Solid Long-Term Fundamentals Remain Intact At Potash

| About: Nutrien Ltd. (NTR)
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Near-term headwinds persist at fertilizer giant Potash (POT), which reported a mixed bag in its third quarter results Thursday morning. The Canadian firm saw revenue fall 8% year-over-year to $2.1 billion, slightly better than consensus expectations. Earnings per share slid 22% year-over-year to $0.74, which was worse than consensus estimates.

Potash (the product) sales tumbled 10% year-over-year to $887 million, the result of declining prices and slumping orders from India and China. Total tonnage sales in North America increased 25% year-over-year to 1.0 million tons, as farmers have continued to invest in fertilizer to compensate for lower yields resulting from poor growing conditions in the US. Sales in Latin America also remained brisk, growing year-over-year driven by strength in Brazil and the anticipation of record corn plantings. The company warns that both regions will likely shift shipment timing in order to avoid distribution congestion, which will result in a smoothing of revenue. We doubt it will negatively impact overall results, though it could alter short-term financial performance.

Disagreements with China and India with respect to new supply contracts continue to weigh on the firm's performance in Asia. Tonnage in both regions fell year-over-year, and the short-term picture remains particularly vague in India. China simply wants to pay lower prices for potash, even though demand for potash in the growing nation continues to surge. The country has been relying on inventories, rail-bound delivery, and domestic production to meet these needs, but the firm believes additional supply will be needed-the only question is when. Management also gave excellent granularity with respect to the situation in China, where government subsidies incentivize nitrogen consumption in lieu of potash. The company seems less optimistic that the situation will turn positive in the near-term, though it expects private sector pressures to eventually force the government's hand.

Overall, the potash segment saw profitability fall substantially, as gross margins per metric ton fell 17% year-over-year to $269. With prices down 5% and input costs rising, it appears as though profitability growth will remain challenged.

Nitrogen sales remained relatively strong, increasing 3% year-over-year to $589 million. However gross profit fell 5% to $251 million as a result of higher natural gas and ammonia prices. Nitrogen demand remains relatively stable, and management hinted that we should see nice gross margin upside in the first quarter of 2013, which we think is achievable given the tremendous decline we've seen in the price of natural gas through 2012.

Looking ahead, the firm reduced its full-year earnings outlook to $2.40-$2.60 from its previous range of $2.80-$3.20. Potash gross profits look to be much lower than previously forecasted, coming in at $2.1 billion to $2.3 billion compared to the previous estimates of $2.6 billion to $2.8 billion. This estimate reflects reduced tonnage as a result of supply-agreement "timing" with China and India, which remain significant headwinds in the near-term. We suspect these issues to subside in the long-term, as the economics of agriculture dictate continued demand for potash. Phosphate and nitrogen profit expectations were reduced to the range of $1.3 billion to $1.5 billion from the firm's previous guidance of $1.4 billion to $1.6 billion.

Overall, we thought the quarter was decent, but certainly not great given the lack of agreement between the major North American fertilizer suppliers and the two developing Asian nations. Still, we think shares are fairly valued at current levels (click here to learn about our valuation process), as commodity producers like Potash require wide margins of safety: The Importance of Using a Margin of Safety. We like the long-term fundamentals of global agriculture, but not enough to get excited at current levels.

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.