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Should Investors Bet the Farm on Potash Corp./Saskatchewan Inc.?

As the world’s population continues to grow, a few problems emerge. Primarily, how are we going to feed all these people?

Certain solutions have already started to emerge, each with its own set of consequences. In South America, the Amazon rainforest is being cut down at an alarming pace so the land can be used to grow crops and raise cattle. Africa is starting to use more of its land to feed its people, depending less on imported food. Here in Canada, farmers have had a handful of consecutive good years thanks to cooperation from the weather, the continued improvement of genetically modified crops, and increased yields.

For the first time in years, farming has become a hot sector. Land values across the prairies have skyrocketed. Speculators with no farming experience are beginning to buy land to rent back to farmers. Foreign money is starting to enter the sector in a big way through official Canadian buyers, since foreigners can’t own Canadian farmland. People who had previously given up on the business are now entering it again, borrowing huge sums of money to buy land at record high prices.

Does this mean there’s a farm bubble? Or is this a sign of a farming bull market that’s only in its beginning stages? What does it mean for Potash Corp./Saskatchewan Inc. (TSX: POT)(NYSE: POT)?

The bull case

Currently, Potash is enjoying a solid year. It beat analysts’ expectations handily in its most recent quarter, coming in with a net income of $0.56 per share compared to expectations of $0.46. Revenue also beat the consensus, coming in at $1.89 billion compared to estimates of $1.68 billion. The stock was relatively flat on the earnings beat.

Plus, there’s the long-term bullish case on farming in general. Proper fertilization right after planting is perhaps the cheapest and easiest way for a farmer to increase crop yields. If times get tough, a farmer will cut back in other areas before cutting back on buying fertilizer.

The company is also taking care of shareholders. It currently pays out a generous 3.9% yield, which it has raised by a factor of five since 2011. The company is also aggressively buying back its own shares, taking more than 29 million of them off the table just in the first half of the year.

The bear case

There are a couple of things that could spell weakness for the company, the most obvious being the price of the underlying commodity.

In 2013, the stock crashed more than 25% on news that Uralkali, a Russian potash producer, was breaking away from the worldwide cartel that strictly controlled demand of the mineral. The news sent potash prices tumbling, which, in turn, hurt all the players involved. Eventually, the price of potash recovered.

This danger is always going to be there. What happens if another company breaks out of the cartel and doesn’t cap production? What happens if the Chinese — who aren’t in the cartel at all — decide to ramp up production even more? Demand is currently strong so these aren’t big issues, but they will become huge issues if overall demand slumps.

Here at home, Potash Corp./Saskatchewan Inc. and its peer Agrium Inc. (TSX: AGU)(NYSE: AGU) face another potential problem. As mentioned earlier, farming is a great business to be in. Canadian farmers are enjoying great crop yields, and are borrowing heavily to expand — but what happens if the party comes to an end? Just a couple of years of subpar production might be enough to chase these new johnny-come-lately farmers away, leaving abandoned land and a decreased demand for fertilizer.

Should you buy?

I’m a believer in the long-term farming trend. I’m just not sure this is a good time to pick up shares in Potash Corp./Saskatchewan Inc.. They’re still within 10% of their 52-week high, and the stock trades at a somewhat expensive 22 times earnings. I’d be more inclined to pick up the stock around 10% lower.

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Fool contributor Nelson Smith has no position in any stocks mentioned. The Motley Fool owns shares of PotashCorp. Agrium is a recommendation of Stock Advisor Canada.

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