Potash: Trying Another Deal Adds Risk

| About: Potash Corporation (POT)

Summary

Potash Corp. and Agrium confirmed the companies are in discussions of a merger of equals.

The deal faces regulator scrutiny, while not solving the market supply issues in the key potash fertilizer.

Potash now trades at a lofty level compared to the operations of the company without a fundamental shift in the sector that this proposed deal doesn't offer.

If at first you don't succeed, try, try again.

- William Hickson

This theory appears to be the mindset of Potash Corp. (NYSE:POT) as the fertilizer markets crash. My investment thesis predicted a few weeks back that the market picture didn't match the stock holding $16.

The company originally attempted to force a deal with K Plus S AG (OTCQX:KPLUY)(OTCQX:KPLUF) from Germany last year. With that deal never working out, Potash has apparently moved on to try another deal with Agrium (NYSE:AGU). The stock is up to $18 now where resistance has existed for most of 2016.

Deals

The basis of the K Plus S deal was to cut production of potash. The company had both high cost production areas in Germany and a new mine in Canada. The Legacy mine in Saskatchewan is on track for starting production by year end. The original goal was for the mine to reach annualized production of 2 million tonnes by the end of 2017.

With a merger, Potash Corp. could cut joint production and help stabilize the supply/demand scenario in the potash market. The Agrium deal is an interesting twist on this plot.

The company has a focus on retail stores as well as a position in the Canpotex marketing arrangement along with Potash and Mosaic (NYSE:MOS). The two already work together to control the pricing of potash, so a merger doesn't appear to add many benefits within the potash market.

As well, Agrium really isn't a big player in this fertilizer. The total potash market is forecasted at around 62.5 million tonnes for this year. While Potash suggests the operational capacity is around 66 million tonnes due to production cuts, Bloomberg Intelligence suggests the global capacity is closer to 82 million metric tons.

For 2016, Agrium only plans sales of 2.2 to 2.4 million tonnes. In comparison, Potash expects to sell 8.3 to 8.8 million tonnes of potash this year. The company has cut production down from the targets of closer of up to 9.7 million tonnes when 2015 started.

The whole amount produced by Agrium is ironically similar to the goal for the new Legacy mine. The difference is that Potash could've prevented that production from coming online and now any adjustments from an Agrium deal requires closing mines.

Will This One Work?

The market appears to think the deal is the answer to all the problems that ails both Potash and Agrium. The stocks are both up around 10% on the news of a potential deal.

POT Chart

POT data by YCharts

Analysts appear very mixed on the subject. Cowen's Amber Kanwar thinks the companies won't benefit from any capex reduction since neither have expansion projects.

Citi analyst P.J. Juvekar sees a merger benefiting Potash Corp. from the diversification away from reliance on potash. The analyst suggests the company can use the retail channel of Agrium to distribute potash for an approximate $50/mt of higher margins. Of course, this is in addition to the lower costs from synergies.

A potentially bigger issue is that farmers are already lining up to block the deal. Reuters suggests that several groups including Agricultural Producers Association of Saskatchewan and the American Soybean Association, amongst others, are lining up to oppose the deal, if it goes through. Despite a global market, the complaint centers around the new company controlling up to 60% of the potash production in North America.

The industry already appears rather consolidated to support regulators approving a deal. Maybe two Canadian companies in the key fertilizer segment with limited overlap will prove to the government the need to consolidate, but the deal appears to fringe on the same consolidation mindset that got several other big deals blocked recently.

Takeaway

The key investor takeaway is that Potash trades at an unjustified price level based on a flawed merger. The only reason to own the stock at these levels is a fundamental change in the potash sector and this proposed merger doesn't achieve that outcome. Not to mention, the benefits to Agrium don't appear to support the company jumping at any offer of a merger.

Steer clear of Potash Corp. with the risk mounting after the recent rally.

Disclosure: I/we 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.

Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.

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Tagged: , M&A, , Agricultural Chemicals, Canada
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