Is Fertilizer Starting to Stink?

If you were Rip Van Winkle (or in a coma) and had looked at the stock price of Potash Corp of Saskatchewan (NYSE:POT) before you fell asleep on January 1 of this year, and then stretched your legs and checked the papers Wednesday, you wouldn't think there was much to this stock. Not much growth, no real action, nothing to see here. But of course, that wouldn't be the whole story, because while you were sleeping, you missed a hell of a ride. 

 Back in March, I wrote about the fertilizer market with its skyrocketing potash prices and crazy-high P/E ratios - with a nod to some pretty heavy volatility. Here's a little snapshot of the numbers from back then: 

	Agrium	Potash	Mosaic
Market Cap ($B)	10.3	50.52	45.62
P/E (ttm)	20.14	47.05	48.31
EPS (ttm)	3.24	3.403	2.13

 

Here's what those numbers look like today: 

	Agrium	Potash	Mosaic
Market Cap ($B)	10.9	43.1	35.5
P/E (ttm)	10.07	21.97	17.10
EPS (ttm)	6.86	6.44	4.67

 What happened?

As predicted, Potash Corp has reported some tremendous profits. The second quarter alone saw its earnings go up 220% - $905.1 million vs. $285.7 million the year before. As we suspected back in March, this was because they were able to lock in high prices, while there was increased demand due to larger crop plantings.

Globally, the fertilizer market remains concentrated and tight; in other words, a market ripe for rising prices. The largest potash-producing countries are Canada, Russia, Belarus and Germany. China has some of its own resources, but may face a shortage of up to 25% of its potash needs for this year and is looking to lock in contracts before any further price increases occur. Both China and Russia have implemented export tariffs to try and keep much-needed fertilizer products at home for domestic use.

Since January 1, Potash Corp.'s stock ran for almost double, from $120.24 on January 17 to $239.50 on June 17 - a price it was unable to sustain, and at a P/E ratio way ahead of most boom-boom tech stocks. Competitor Mosaic (NYSE:MOS) also doubled its stock price - going from $80.02 on January 18 to $161.08 on June 17.

No coincidence. Both stocks were running as hot knockoff agricultural commodity plays. But P/E ratios have come down by half all over the commodities markets, and the potash business has been no exception.

But there's more going on here than just the revaluation we saw in other commodity equity markets like coal, especially with regard to what happened in August. We tend not to spend a lot of time worrying about Canadian labor disputes down here in the U.S., but in this case, we do so to our peril.

In early August, close to 500 United Steelworkers union members walked off the job at three Potash Corp. mines after contract negotiations broke down. The workers had been without a contract since April. As of Monday, there weren't any talks scheduled between the union and the company. Potash Corp. has plans to increase capacity at their mines by 76% by 2012, and is still expecting to go forward with those expansion plans. Of course, increasing capacity without actual miners to turn that into capacity utilization ...

As of now, Potash has managed to start up one of the mines, at least in a limited fashion. While the strike has affected deliveries of the mineral to Potash Corp.'s industrial customers, farming season demand has yet to hit - look for headlines to scream of a potash shortage, and spot prices to rise, if the strike continues on into October. (That all could be good news for Mosaic, of course, which is the key competitor in terms of potash production.)

Many analysts are looking for a Potash comeback. Not a hard call, looking at the volatility of the stock, but it's difficult to say how much of the current drop is really about the event - the strike - and how much is a real reassessment of value of these old-economy stalwarts to a more stately P/E - say, one under 20, more in line with the historical norm for natural resources extractors.

Business Week/Standard & Poor's suggests that Potash Corp. is a strong buy, believing that high earnings per share will continue into 2009: higher potash prices, increasing fertilizer demand due to population growth, and increasing crop plantings. Morgan Stanley takes things a bit further, stating that this latest stock price slump of "Ag Names" is "unfounded."

My call? I'm not so sure. These companies are intrinsically tied to agricultural commodities, and with the recent slump in commodity prices, they could not hope to escape the bloodbath. Yes, prices will probably stay high, demand will remain strong and earnings will be great. But ultimately, how much of that is priced in, with P/Es back at historical norms?

It's like Arch Coal all over again.

Comments

[BxCapricorn:]

I don't know why you took the time to perform such a thorough analysis, only to come to a "I don't know what's going to happen from here" conclusion. It was easy for me today. BUY at $142, timeframe - long term. I'd buy more as commodity hedge funds collapse. We all know what's going on here. This is a trader's market.

2008 Sep 11 04:12 PM

[dwlima:]

"...but it's difficult to say how much of the current drop is really about the event - the strike" I would have to say none of the current drop is about the strike. POT's comparables (MOS, AGU, etc.) have declined a similar percentage and do not have laborers on strike. The fundamentals remain strong (supply coming on-line slowly compared to the rising demand) and the spot price for Potash has remained stable while input costs (energy) have decreased.

The stock's decline is due to the "protect the profits" mentality that is moving to a "stop the bleeding" mentality. In a situation where the float is large (no one in control), this type of stock action occurs. Until potash prices decrease significantly, this stock will rise significantly.

Last quarter the firm earned $2.82 per share and increased guidance. Assuming stable earnings at $2.82 per share, you have almost $12 per share per year in earnings or a P/E of 12. You mention historical P/Es, and you will see that POT historically traded with a P/E over 12.

2008 Sep 11 04:23 PM

[Will Bauer:]

Hmmm...gee...let's see...Provided potash prices remain high - and there is every reason to believe they will with Uralkali now plumping for a 2009 $1K/mt contract with China and the possibility that up to six per cent of world production (arising from POT's mines currently idled by the strike) is temporarily gone (until the strike ends) - if I wait a year, that puts POT's predicted profit per share at about $21 US (based on analyst estimates for 2009)...so a P/E of 15X trailing earnings would send the share price a year from now to over $300. Not only that, let's now add in a 2009 5% share buyback like 2008's or some purchasing of additional companies using 2008 profits (or both)...hmmm...that makes about $320/share. Sounds good - I'd take that bet...and I have. Better yet, if people actually start valuing POT like some of the ridiculous retail chains or credit card companies out there and it sells for 25 times *forward* earnings, things will go absolutely crazy (in a good way)...but I'm happy with the notion of $300/share based solely on the bet that the 9M or so Mt of world under-supply of potash keeps the 2009 price at ca. $1K/Mt. ...And this doesn't even start to account for their expansion in production capacity, some of which will be available for 2009/2010.
IMHO, POT is about as solid a winner as I've ever seen...with a very plausible growth scenario over the next four years...which is why people call it *investment*, as opposed to month-to-month, week-to-week, or day-to-day speculation.

2008 Sep 11 04:26 PM

[frs:]

It makes little sense to evaluate POT based on the ttm P/E. With the price of potash rising so dramatically over last years levels, and with the increased guidance from the company, the business is better evaluated by estimating the forward P/E. On that basis, this stock is a screaming buy.

2008 Sep 11 04:55 PM

[einstein p ...:]

The decision by Joy Global to buy back 2B dollars of their own shares may have been a game changer. There are a lot of companies like POT that are awash in cash and have visible earnings for the future. They may decide to put that cash to work and buy back their own shares or the shares of undervalued competitors. I agree, this stock is a strong buy.

2008 Sep 11 06:05 PM

[Tim Plaehn:]

During the recent pull down of financial stocks even those with zero exposure to the subprime or any other possible write downs were taken to prices that were 4 to 5 times earnings. That could happen if the fertilizers stay out of favor.

A month or so ago I stated here that I thought POT could go to $120. That was when it was just under $200. Seems well on its way!

2008 Sep 12 08:34 AM

[einstein p ...:]

Would have loved to have bought POT for $120.

2008 Sep 12 01:18 PM

[Urbane Gori...:]

einstein ..."Would have loved to have bought POT for $120"... meet me behind the school at 4PM... I'll let you have a lid for $30.... jegan ;-)

2008 Sep 12 03:25 PM

[daveddawg:]

With an ever growing world population, all ferts. are a case of finite supply and infinite demand. After a big runup, a correction is not surprising.Ferts. are the only "juice" that can make the finite supply of land feed the infinite population. Buy the dips and dont let the big boys shake you out of the tree. Look at CF for a stock with low float and lots of profits and cash.

2008 Sep 13 02:04 PM

[User 265012:]

Google Australian junior, Minemakers ltd.Auatralias largest undeveloped rockphosphate deposit, aiming to be in production 2010 ASX code MAK. Some potential DSO grades.Bargain shareprice.Listen to the latest Boardroom radio interview.Cheers, Good luck to all holders

2008 Sep 18 07:58 AM