About one month ago, Potash Corp. (POT) reported 2008 2nd quarter results. These results have inspired numerous articles and comments, all well worth reading, as well as the report itself.
Through these reports, it has become the practice of the CEO, William J. Doyle, to offer tremendous insights into his company, as well as the general industry trends in fertilizers.
This has resulted in a massive flow of information so strong and positive that it is difficult for anyone to digest it all in just one sitting. Therefore it seems best for all concerned to have many different articles written by many different people, in order to fully understand and appreciate what he is saying.
One set of numbers that some people may have missed concerns the projected 2008 gross margin increase. In relation to the previously announced price increases that are already in the pipeline for the remainder of 2008, he said,"We are now forecasting 2008 potash gross margin more than 300% higher than achieved in 2007," and "Our nitrogen and phosphate margins are now forecast to exceed 2007 levels by more than 85% and 200% respectively."
To better understand and appreciate what his words and numbers actually mean, it's necessary to go back to the year 2007 gross margin results for each segment, and work forward from there. These were 912.3 million for potash, 536.1 for nitrogen, and 432.8 for phosphate. These numbers must now get multiplied by their respective 2008 projected percentages to get 3649.2 for potash, 991.8 for nitrogen, and 1298.4 for phosphate. When added together, the projected 2008 total gross margin becomes 5939.4 million, or almost 6 billion, which is a 216% increase over the actual 2007 total gross margin of 1881.2 million.
Is this what has caused the recent 13 day, 20% sell-off in stock price from the close of 200.69 on July 23rd, the day before the report was issued, to the close of 160.91 on August 11th?
Or was it just a part of the 38 day, 33% sell-off from the June 17th all time record closing high of 239.5?
The year to date stock price increase at the close of the day, August 11th, 2008, was about 12%. Does this 12% increase accurately reflect a year on year projected 216% total gross margin increase? Or, am I supposed to believe that the numbers given were simply not good enough to justify the stock valuations?
Or, shall I conclude, once again, that investors simply don't understand what this company's stock is actually worth?
What I particularly like about this 216% number is that it reminds me a lot of another number, 201%, which is the 2007 stock price increase. While gross margins are only one type of measurement, and are not considered to be a reliable guide to appropriate stock valuations, I think that it is worth noting that the similarities are striking, and anything can happen in stock markets. But, let's all come back to earth and see if any of the 2nd quarter facts can actually support what are, after all, only forward looking statements.
The 2008 2nd quarter gross margin for potash was 886.4, which is 240% higher than 2007's 2nd quarter gross margin of 260.4. The 2008 1st half gross margin for potash was 1.4 billion which is 222% higher than 2007's 1st half gross margin of 434.6 million.Therefore, both the 2008 2nd quarter and 1st half factual percentages for potash gross margin increase more than support Mr. Doyle's 216% forward looking statement.
The 2008 2nd quarter gross margin for phosphate was 340.9, which is 252% higher than 2007's 2nd quarter gross margin of 96.8. The 2008 1st half gross margin for phosphate was 496.9, which is 209% higher than 2007's 1st half gross margin of 161.0 million. So the phosphate numbers for 2008, so far, also lend support to Mr. Doyle, and the future is looking more and more possible.
It should be mentioned here that the 2008 1st half gross margin for potash, 1.4 billion, has already surpassed the TOTAL 2007 gross margin for potash, 912.3, by 53%. Meanwhile, the 2008 1st half gross margin for phosphate, 496.9 has already surpassed the TOTAL 2007 gross margin for phosphate, 432.8, by 15%.Therefore both of these segments are already well on their way to meet Mr. Doyle's expectations.
Nitrogen is a somewhat different story, as Potash Corp. does not produce natural gas itself. It must buy it at market prices or through long term contracts. These activities resulted in 11.8 million in hedging gains, which somewhat offset the negative impact of higher priced natural gas, which was 76% higher YoY, 2nd quarter.
Even so, the nitrogen segment recorded a record 210.0 in 2008 2nd quarter gross margin, which is 46% higher than the 144.2 from 2007's 2nd quarter. This was in spite of 25% lower ammonia volumes, caused by a 53 day shutdown at their Trinidad 04 plant, a 31% drop in nitrogen solutions caused by the late spring, and restricted availability of production inputs.
In other words, the nitrogen segment had a challenging 2nd quarter, but still managed to do astoundingly well. The 2008 1st half gross margin for nitrogen was 395.4, which is 44% higher than the 2007 1st half gross margin of 275.5, and therefore also a record.
At this point, I would like to add that almost any CEO of almost any company outside of the agriculture sector would simply drool with envy at these kinds of results. If the nitrogen segment was spun off as a separate company, at an appropriate market valuation, it would be an excellent investment opportunity in itself. As it has the world's second largest capacity for agriculture nitrogen, as well as the world's largest capacity for industrial nitrogen, the nitrogen segment at Potash Corp. is no small matter, and will be covered in a future article.
However by "establishing a new standard of performance for the company," the nitrogen segment can't quite measure up to the high octane over-performance of both the potash and phosphate segments. This is what "held down" the 2008 2nd quarter total gross margin to 1.4 billion, which is a 187% increase over the 2007 2nd quarter total gross margin, of 501.4, for all three segments combined. The 2008 1st half total gross margin was 2.3 billion,which is 164% higher than the 2007 1st half total gross margin of 871.1, for all three segments combined. The 2008 1st half total gross margin has already exceeded the record FULL YEAR 2007 total gross margin of 1.9 billion by 21%, so there is not too far to go to reach 216%, and two whole quarters to get there.
In the pipeline, of course, is the revolving door effect of ever increasing prices for the potash, phosphate, and nitrogen contracts. These kick in during the third, and especially the fourth, quarter 2008 and beyond, as far as the eye can see. These agreed upon higher prices for the previously agreed upon volumes, modified by the projected costs, are what ultimately support Mr. Doyle's projected 2008 total gross margin increase of 216% at Potash Corp.
History will soon prove how much Mr. Doyle has UNDERSTATED the case.
Disclosure: Long on POT