Shares of Potash Corporation of Saskatchewan Inc. (TSX:POT)(NYSE:POT) have fallen 40% in 2015, and the dividend now offers a yield of 8%.
Let’s take a look at the current situation to see if the fertilizer producer deserves to be in your portfolio.
Tough times in the fertilizer market
A quick look at global demand for potash would suggest things are rolling along nicely. Sales hit a record 61 million tonnes in 2014, and this year’s number is expected to be just shy of that total.
Unfortunately for Potash, the world’s largest producers are embroiled in a nasty battle for market share, and that has put pressure on prices. Weaker demand in the U.S. has also had a negative impact.
Potash is responding by moving forward the closing of an older facility and temporarily shutting down production at other sites. These moves are expected to lower Q4 production by 500,000 tonnes, which will have an impact on Q4 cash flow.
The situation is not expected to improve significantly in the first part of 2016.
Concerns about the dividend
The steep drop in the stock price has driven the yield on the dividend north of 8%, and that has investors concerned that the market is anticipating a cut to the distribution.
Potash pays a quarterly dividend of US$0.38 per share.
A look at the cash position and operating cash flow for the end of the third quarter suggests the payout might be at risk if weak market conditions persist for an extended period of time.
Potash reported Q3 2015 operating cash flow of US$358 million. The company spent US$333 million on capital projects, so cash flow is more than adequate to cover the investments needed to keep production on track.
Potash also paid out US$313 million in dividends during the quarter. The US$288 million shortfall had to come out of cash the company had in the bank. That’s still okay because the company didn’t have to borrow to pay the distribution, but the cash position at the end of Q3 was just US$78 million, so a similar cash flow gap in Q4 will have to be filled using the credit lines.
Acquisition wildcard
In early October, Potash dropped a US$8.7 billion bid for German competitor K+S AG. The move was a relief to shareholders because the company would have either saddled the balance sheet with debt or issued new stock to pay for the acquisition, which would have put the dividend at risk.
If management decides to use the slump in the market to take another run at K+S, investors should prepare for a reduction in the payout.
Should you buy?
Potash is a low-cost producer in an industry with very strong long-term growth potential. The world’s population is expected to increase from 7.3 billion in 2015 to 9.7 billion in 2050, according to projections by The Economist. With so many new mouths to feed, global farmers will need to use significantly more fertilizer to improve crop yields.
I wouldn’t buy the stock for the dividend yield, but Potash looks attractive right now as a long-term investment, and the distribution should be viewed as a bonus.
