What Was Behind Uralkali's Move?

| About: Uralkali Jsc (URALL)

Yesterday, leading potash producer Uralkali (OTC:URALL) announced it was "going it alone" without traditional marketing partner Belaruskali. Uralkali merged with another Russian producer Silvinit, and combined, they sell their potash for export exclusively with Berlaruskali through Minsk-based Belarusian Potash Company (BPC).

What was behind the move, which roiled potash producer equities, worldwide? Is Uralkali going to make more money on its own? What is the prognosis for international potash prices?

I've watched Uralkali grow to become a modern, professional, mining and fertilizer production corporation over the past several years.

Uralkali earned $1.6 billion USD on $3.95 billion in revenues last year.

Uralkali earned a stunning 71% EBITDA margin. Operating cash flow before working capital changes was $2.3 billion USD.

The cash cost of its finished MOP (Muriate of Potash) production is reportedly $62/ton, but continuous investment and improvement is probably pushing this number down all the time. Of course, Uralkali has also benefited from a weak Russian ruble and a strong US dollar.

Uralkali spent $870 million in CAPEX in 2011 and 2012 combined, of which $415 million was required for maintenance. The other $455 million was for expansion increasing its potash capacity by 1.5 million tons. Comparatively a western potash producer is spending a budgeted $1.5 billion for 1 million tons of added capacity.

During these two years Uralkali paid out $800 million in dividends and launched a $1.64 billion share buyback, of which $1.25 billion had been completed just before yesterday's announcement.

Uralkali has shrunk its share count from 2.94 billion to 2.36 billion and one quarter of these are bundled as GDR's (5 ordinary shares each).

The company has been buying GDRs and ordinary shares back every month and up until recently was purchasing GDR's for $32.90-$33.73 USD.

Here is where it closed trading today on London and Moscow: $21.54 USD (6.4%) and 143.5 RUR (6.7%). One Russian ruble equals about 3 US cents.

Uralkali has achieved investment grade bond ratings from both Standard & Poor's (BBB-) and Moody's (Baa3).

Uralkali's potash production facilities include five mines, six potash plants and one carnallite plant, situated in the towns of Berezniki and Solikamsk, in the Perm Krai of Russia, to the south of the Ural Mountains.

Uralkali produced 9.1 million tons of KCL in 2012 with capacity of approximately 11.5 million tons, for an operating rate of about 79%.

Uralkali sold 9.4 million tons in 2012 - 7.3 million of which were exported and the other 2.1 million used domestically.

The company sold to a broad list of market areas - 78% were exports (China 26%, SE Asia and Latin America 13% each, Europe 11%, India 9%, US 5% and Other 1%).

22% were domestic sales and were 15% to Russian non-farmers (most likely NPK blenders and industrial users) and 7% to Russian farmers.

Now that Berezniki-4 has been completed, potash capacity has increased to 13 million tons.

Let's look at Uralkali's ex-partner, Belaruskali, and the sales entity which they use to jointly market their potash, Belarusian Potash Company.

BPC sold 13.5 million tons of potash for $5.6 billion USD in 2012, about $414/mt. Belaruskali's share was 6.4 million of that (47.4%) and Uralkali's share was 7.1 million (52.6%).

In 2011, BPC sold 12.9 million tons of potash for $5.3 billion USD, or about $410/mt. Belaruskali's share was 7.7 million (59.7%) but Uralkali only 5.2 million (40.3%).

I have looked at the Belaruskali website for several years, and it has never changed. I have its MOP production at 9 million tons per year.

The company says it has four mining and refining complexes in the Salihorsk (also called Soligorsk) city south of the capital Minsk in Belarus. Minsk has about 2 million of Belarus' 9.6 million population.

Belarus is a small country with GDP of about $150 billion.

It appears to me Belaruskali probably does not have the access to capital that Uralkali has to improve its mines and production processes and infrastructure. Its cost of production is probably higher than Uralkali's.

It is not clear to me who the owners of Belaruskali are, but I would not be surprised if they were controlled completely by the State. President Alexander Lukashenko has been in power many years, and probably runs the company, a major export earner for the country, as a personal fiefdom.

According to the website, Belaruskali improved one of the mines, and there was a project to add 1 million tons of NPK fertilizer capacity.

I imagine that Uralkali looked at its enlarged 13.0 million tons of capacity (planned to rise to 19 million) and wondered why it was sharing marketing with a smaller, inefficient and apparently untrustworthy partner.

Rather than accept its share of BPC's sales alone, Belaruskali was also selling potash outside of BPC to increase its revenues, which no doubt compounded the increasing feeling at Uralkali that it was married to a slacker rather than a climber.

Here are comments by Lukashenko made on July 22, a little over a week before Uralkali's bomb exploded into the global potash world.

It's a question mark whether Belaruskali would have accepted a smaller and smaller quota of BPC's sales allotment as the Uralkali production capacity grew.

Hence, Uralkali has chosen to "go it alone" and we have to take seriously the possibility it will be reluctant to join up with Belaruskali again. It probably decided a sharp lesson in the rule that the lowest cost producer eventually wins, might indeed teach the Belarusian company, and its masters, a lesson.

If the price of potash declines dramatically, Uralkali figures it will hurt high cost Belaruskali, and the finances of Belarus, a lot more than themselves. They've probably done the math.

As to the 33% drop in the Uralkali stock price over the past nine trading days (clearly the pending move was leaked), I feel the controlling shareholders will bite the bullet on that, and maybe buy back more shares, with the $400 million left in the program.

The highest cost potash producers would be most vulnerable to a lower international, outside of Belarus would be in Europe, and include Kali + Salz AG in Germany and Israel Chemical's operations in the UK.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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