Saturday, 28 July 2012

Potash Corp - 2012 Second Quater Update

Potash Corp recently reported what would have been record second quarter earnings, but for a write-down in one of the company’s common stock investments.  The year is likely to finish strong, and the company left earnings guidance unchanged, ignoring the effect of the earnings charge.  Business figures to strengthen further in the years to come, as well.

Recent drought conditions in the US have served as a reminder that food doesn't magically appear on people's plates - an obvious fact, but one that many often forget.  Supply shortfalls naturally elevate prices, and as the price of agricultural commodities increase, so does the demand for fertilizer.  Any forgone food production today will require increased fertilizer use in the future, over a multi-year time horizon.  Potash has the added benefit of helping to protect crops from stress, including weather-related troubles.
As the CEO of the industry's leading company, who also serves as the President of the International Fertilizer Industry Association, Bill Doyle has access to an imposing pair of soapboxes; when he speaks, people listen.  Though he is honest and plain-spoken, Doyle uses conference calls in part to maneuver and negotiate with  potash buyers, particularly China and India, the only major countries that buy on contract, with volumes and prices agreed upon before delivery (most buyers purchase their product as needed on the spot market).  He firmly stated on the conference call, for example, that potash prices will be heading upward, beginning now and extending for years to come.  But coming from Doyle this is not a passive prediction from someone sitting on the sidelines, it's a pledge that Potash Corp will be increasing prices.  Considering the industry's disciplined supply management, the newly diminished US crop, and the relentlessly increasing demand from hungry people, it's a safe bet that forthcoming price increases will stick.

However, Potash Corp announced that its capital expansion program is now expected to cost $8.2 billion, up from past estimates of $7.7 billion, thanks to the perverse incentives of cost-plus construction contracts.  While $500 million is a large number, even for a giant company, shareholders have a few reasons to at least feel ambivalent about the news.  For one, the new supply is still expected to arrive on schedule.  Second, with 78% of the capital expansions complete, there's a limit to future expenses.  And most importantly, it's an indication of the substantial cost, and technical difficulty, of bringing on new supply.  This is a plus for all incumbent producers, but is disappointing to would-be competitors that have never actually been in the challenging business of producing potash, and will not be immune themselves to the inflationary consequences of cost-plus work.
My original write-up on Potash Corp is here.

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