It has not been the best year for Potash Corp. Saskatchewan Inc. (TSX:POT)(NYSE:POT). Shares are down 19% year-to-date (compared to 7.5% for the TSX), and prominent hedge fund investor Ray Dalio recently sold his entire 1.2 million share position in Potash Corp.
While there are definitely challenges for Potash Corp.—mainly an oversupplied potash market and soft economic growth from China—the market has been largely caught up in the short-term picture of potash, ignoring the extremely favourable mid and long-term fundamentals.
Outside of the macroeconomics, Potash Corp. itself is performing better than ever in terms of operating costs, free cash flow, the dividend, and growth opportunities. Here’s why the rewards going forward outweigh the risks.
The bearish case for Potash Corp.
The Potash Corp. bears are largely focused on the macroeconomics for potash prices, not Potash Corp. itself. Excess potash supply is one of the most cited issues.
Traditionally, over 70% of the potash market was controlled by two marketing cartels—the BPC cartel, and Canpotex (comprised of Potash Corp., Agrium Inc., and Mosaic Company). As a result, potash production was highly disciplined with a focus on maintaining prices.
In 2013, however, the BPC cartel broke up, resulting in the two constituent companies—Uralkali and Belaruskali—each producing at near-maximum capacity and pursuing a volume-over-price strategy. The end result? Potash prices plunged over $100 per tonne to below $300.
Currently, Belaruskali is still producing at near full-capacity as they attempt to gain market share in America, which adds some pressure to potash prices. Over the next few years, several new potash projects from various producers will add to the supply picture, and some of these major projects include two million tonnes from K+S Ag’s Legacy project, and an initial 4.6 million tonnes from Eurochem’s two Russian projects.
The bottom line is there will be no shortage of capacity going forward.
The long-term picture is very favourable
While there is sufficient supply, the long-term demand picture is favourable. Most importantly, the risk of oversupply is less than it seems. Just because a producer has available capacity does not necessarily mean they will use it.
A large chunk of the new supply coming online is from producers like Potash Corp. that are concerned about price, and this means that these producers will remain disciplined about production, which will in turn reduce the risk of oversupply occurring. This is possible because most potash supply is controlled by a small handful of very large players.
On the demand side, things look optimistic. Analysts at Morningstar expect demand to grow by 3.3% per year from now until 2020 compared with 2.7% from 2005-2015.
Over the long term, the trends of rising population, increased caloric intake from developed countries, and a shift to more protein-intensive diets will all add to the demand for fertilizers like potash. This is because the only ways to grow more food is either to increase arable land or increase the crop yields from available land.
Since arable land is limited, developing countries like China will need to use more potash fertilizer, of which, they currently under apply.
Potash Corp. itself is in good shape
Outside the macroeconomic picture, Potash Corp. itself is also doing well. Potash Corp. is currently the dominant global fertilizer producer, having 20% of available capacity, and controlling almost half of the new supply that is coming online.
In addition to this, Potash Corp. is also one of the lowest-cost producers, and is shifting production to its lowest-cost mines to further reduce costs. With its major Rocanville potash expansion completing, Potash Corp. is expecting $1.7 billion in free cash flow by 2017, and earnings will also grow at a solid pace as volumes increase. This will allow Potash Corp. to grow its already high dividend, buy back shares, or make acquisitions.
