Potash Corp. Of Saskatchewan - Dirt Cheap And Ready To Grow
Summary
- Potash Corp of Saskatchewan is the largest fertilizer company in the world and has operations in Canada where half of the world's potash reserves exist.
- A strong investment case can be made for investing in fertilizer companies based on macro trends such as population, longer lives, economic progress of EM population, and climate change.
- Earnings appear stagnant and stock is overly punished providing a great long term entry point.
Potash Corp of Saskatchewan (POT) is a fertilizer giant that mines, produces and sells industrial and feed products worldwide. The company operates in three segments: Potash, Nitrogen, and Phosphate.
Potash is a mined commodity and Potash Corp of Saskatchewan is well suited geographically to take advantage of the large reserves in Canada - which account for nearly half of the world's reserves.
(Source: Potash Corp IR)
Potash Corp is the largest fertilizer company and competes with Mosaic Co (MOS), CF Industries (CF), Agrium Inc (AGU), Israel Chemicals (ICL), Sociedad Quimica y Minera de Chile (SQM), Intrepid Potash Inc (IPI) etc.
Corporate Profile (from Yahoo! Finance)
Potash Corporation of Saskatchewan Inc., together with its subsidiaries, produces and sells fertilizers and related industrial and feed products worldwide. The company operates in three segments: Potash, Nitrogen, and Phosphate. It mines and produces potash, which is primarily used as fertilizer. The company also offers solid and liquid phosphate fertilizers; animal feed supplements; purified phosphoric acid, which is used in food products and industrial processes; hydrofluosilicic acid; and silicon tetrafluoride. In addition, it produces nitrogen fertilizers and nitrogen feed, as well as industrial products, including ammonia, urea, nitrogen solutions, ammonium nitrate, and nitric acid. The company owns and operates five potash mines in Saskatchewan and one potash mine in New Brunswick. It holds the right to mine 774,861 acres of land in Saskatchewan; and 58,263 acres of land in New Brunswick in Canada. The company sells its fertilizers to retailers, dealers, cooperatives, distributors, and other fertilizer producers; industrial products primarily to chemical product manufacturers; and feed products to feed manufacturers. Potash Corporation of Saskatchewan Inc. was founded in 1953 and is headquartered in Saskatoon, Canada.
The Case for Investing in Fertilizer Companies
The fertilizer industry provides an excellent opportunity for investors looking to benefit from large global macro-level trends. The world population continues to grow and with that comes the added stress on resources such as arable land, water table, pests and land overuse. In order to keep up with the demand of feeding the world, farmers have had to resort to using genetically modified crops coupled with liberal use of fertilizers.
There are plenty of reasons to be bullish about the fertilizer industry including:
- Rise in global population. According to UN, the global population is expected to expand to 9.5 billion by 2050 from the current 7 billion.
- Not only is the population growing, but humans are now living longer thanks to advances in healthcare. This puts added pressure on global food resources.
- Not only humans, but the demand from animals is also rising. As emerging economics grow richer (recently, China surpassed the US in the number of people who belong to the middle class), population shifts to eating a more protein heavy diet. Feeding the animals consumes more ag output - for e.g., according to the Economist, each kilogram of pork requires 6 kilograms of feed, which is usually processed soy or corn. Countries such as China are now the top consumers for grains that go into feeding both humans and animals.
- As global climate changes and water tables run dry, arable land is turning scarce and is seeing record purchases. Following charts show how the arable land per capita is expected to continue the decline we have observed over the decades. Coupled with the loss of renewable water for farming, this puts higher demand on agricultural and industrial purposes.
(Source: Potash Corp IR)
The Components of Fertilizer Industry
The three main components in the fertilizer industry are: Nitrogen, Phosphate and Potash. Together, they are popularly termed NPK. Detailed information about the use and target of each type of fertilizer and their respective commonly used product names in the industry can be found here.
The Fertilizer Companies
There are a lot of fertilizer companies in the world - but for the sake of this article, I consider the ten largest companies only.
The following chart lists the ten largest fertilizer companies in the world and provides a great perspective breakdown of which of the NPK elements each company focuses on. The Ammonia refers to Nitrogen, Phosphoric Acid refers to Phosphate, and KCI refers to Potash.
(Source: Potash Corp IR)
(Source: Created by author. Data from Google Finance)
(Source: Created by author. Data from Google Finance)
I present a more detailed fertilizer sector overview in this post.
The K+S Failed take over Bid
Earnings are Potash Corp are expected to be stagnant over the next five years growing only at 0.79% per year. This has caused POT to look towards M&A for fueling its earnings growth. Recently, POT launched a $8.7B hostile bid to take over Germany's K+S AG, which was rejected. POT has decided to drop that bid and move on for the time being.
Dividend Stock Analysis
Financials
Expected: A growing revenue, earnings per share and free cash flow year over year looking at a 10-year trend. A manageable amount of debt that can be serviced without affecting future operations.
(Source: Created by author. Data from Morningstar)
(Source: Created by author. Data from Morningstar)
Actual: Revenue and earnings have followed the economic cycle. Post financial crisis, as fuel prices rose, other commodities followed higher and companies such as Potash Corp were able to cash in with higher revenues and earnings.
The company's debt is manageable, has a debt/equity of 0.46. The debt schedule is detailed below.
(Source: Morningstar)
Dividends and Payout Ratios
Expected: A growing dividend outpacing inflation rates, with a dividend rate not too high (which might signal an upcoming cut). Low/Manageable payout ratio to indicate that the dividends can be raised comfortably in the future.
(Source: Created by author. Data from Morningstar)
Actual: Potash Corp currently yields ~7%, a very high yield for a company and has a high payout ratio as well - at 80.20%. The company has raised dividends for 4 consecutive years. The 1-, 3-, 5-, and 10-yr dividend growth CAGRs are 17.6%, 79.2%, 60.0%, and 37.4%.
Outstanding Shares
Expected: Either constant or decreasing number of outstanding shares. An increase in share count might signal that the company is diluting its ownership and running into financial trouble.
(Source: Created by author. Data from Morningstar)
Actual: Potash Corp has managed to reduce share count over the period of last ten years.
Book Value and Book Value Growth
Expected: Growing book value per share.
(Source: Created by author. Data from Morningstar)
Actual: The book value has steadily increased over the years although the trend is now seeing a reversal due to the fall in commodity prices.
Valuation
To determine the valuation, I use the Graham Number, Average Price-to-Earnings, Average Price-to-Sales, Dividend Discount (Gordon Growth Model) and Discounted Cash Flow. For details on the methodology, click here.
The Graham Number for Potash Corp with a book value per share of $10.88 and ttm EPS of $1.81 is $21.05.
POT's 5-year average P/E is 18.48 and the 10-year average P/E is 21.83. Based on the analyst earnings estimate of $1.67, we get a fair value of $30.86 (based on 5-year average) and $36.46 (based on 10-year average).
The average 5-year P/S is 4.86 and average 10-year P/S is 5.03. Revenue estimates for next year stand at $7.38 per share, giving a fair value of $35.88 and $37.14 based on 5- and 10-year averages, respectively.
The Gordon Growth Model is a quick way to calculate the fair value of a company using the current dividend, the expected dividend growth rate, and our required rate of return or discount rate. Using an expected rate of return of 10% and a dividend growth rate of 5%, we get a fair value of $33.40.
The consensus from analysts is that earnings will rise at 0.79% per year over the next five years. If we assume a number at 2% instead and assume that POT is growing its earnings by 5% thereafter, running the three-stage DCF analysis with a 10% discount rate (expected rate of return), we get a fair price of $25.17.
The following charts from F.A.S.T. Graphs provides a perspective on the valuation of POT. For details of how to read the graph, click here.
(Source: F.A.S.T. Graphs)
The chart above shows that POT is undervalued. The 3-5Y Estimates section of F.A.S.T. Graphs predicts that if the stock returns to a P/E valuation of 15, the 3-yr annualized return would be 27.12%!
(Source: F.A.S.T. Graphs)
Conclusion
Fertilizers play an important role in the economy as every human being (and feed animals) need to eat. The global trends of population, longer lives, economic progress of emerging markets, and added stress on arable land combined with reduced water resources make a strong case for fertilizer companies. Potash Corp is the largest company in the space and is based in Canada where half the world's potash reserves are to be found. The company has fallen lately following the tumble of the economic and commodity market cycle, and earnings are expected to be stagnant over the coming years. However, Potash has been looking for M&A to grow its earnings as noted in the recent K+S $8.7B bid. That bid failed, and Potash Corp is moving on for now. The company's stock has been punished severely by investors and looks attractive right now with a calculated fair value of $30.60 based on the metrics discussed above.
Disclosure: Long AGU. My full list of holdings is available here.
This article was written by
Disclosure: I am/we are long AGU. 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.