Potash Corporation of Saskatchewan Inc. (TSX:POT)(NYSE:POT) currently pays out a huge $1.2 billion dividend annually, which works out to a yield of about 6.4%. With Potash Corp.’s average selling price for potash in the third quarter falling 11% from last year, however, worry about the sustainability of the dividend is increasing.
Potash prices have been in a free fall in nearly every market since 2013, and prices are approaching levels where the company will no longer be able to support its current dividend as well as its ongoing maintenance capital expenditures.
Should investors be worried?
At the end of the day, Potash Corp.’s dividend depends on two major factors—potash sales and volumes, and ongoing capital and operating expenses. Here’s what needs to happen on each of these fronts to make Potash Corp. cut their dividend.
Potash prices would need to decline by over 10% more
The number one factor determining the future of the dividend is Potash Corp.’s selling price as well as the volume sold. Potash contributes about 58% to total gross margins.
Recently, Potash Corp. released a report that stated that their dividend would be safe with average realized selling prices all the way down to $200 per tonne. Current realized prices are $250 per tonne, which means potash prices need to fall 20% before any risk is present.
However, Potash Corp. made some big assumptions with these calculations. They assumed they would be selling 10 million tonnes annually. Their recent guidance is projecting 9-9.2 million tonnes for 2015. Never in Potash Corp.’s history have they sold 10 million tonnes.
With most analysts expecting 2016 global potash shipments to be similar to this year or slightly higher, it is reasonable to assume that Potash Corp. will have sales volumes in the 9-9.5 million tonne range in 2016.
The end result is that Potash Corp. will likely need prices to be higher than $200 per tonne in order to maintain their dividend. How much higher? Assuming they sell 9.5 million tonnes, they would need prices of about $225 per tonne to sustain their dividend, according to analysts at TD Bank.
The big question then becomes, How likely are potash prices of $225 per tonne? Potash Corp. seems to think a price move towards the $200 level is a very unlikely outcome, and they may very well be correct.
While there is a decent amount of supply slated to come online before 2023 (about 15.7 million tonnes, which is significant considering global shipments this year are expected to be 59 million tonnes), much of this supply will not start to come online until 2017. In the meantime, demand has time to catch up, and many producers are cutting back production.
Potash Corp. itself just reduced its production by about 500,000 tonnes; Mosaic announced production cuts; so did European producer Uralkali. The fact the potash market is still controlled by a few players means they are disciplined on production, and this should support prices.
On the demand side, things also look healthy. Global shipments for 2015 are actually the second highest ever recorded, despite the fact that currencies are weak in key importing nations and crop prices have collapsed, which reduces farmer income. In Brazil—Potash Corp.’s biggest offshore customer—they are expecting the second-best year in history for fertilizer demand despite numerous headwinds.
Farmers will need to reapply potash at higher rates due to the nutrients being removed from the soil after 2014’s record global harvests, and fertilizer is still affordable for farmers. These factors should prevent prices from dropping to $225 per tonne.
Potash Corp. would need to fail at reducing its capital spending
In addition to prices falling, Potash Corp. would also need to have its capital spending remain at current levels to see a dividend cut. Fortunately, this is unlikely.
The company is expecting its capital expenditures to drop from around $1.1 billion this year to about $800 million in 2016. This drop will support the dividend, and the decline comes from the fact that Potash Corp. is completing several major projects, including their $2.8 billion Rocanville mine.
Things have been going according to plan and, unless major issues emerge, capital expenses should continue to fall.