Potash Corporation of Saskatchewan (POT) announced today that its earnings guidance for the present year will fall below the low end of previously announced range of $2.80 to $3.20, due to a delay in new contracts with India and China. However, we believe this news has already been priced in to the stock and doesn't change our bullish view on Potash.
POT is a well positioned fertilizer stock. It is one of the largest producers of low cost potash, which is the nutrient (the key macro nutrients are potash, nitrogen, and phospate) with the highest margin. At low cost, it also controls one of the largest potential potash expansions. It is also the third largest producer of nitrogen and phosphate.
The poor agriculture output around the globe has resulted in a decline in food supplies. More plantations are expected next year to fill this gap between the demand and output and POT is well positioned to benefit from this situation. The weak agricultural supply can be attributed to droughts in the U.S., Australia, and Russia and poor monsoon rains in India.
In response to a recent U.S. government report, corn futures surged to a three-week high as global corn inventories are set to drop more than expected. This will not only result in higher income for farmers, but also higher demand for fertilizers as the farmers will fill the shortage with more plantations. On the other hand, food demand is rising in the world due to rising populations and increase in the middle class of India, China, and other emerging economies. This will again benefit POT as more food demand means more use of fertilizers.
POT is the world's largest publicly traded potash producer. Its potash reserves amount to over 100 years of production. The company controls the majority of the world's excess capacity and has always followed a price leadership strategy whereby it has matched production to sales. Potash Corporation is also the world's third-largest phosphate and nitrogen producer. Current phosphate reserves should last more than 50 years.
Prior Quarter Earnings Highlights
Potash reported Q2 earnings of $0.60 per share amounting to total earnings of $552 million. Excluding the impact of Sinofer impairment, its earnings were in line with analysts' expectations. The earnings were lower compared to the same period last year when POT reported earnings of $0.96 per share. The following charges affected Q2 2012 results significantly:
- Impairment charge of $341 million ($0.39 per share) for investment in Sinofert Holdings Limited, which was the most significant of the expenditures.
- A $29 million charge related to the phosphate segment.
However, if we take out the one time impact of Sinofert Holdings, POT reported earnings of almost $1 a share. Exceptional offshore potash demand and record contribution from the company's nitrogen business helped POT report not only a better gross margin than what it reported for the same quarter last year, but also its third best quarterly gross profit of $1.2.
POT has a consensus recommendation of outperform. Out of 28 sell side analysts, 14 have a buy recommendation and three have a strong buy recommendation; only one has an underperform recommendation. Our target price of $54, based on trailing P/E and next year's earnings expectations, shows an upside potential of as much as 29%.
POT is trading at a relatively high P/E of 11.2 times, but compared to its peers it offers a very attractive dividend yield of 2% with a payout ratio of 12%, along with enjoying higher margins. It reported a higher operating profit margin than both The Mosaic Company (MOS) and Agrium Inc. (AGU), with only CF Industries Holdings (CF) reporting a higher operating profit margin. Its profit margin of 32% is higher than all of its peers. Although the stock has declined 4.5% YTD, but as discussed earlier, it has an upside potential as high as 25%. It also has a long-term earnings growth rate of almost 11%, higher than all its competitors.
CF Industries Holdings
The Mosaic Company
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Share price Performance (YTD)
September North American potash inventory decreased 3% from August, by approximately 73,000 tonnes, resulting in an inventory of about 2.3 million tones. Even after this decrease, the inventory remains 39% above the five-year average and 39% above 2011 levels. The inventory swell can be attributed to the gap between production and shipments, with delays in shipment contracts with key export markets of China and India. The sequential increase was also likely driven by an increase in demand for U.S. fall applications, as is the typical seasonal trend.
The following considerations may impact POT share performance in future.
Crop prices: Crop prices influence farm plantings. Should crop prices rise/decline for an extended period of time due to moderating consumption or rising crop stockpiles, fertilizer demand is also likely to rise/decline with farm revenues.
Industry production capacity: Fertilizers are commodity inputs serving commodity crop markets, and supply/demand balances ultimately determine profitability. While industry conditions remain relatively tight for potash, if supply outpaces demand growth, prices are likely to decline.
Natural gas and other input costs: Natural gas is the primary input in the production of nitrogen products. Any decline in natural gas prices is likely to help Potash and vice versa. In addition, any surge in grain prices due to supply shortfalls or unanticipated demand strength would positively impact POT.
In conclusion, potential risks to our analysis include decline in global crop prices, oversupply of key fertilizer nutrients (potash, phosphate, and nitrogen), and deterioration in the global macroeconomic environment. In such cases we might see a downward pressure on stock price in the short term, but POT still remains a very attractive long-term investment.