CF Industries (CF), and Intrepid Potash (IPI) have market capitalizations of $26 billion, $16.5 billion, $14 billion, and $1.8 billion, respectively. In addition, there are a number of competitors not listed on a major U.S. exchange including K+S AG (Germany), Uralkali (Russia), and Belaruskali (Belarus).
Potash Corp expects to earn between $2.80 and $3.20 per share in 2012 for an estimated price earnings ratio of about 14. The earnings per share would have been better if not for a $0.39 per share non-cash charge related to the company investment in Sinofert, which was an accounting requirement. When BHP made its bid for the company, the price to earnings ratio was 22+ times 2010 earnings of $1.90 per share (split adjusted). Assuming a price to earnings ratio of 22 for Potash, this gives a current price of $66 per share or 53% higher from recent price levels. In addition, Potash Corp's major competitors, including Mosaic, Agrium, and CF Industries, trade at lower price to earnings ratios of 12.1, 10.1 and 8.3 respectively. Only Intrepid Potash has a higher valuation based on price to earnings ratio of 19.8 for its 2012 estimated earnings. One reason for this valuation could be that in its most recent full year Potash Corp earned 64% of its gross income from its potash operations compared to 47% and 12% for Mosaic and Agrium. CF Industries does not have significant potash production while Intrepid Potash is essentially a 100% potash producer. The significance of potash is that it has a limited supply while nitrogen is virtually unlimited and all crops need potash for a long-term optimal yield. Farmers also can postpone potash application for a few years but not indefinitely.
In terms of profitability, Potash Corp is one of the most efficient companies with a gross income margin of 49.2% compared to 31.4%, 28%, 47.5%, and 39.8% for Mosaic, Agrium, CF Industries, and Intrepid Potash, respectively. On a tangible book value to price basis, Potash Corp has the second highest valuation with a ratio of 4.2 compared to 2.6, 3.7, 4.8, and 2 for Mosaic, Agrium, CF Industries, and Intrepid Potash. However, this is in line with the market average of 4.6. And finally, Potash Corp pays a quarterly dividend of $0.21 for an annualized yield of about 2%. This is in addition to repurchasing $6.3 billion of its own shares since 1999 and compares well to annualized yields of 1.6%, 1%, and 0.7% for Mosaic, Agrium, and CF Industries (Intrepid does not pay a dividend).
As mentioned earlier demand for food is rising due to increases in world population and incomes in developing countries. Also, a number of major agricultural producers experienced the worse drought in years, which negatively impacted crop yields. According to Potash Corp, the year following a drought year usually has an increased demand for fertilizers. In addition, due to economic uncertainty many dealers have depleted their stockpiles of potassium based fertilizers and reserves are at a multi-year low.
Finally, in the past few years, India has relied mostly on nitrogen fertilizers, which boost yields in the short term. Currently, the potash application in India is at record-low levels and the country is in need to increase its potash application if it wants to feed its population at a reasonable price. While it is difficult to predict when a government will decide it is time to act, given the weak monsoon season and drought there, the Indian government may have to accept paying market prices for fertilizers in 2013.
As the largest producer of potash and the third-largest producer of phosphate and nitrogen in the world, Potash Corp is well-positioned to benefit from an increase in demand for fertilizers as early as the Spring of 2013. This demand should remain relatively stable as the world population and demand for food continue to grow. Its stock price is at attractive levels due to a number of reasons, including economic uncertainty, risk aversion, and an over-supply of potash in early 2012. It appears that there is less economic uncertainty after recent moves by the European Central Bank to buy more bonds and another round of quantitative easing by the Fed. The S&P 500 has rallied 18.4%. And food inflation appears to be back after U.S. food inflation posted a 0.9% rise in August of 2012, the largest since last November according to the consumer price index. Potash Corp common stock seems like a very good investment due to its valuation and the tailwinds, which may soon turn into a full-blown gale.