How to Dig Out the Real Meat From an Earnings Report
Neha is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
PotashCorp’s (NYSE: POT) first-quarter report was a pleasant surprise. Revenue as well as profits inched up on strong domestic demand for nutrients. It refueled the market’s interest in the stock – It has already gained more than 3% in less than a week since the earnings announcement.
Was everything really so good about PotashCorp’s numbers? Not quite. Ironically, investors of rival companies must feel greater excitement after PotashCorp’s report than those of the company itself!
Pressure on top
Mosaic (NYSE: MOS) had upped the ante for PotashCorp when it reported 63% year-on-year improvement in its last-quarter potash sales volumes, backed by solid demand from farmers ahead of the U.S. spring planting season. PotashCorp chimed in with a whopping 78% jump in potash volumes. But prices of the nutrient continue to trend lower, which is a concern.
PotashCorp’s realized $417 per metric tonne for potash in North America in the first quarter compared to $447 per MT in the fourth quarter. The downward trajectory in prices was evident in Mosaic’s last quarter as well – It reported a selling price of $385 per tonne for potash, down 13% sequentially.
In an earlier post, I had highlighted how low potash prices are exerting downward pressure on top lines of nutrient producers for several quarters. Investors should remember that the last quarter included supplies made to China and India at relatively higher prices under recently-signed contracts. That overall average prices were very low despite this proves how soft domestic prices are.
Though volumes helped both PotashCorp and Mosaic report good revenue growth, what’s worrisome is that sales will not be as high as the year progresses. That’s because this past quarter coincided with the peak buying season for farmers in North America which boosted demand. Latin America should hold the key for the second half, but by then the contract with China will be over, unless of course the nation extends it, which is an uncertainty. China represented 25% of Canpotex’s sales this past quarter. Canpotex is the three-member legal cartel that controls potash exports out of Saskatchewan, and includes PotashCorp, Mosaic, and Agrium (NYSE: AGU).
In fact, PotashCorp will continue keeping production well below full capacity this year till demand in the market aligns with excess supply. Mosaic’s potash plants also operated at just 78% capacity in the last quarter despite a busy season. That’s a sign that investors shouldn't expect much on top-line growth for either company this year. Moreover, demand as well as prices for phosphate, the other nutrient both companies deal in, remains weak in the absence of contracts from key market India. Mosaic is in deeper trouble as it gets 70% revenue from phosphate. In short, low price for nutrients is a headwind hard to ignore.
Pressure at the bottom
Fertilizer companies, particularly those specializing in nitrogen nutrient are worst hit when natural gas prices rise. Gas is a key input for them. A third of PotashCorp’s revenue depends on nitrogen, so there’s reason to worry. It’s actually a double whammy for PotashCorp. Unlike CF Industries (NYSE: CF) that’s a Midwest producer, PotashCorp sources gas largely from Trinidad where supplies have been unstable for some quarters, thereby adding significantly to PotashCorp’s costs. The first quarter was no different -- When gas prices hovered below the $4 mark, PotashCorp shelled out $6.1 per million British thermal units for gas.
The Trinidad factor is not only putting a squeeze on PotashCorp’s margins but also allowing peers to earn greater profits from the same business. So in the fourth quarter, while PotashCorp paid $7.01 per MMBTu, CF’s natural gas cost averaged just $3.61 per MMBtu. That’s a huge difference, something that could continue showing up in the near future. CF is about to report numbers in some days, and I expect its first-quarter gas cost to be well within $4 per MMBtu. Naturally, its margins should be better than PotashCorp’s. Bad news is that PotashCorp expects supply curtailments to continue through the year.
Who should be excited?
PotashCorp didn’t leave its investors with much to get excited about. They would have expected a brighter outlook after the better-than-expected quarter, but that was not to be. PotashCorp stuck to its earlier guidance of full-year earnings to be between $2.75 and $3.25 per share.
But yes, PotashCorp’s first-quarter report certainly leaves investors of peer companies with a lot to look forward to, especially from companies that are about to report numbers over the next few days, like CF Industries and Agrium. Both will report on May 8.
PotashCorp's high volumes for its namesake nutrient means CF should have done fantastically well in its last quarter because its core product nitrogen has much wider application than potash. PotashCorp also realized 12% higher prices for ammonia (a nitrogen product) in the first quarter. I strongly feel analysts are too pessimistic about CF with their forecasts of 4.6% lower revenue for the company. Likewise, the Street expects a 3% drop in Agrium’s first-quarter revenue year-on-year even though nitrogen is the highest contributor to Agrium’s largest division, retail. Through its wholesale division too, Agrium sells more nitrogen than potash and phosphate combined. Further, Agrium gets 10% revenue from potash. Taking these factors into account, I feel Agrium might be successful in proving analysts wrong with their tepid outlook.
So while investors of CF and Agrium have reasons to be excited, PotashCorp investors needn't sulk. Despite the headwinds, one thing’s clear: This will be a better year for the company than 2012, at least in terms of performance. Stock prices should ideally follow suit, which makes PotashCorp good enough to have on your stock watchlist. Click here to add it.
With less and less arable land available around the world, increasing yields from existing plots could become vitally important to keeping up with expected population growth. Cheap and effective fertilizers could be the key to achieving this goal. As the global leader in potash production, PotashCorp has established several barriers to entry that make it nearly impossible for competition to break through. Click here now to access The Motley Fool's premium research report that covers precisely what these barriers to entry are and details several other key reasons why PotashCorp presents such a compelling investment opportunity today.
Neha Chamaria has no position in any stocks mentioned. The Motley Fool owns shares of CF Industries Holdings. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!