Dividend Investors: Is the 7.5% Yield Safe at Potash Corporation of Saskatchewan Inc.?

Potash Corporation of Saskatchewan Inc. (TSX:POT)(NYSE:POT) has a juicy yield, but investors should be careful.

The Motley Fool

Potash Corporation of Saskatchewan Inc. (TSX:POT)(NYSE:POT) offers an attractive dividend, but the yield has risen to the point where investors are concerned that the distribution could be at risk.

Let’s take a look at the current situation to see if the company deserves to be in your portfolio.

Financials

Potash reports all of its results in U.S. dollars. Earnings for Q3 2015 came in at $282 million, or $0.34 per share. Operating cash flow for the quarter was $358 million and the company spent $333 million on capital outlays, so cash flow covered the capital program.

Dividends ate up another $313 million, so the company had to use up a large part of its $449 million in cash positions from the previous quarter to pay most of the dividends.

For the full year, Potash is expecting earnings to be $1.55-1.65 per share.

Market outlook

Global potash demand remains strong and total shipments for 2015 are expected to be just below the record 60 million tonnes hit in 2014.

However, prices have dropped significantly in the fertilizer space over the past six months. A global battle for market share is combining with weak U.S. demand and forcing suppliers to lower their rates. The market is actually weak enough now that producers are beginning to curb some output.

Potash has decided to fast-track the shutdown of one of its older mines and will temporarily halt production at other facilities to remove about 500,000 tonnes of supply from the market in the fourth quarter.

Weak prices for potash and nitrogen are expected to continue into 2016.

Dividend concerns

Cash flow is going to take a hit in Q4 and the outlook for 2016 is still sketchy.

Management recently scrapped its $8.7 billion bid to purchase German producer K+S AG. That is good news for investors because the company won’t put pressure on the balance sheet or dilute shareholders through a stock issue to pay for the deal.

Potash finished Q3 with $78 million in cash and cash equivalents and only has $3.7 billion in long-term debt, so the balance sheet is quite healthy and the company could tap its credit lines to cover a cash flow gap for a few quarters to pay the distributions.

Potash is also near the end of an extensive capital program, which means more of the funds from operations should be available for dividends in the coming years.

Potash pays a quarterly distribution of US$0.38 per share that yields 7.5%.

Should you buy?

The extent of the slump will determine the safety of the dividend. At this point, the distribution is probably safe, but management might decide to scale it back a bit if fertilizer prices remain weak in the second half of next year.

Potash is a major player with low production costs and nearly all of its future growth fully funded. The long-term demand outlook for fertilizers looks good, and the company’s stock is attractively priced right now. New investors should buy for the potential upside when the market recovers and treat the dividend as a bonus.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Andrew Walker owns shares of Potash Corporation.

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