Sunday, 28 October 2012

Potash Corp - 2012 Third Quarter Update

Among the reasons that many investors prefer potash to other minerals and commodities is that it tends to be less volatile - in terms of both prices and volumes.  In many cases, that's true.  The potash industry, however, remains a lumpy business.  The soft results of the third quarter - EPS was $0.74, down from $0.94 in the year-ago quarter - are a result of demand lumpiness from both China and India.  Prices have remained quite firm, though, at $429 per tonne, in line with the second quarter, though down about 5% from a year ago.
In China, demand for seaborne potash has been weak in recent months, as the country meets in near-term needs by drawing down domestic inventories, as well as increasing purchases of more locally sourced production.  The Chinese are very shrewd negotiators, and some of their recent behavior is motivated by the desire to purchase fertilizer at lower prices.  Ultimately, however, Chinese demand for potash increases every year, and short-term tactics to gain negotiating leverage do not change the long-term supply-and-demand equation, which favors suppliers.  Potash Corp management - along with the other members of Canpotex - has elected to counter reduced demand with reduced supply, and pledged to continue doing so into next year, despite the ever-growing gulf between the company’s capacity and its actual production.

India poses a different and trickier problem.  Indian fertilizer buyers depend on heavy government subsidies.  The subsidy regime, though, has been reorganized in the past year, and now favors outlays on nitrogen-based products, at the cost of potash.  But Indian crops face a widening fertilizer imbalance, where the proportion of potash as a percentage of overall fertilizer inputs is far below the scientifically recommended number.  In consequence, India's yields are far below those enjoyed elsewhere in the world.  Over time, this problem will be corrected, but given the political element to it, how and when any remedial action plays out is unclear.
Happily for shareholders, potash demand is robust in virtually all areas outside of China and India, particularly in North America and Brazil.  Given that the two countries have a combined 2.5 billion mouths to feed, and relatively high food inflation, it’s only a matter of time before agreements are signed and potash shipments resume.

As Potash Corp moves closer to completing its large, long-running capex program, the company will begin to generate substantial amounts of free cash flow, especially compared to today's stock price.  Management recently approved a significant increase of the dividend, to $0.21 per quarter, a 2.1% dividend yield at the current share price.  Though significant, a dividend payout at that level leaves ample room for further dividend increases, share repurchases and acquisitions (management reaffirmed their long-term intention to take control of one or more of the companies that Potash Corp owns common stock positions in).
My original write-up on Potash Corp is here.

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