Why This Fertilizer Giant Remains in Power Despite Weak Outlook
Neha is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Potash Corp’s (NYSE: POT) stock is trading at a three-month high—that after the company reported lower-than-expected profits and slashed its full-year outlook. Any stock would have tanked in such a situation, but Potash didn’t. Strange, is it?
Not really. The company’s second-quarter profits were lower because of a one-time impairment charge, and sales remained firm. Mr. Market seems intelligent enough to know what’s going to power Potash in the near future. Here’s what I think will work for the company.
Strengths to boast of
Potash deals in three top nutrients (potash, phosphate and nitrogen) applied by farmers and enjoys a distinct advantage because of two main reasons- leadership position and input cost benefit.
Potash is the world's biggest potash maker by capacity, and owns the highest stake in Canpotex, the three-member legal cartel that controls all potash exports out of Saskatchewan. Canpotex’s days this year might not have been as good as they were in 2011, but things are rolling. The good news is that at a time when an important market like India is yet to sign contracts this year (the situation continues to look dim as the nation stares at near-drought conditions), China and Latin America continue to import large amounts of nutrients.
The first contract from China came after a long gap this year. Shipments under the contract signed with Chinese agriculture giant Sinofert concluded in June, but talks are already underway for another contract, which should take care of shipments in the second half once it comes through.
As for Latin America, it accounted for 35% of Canpotex’s total shipments for the second quarter. The region, in fact, could be a savior for fertilizer companies in the second half of the year. Corn and soybean planting will get into full swing in the nation over the next two months, and June to August is generally the peak season when farmers shop for inputs. Brazil’s government recently said corn harvest will come in much higher than forecasted earlier. Quite obviously, soaring crop prices have come at the right time to incentivize farmers to boost seed and fertilizer purchases. Potash feels deficiencies of potassium in soil could further boost demand for potash from the region.
Expected weak corn yield from the U.S. could also encourage Latin American farmers to grow more. Large corn-feed consuming companies like Smithfield Foods and Pilgrim’s Pride are actually turning to Brazil for their corn requirements. Latin American corn is clearly in demand, and fertilizer makers like Potash should benefit from this.
Hopes at home
But it isn’t just Latin America that’s keeping Potash optimistic. It is unlikely that the prices of crops like corn will give up gains soon. If drought conditions lead to huge crop shortfalls in the U.S. (which seems likely), crop prices will remain at levels high enough to induce farmers to buy more nutrients to increase yields as fall application season approaches. The case is particularly bullish for nitrogen players. I’ll explain why.
The chances of farmers pulling out stunted corn not fit for harvesting are high this time. When they do, it has generally been observed that while nutrients like potash and phosphate may be retained in the soil (soon to be readied for next spring plantation), nitrogen gets absorbed quickly. Which means nitrogen needs to be re-applied every season—a factor that could boost demand during the upcoming fall season. This is one reason why Potash is expecting ‘significant fall fertilizer applications’ for nitrogen. And post-fall, the race for another spring season begins.
No wonder Agrium (NYSE: AGU) raised its earnings forecast and is breaking its own 52-week high records week-after-week. It sells more nitrogen than both potash and phosphate put together through its wholesale division. In such situations, one might argue that Agrium or CF Industries (NYSE: CF), which is the largest producer of nitrogen in North America, appear to be better bets than Potash. True, nitrogen has historically proven to be more profitable than the other two nutrients, but Potash might fare better than, say, Mosaic (NYSE: MOS) which doesn’t deal in nitrogen. Rock-bottom natural gas (key input for nitrogen fertilizer) prices are helping immensely too. Potash enjoyed high gross margins in its nitrogen division during the second quarter because of this, and should continue to do so as long as nat-gas prices remain low.
In better stead
The other advantage Potash has is in its phosphate division. While high prices for inputs like phosphate rock continue to be a pain for most fertilizer makers, Potash is one level up, as it mines 94% of its rock requirements. Further, phosphate volumes are firming up, and so are prices--as evident in Mosaic’s last quarter. CF Industries, too, expects the phosphate market to bounce back soon as demand improves.
Forget the near term, the fundamentals for the fertilizer industry anyway remain strong for the long run, and Potash is a solid bet for those who believe in the buy-and-hold strategy like I do. I strongly urge you to add Potash to your stock watchlist. Click here to add it.
Neha Chamaria has no positions in the stocks mentioned above. The Motley Fool owns shares of CF Industries Holdings. Motley Fool newsletter services recommend PotashCorp. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.