For Potash Corporation of Saskatchewan (TSX:POT)(NYSE:POT), 2013 was a year to forget. The stock, which traded above $40 in late 2012, traded as low as $30 by mid-2013.
The big event was Russian rival Uralkali’s decision to withdraw from a marketing agreement with the Belarusians and pursue a volume-over-price strategy. The move sent potash prices from $400 per tonne down to $300. PotashCorp CEO Bill Doyle called the move “probably the single dumbest thing that I’ve ever seen”.
PotashCorp produces all three soil nutrients – potash, phosphates, and nitrogen – but is of course best known for being the world’s largest potash producer. The global potash market is extremely concentrated, with production limited to 12 countries.
Making the industry even more concentrated, PotashCorp has collaborated with its two main Canadian rivals, Mosaic (NYSE:MOS) and Agrium (TSX:AGU)(NYSE:AGU) to sell potash overseas through a single marketing agency, Canpotex.
Until last July, the world’s second and third largest producers were doing the same thing. But after Uralkali backed out, prices slumped. Buyers were also more timid, causing PotashCorp to miss sales volume estimates for the last two quarters of 2013.
Looking ahead, the future looks just as turbulent for PotashCorp. A major headline has been increasing industry supply on the horizon, especially from the world’s largest miner, BHP Billiton. Such developments could not only flood the market with excess capacity, but also undermine the pricing power of organizations like Canpotex. So why would anyone own shares of PotashCorp?
First of all, PotashCorp’s replacement value (the amount of money a rival would have to spend to replicate PotashCorp’s production) is over $50 per share, well above the current share price of $35. Replacement value can be a very useful metric for valuing commodity companies, partly because it isn’t overly sensitive to changes in the cycle.
The story gets better. PotashCorp is one of the industry’s low-cost producers, and the company has already taken steps to lower its cost of production by another $15-20 per tonne. Its production expansions, which began in 2003, are over 90% complete. The mines are very long life, deferring the need to make large capital expenditures in the future.
In the meantime, PotashCorp can return cash flow to shareholders. The company currently has a 4% dividend yield, and is also buying back shares. As long as the stock price stays near current levels, PotashCorp will likely complete its $2 billion buyback program by August. Mr. Doyle said on the last earnings call he finds the company’s shares “extraordinarily cheap”, thus making buybacks one of the best uses of cash flow now that the mine expansions are nearly complete.
Foolish bottom line
One of Mr. Doyle’s comments that everyone can agree on is that potash is a “notoriously difficult business to forecast”. Investors, be warned. Certainly, very few could have predicted that 2013 would turn out the way it did. But at $35 per share, PotashCorp offers plenty of upside for the risks involved.
