Ten Reasons Why I'm Waiting to Buy PotashCorp

PotashCorp of Saskatchewan (POT) is one of the world's largest fertilizer companies. It produces three plant nutrients, nitrogen, phosphate, and potash. The firm reported very solid earnings recently. Gross profit tripled year over year on a 94% jump in revenue. This came on significant price increases on nitrogen (up 57%), phosphate (up 135%), and potash (up 162%). POT expects the good times to continue, and has raised its guidance for the year to between $12 and $13 a share. The consensus among analysts, as of writing, is around $11.70 a share.

Here are some of the pros for investing in POT:

1. At about $200 a share (as of writing) Potash is trading around 17 times its full year earnings estimated by analysts, which is below the company's forecast.
2. The company is a cash machine. Free cash flow accounted for over 20% of sales in the last two quarters.
3. POT has been buying back shares. The company stated it intends to buy 5% this year.
4. The world's food stocks and arable land are at historically low levels while demand is high.
5. There is plenty of room for growth, as farmers in markets like Brazil and China have underused fertilizer in the past.
6. There are significant barriers to entry into the nitrogen, phosphorus, and potash markets.
7. The stock can easily double in the next couple of years as long as fertilizer prices continue to rise.
8. Management is knowledgeable, responsible, and shareholder friendly. The CEO has three decades of experience in the industry.

If you are interested in agriculture businesses in general, and would like a more diversified approach across a number of industries, you may want to look at the Market Vectors Agribusiness ETF (MOO). POT is currently its second largest holding while agriculture chemicals stocks account for almost half of its holdings.

Despite POT's potentially bright future, I'm waiting for a lower entry point. The reason is that there is a host of unpredictable risks:

1. In the near term, there is a threat of a strike at a few of the company's potash mines (they account for almost one third of the firm's potash production). A labor strike, depending on its duration, may hurt profits. The share price may fall too.
2. While POT's private competitors, like Agrium (AGU), Mosaic (MOS), and Yara International (YARIY) have an interest in not overly increasing supply, government owned competitors have less incentive. They may overproduce, lowering prices.
3. Fertilizer pricing is volatile. While prices have gone up recently, the trend may reverse. Factors affecting pricing include the weather, agriculture commodity prices, and natural gas prices.
4. Government policies may also affect pricing. For instance, the U.S., in its recent negotiations with India has signaled that it might cut farm subsidies. As another example, if the price of oil continues to fall, the U.S. may be less favorable toward biofuels. The Environmental Protection Agency is set to decide whether to cap corn for fuel use at 9 billion gallons for the foreseeable future (it was widely expected that the cap would rise to 15 billion gallons). This could drive corn prices lower, which in turn would hurt fertilizer demand.
5. While demand for food is historically high, slowing economic growth and rising inflation could cut demand for meat in places like China. This can drive down grain prices, and thus demand for fertilizer.
6. There are already signs of weakness. China's phosphate fertilizer demand dropped around 10% (year over year) in the last two quarters. Its potassium fertilizer demand fell about 15% (year over year) over the same period.
7. Rising sulfur (an important ingredient in phosphate fertilizer) costs can contract margins.
8. Water inflow, which potash mines commonly face, can ruin mines. This can seriously hurt profits.
9. Nitrogen and phosphate prices are not expected to rise very much in the future. Nitrogen and phosphate accounted for around two thirds of sales and just over half of POT's gross profits in 2007.
10. If the U.S. dollar weakens against the Canadian dollar, POT's earnings can be hurt.

The risks don't necessarily outweigh the potential returns. Nevertheless, as they are numerous and unpredictable, I would prefer a lower price at which to buy shares. I'll be a buyer at around 14.5 to 15 times analyst projected full year earnings. That would be around $170 to $175 a share. I may miss the boat on this one, but that's okay.

Disclosure:  The author does not own POT.

Comments

[will:]

Your way off base. Only pro's for Potash and 300 stock price around the corner. Any firm that isn't buying now are dummies.

2008 Jul 27 09:12 AM

[RossQ:]

Nice work on your article but please go back and do some homework. All you reasons for why POT should be lower were valid 5 plus years ago when I first found this stock on my stock screener. My home work lead me to believe the stock was over valued according to my metrics. I watched it double and by looking at the chart you know its been a real winner, and you do concede that it could easily double in a year or two, that just leads you to your entry point. IMO, this recent pullback on wed and thursday is the last you'll see unless Mosaic blows up on Monday after the close. If they dont blow up, better get your chasing shoes on cause we are going to 230-240 by Friday. PS if you check out MOS last conference call they have earnings visibility until 2010. I know MOS isnt POT but they trade together. Good Luck

2008 Jul 27 11:07 AM

[RossQ:]

PS the Loonie is at historic highs against the US dollar, if our buck blows up more, this conversation is moot cause it will teardown the Candian economy much like the internet bubble did.

2008 Jul 27 11:09 AM

[nova:]

POT is a commodity play. If US$ is going down, and it will, commodities prices will rise.

The US economy is in a toilet but certain segments of it are doing very well. With falling US$, the best US companies are becoming a takeover play by EU and Japanese companies. China will do the same shortly.

2008 Jul 27 11:23 AM

[pennystocks...:]

If your arguments are valid, you shouldn't buy POT at all. Otherwise, I suggest to jump on board right now. As you mentioned yourself, the stock is currently not that expensive. Trying to time the market will never lead you anywhere. POT might go up to $ 300 while you're still waiting for a pullback.

2008 Jul 27 11:45 AM

[podiddly:]

I concurr with the first comments by Will and Ross. The "10 negative reasons" look mostly dated, based on negative hypotheticals or some doom and gloom concerns of world wide decline and depression. A consensus of current analysts (July 2008) cite the stock's current value above $300. (UBS, for example DOWNGRADED POT's 2008 target price at $308; while other analysts have it above $350 and Vector Vest states POT's "current value" at $425.00 (USD), based on an extensive dissection of all financial and operational fundamentals, current to July 24, 2008. If the stock falls to $170-$175, I agree it will be a screaming BUY...and I recognize that such a fluctuation is not only possible but also a recent occurance...when POT hit $179 for about two seconds on the 24th of July. In any event I will add to my position aggressively below $220.00 which I think is far safer, long-term, than, say financials these days.

2008 Jul 27 11:57 AM

[RossQ:]

Used Vectorvest since 02 and love the software. I would just caution you as to the valuations or RV price. A lot of stocks like ECA, PBR and POT, RIMM, and ISRG (that were real winners) appeared overvalued by VST metrics. I missed early moves in those particular stocks. I know use growth to PE ratio instead of RV now, as along as Price remains less that 2x the growth rate I hold the stock.

2008 Jul 27 12:58 PM

[Urbane Gori...:]

Nicely thought out article...Just checking Stochastics over several time frames indicates to me that all these companies are bottoming (doesnt mean that can't drop more though!)...

I do have one quibble re: "the U.S., in its recent negotiations with India has signaled that it might cut farm subsidies. As another example, if the price of oil continues to fall, the U.S. may be less favorable toward biofuels."....

We're heading into election time. Who exactly is going to cut farm subsidies? We certainly expected the Democrat run congress to do so, but in fact, they certainly did not and in fact rushed it forward. As to biofuels.. The same would seem to apply. Both parties seem very interested in supporting this wasteful and inflationary business. (Buy ADM now while it's cheap ???? )

jegan ;-)

2008 Jul 27 03:12 PM

[strawtogold:]

Your ignorance of the supply and demand position and economics of potash is apparent. You also may not be aware but the world demand for potage exceeds capacity by several million tonnes per year. Worldwide inventories are barely existent. While selling 100% of its capacity at prices that have risen 300% this year (including the December price rise to $1000 per tonne), China has bought minute volumes as it has drawn down its inventory to practically nothing.

The U.S. corn market no longer drives potash volumes and prices though you continue to spout this mindless dribble. The return for potash to farmers, even with price increases, is 3:1. In the BRIC countries, it is about 8:1 (you really should read the POT website to learn about the company and its products). A decline in corn prices does not change the economics of using fertilizer.

Where in the world did you get your knowledge that Agrium and Mosaic might overproduce and adversely impact prices? Every company in the world is producing at capacity. Did you mention that in 2 years, POT will increase capacity by 30% and in 5 years by 80% - done faster and at lower costs?

You have an obligation to fully research your analyses. You have failed.

2008 Jul 27 03:17 PM

[Dan Schmeidler:]

Looking at the POT chart, I am going to have to agree with this article with respect to a potential downward POT stock move. A lot of the commodity stocks (granted, outside of the AG group), have recently visited their 200-day moving averages. Many experienced sharp and sudden declines from their 50-day averages. The recent sell-off in POT to just below its 50-day moving average, could be a sign of the markets setting itself up for a further downward move. Certainly, a move back up to $220 is a possibility, but then, market expectations would be to break a new high above $240. If a susbstantial move above $220 fails, look out below: $160. And who is not to say that the world's rampant carnivores, might opt for a healthier diet of fruits and vegetables for a while.

2008 Jul 27 04:49 PM

[TerminatorX:]

<<And who is not to say that the world's rampant carnivores, might opt for a healthier diet of fruits and vegetables for a while. >>

Guess what uses a large, large amount of potash per unit? Fruits & Vegetables. Potash has huge benefits for these crops, not in the least - taste!

And who says fruits and veggies are healthier than meat? It's actually been proven that it's less healthy, as long as the meat diet isn't just scarfed with reckless abandon.

2008 Jul 27 08:12 PM

[Dan Schmeidler:]

Yes, to some, meat is an essential component of the diet. But there are other ways to feed a global population than to rely soley on expensive fertilizer products. There is a supply story attached to it that has allowed Potash to profit massively from price increases. How high can Potash Corp. continue to push up its prices before countries such as China or India or going to find alternative solutions to feeding their people. Does this theme sound familiar? Look at what happened to the supply side of oil when it hit $140. It took weeks to figure out that inventories were starting to "fill" up, because everyone was so obsessed with the essential necessities to run the world on oil, no matter at what price. Well, price mattered in the end. And as oil dropped, no one wanted to get near it for about $20 to the down side, and still, more to go. I am not sure when potash and other fertilizer makers are going to run into this issue, but eventually, those empty warehouses are going to fill up with fertilizers if the ag group keeps raising their prices. Don't count on Q-3 to deliver on their earnings forecast, and don't count on the next quarter to be revised upwards once again.

2008 Jul 27 11:01 PM

[zorro2828:]

Well, after read the dribble, I have concluded the author knows little about world demand for FOOD! North Americans are without question very fortunate to have almost any food they wish anytime of the year. POT is a Company that facilitates production levels of food stuffs in a market where there are no substitutes.. they are the 1000 pound gorilla in the jungle... and as such, they are a screaming buy at sub $200 levels which will look like ancient history in less than a year... Yes, I am long POT and have been buying all last week .. see you at $400 in 18 months

2008 Jul 28 08:36 AM

[Judoguy:]

I am long POT.What we have here is variable speculation.The world will use ever increasing amounts of potash and they will pay more and more for it untill there is more available sometime I would guess in 2012-2014.Until then the stock will ebb and flow but ultimately be much higher.Most posts I read tell me they are written by guys who worry about a 5 or 10 dollar entry point when none of you look at the long -long term prospects.I"ve owned POT since 1989 and its returned around 5500% with divdends and splits. I started with 100 shares of POT and 100 shares of Agrium which Agrium sat for years doing very little but in time exploded as I knew there would be a global food sqeeze and these materials would needed in a big way. I regret to say the majority of postings I read are written by traders with microwave mentality who don"t have the vision to see simple future global trends that affect everyone.Hint All Humans Eat Drink Or Use Energy Water or Food every day! Either the commodity or the infrastructure in all these related themes will have enormous runs- be in them before they arrive not after- so you all won:t sound at times like impatient day traders .Above all do your homework look at the world what will people absolutely need do your homework buy sit be patient and you will be rewarded greatly.

2008 Jul 28 10:37 AM

[Deltaxray7:]

Apparently the new "Long" is measured in hours.....

2008 Jul 28 11:00 AM

[David Barsan:]

#4 is exactly why it seems to me that people misunderstand POT and other fertilizer companies. Let's say that you're scenario plays out, and they do cap it at 9 billion gallons, and corn prices come down. Do you think those corn farmers who now aren't going to plant as much corn will now plant NOTHING? Not likely....they'll plant something else, and use fertilizer to maximize the yield.

The stock price may well come down, but I just keep seeing that same argument used about 'if commodity prices come down then POT will be worse off'....that doesn't have any impact except as a self-fulfilling prophecy because people actually believe it.

2008 Jul 28 11:16 AM

[kulicow:]

I did my research, POT has been the best investment I've ever made. People need to eat & the world population is not getting any smaller. Every farmer is looking to get maximum yield per acre, no matter what they grow.
Bought Potash at close to the then 52 week high of $119 US.
I should have invested more.....If only I didn't invest in the duds my stock broker recommended!

2008 Aug 02 10:52 AM