With Potash Corporation of Saskatchewan Inc. (TSX:POT)(NYSE:POT) down 42% year-to-date, investors are likely ready to look forward into the new year. Fortunately, there is much more reason for optimism in 2016.
The fact of the matter is, potash demand is in a secular uptrend. In the year 2000, global demand was 40 million tonnes. By 2005, it moved up to 50 million tonnes before hitting about 60 million tonnes the past few years. Now, Potash Corp. and many analyst groups are projecting demand of 70 million tonnes by 2020.
Potash demand typically does not decline because farmers realize the economic benefits of increased crop yields, and as a result demand is expected to head upwards in 2016. For Potash Corp.—the largest player by capacity—this is a positive as Potash Corp. has the capacity to meet growing demand and boost its volumes.
Why demand is headed upwards in 2016
It was widely publicized that 2015 was a weak year for potash demand, but this is not entirely true. Potash hit all-time record demand levels in 2014 (62.7 million tonnes), and while 2015’s drop to 58-59 million tonnes was widely seen as bearish, it is not as bearish as meets the eye.
This year’s shipment levels are actually the second highest on record, and many analysts believe that the significant drop off in shipments this year was not due to a major collapse in actual consumption, but rather to a drawdown of inventories, which were built up enormously in 2014 in response to low prices and strong demand from farmers.
In 2016, most analysts are expecting a rebound. Mosaic, for example, is predicting demand of 61-63 million tonnes, and the high end of this range would represent a new record. Potash Corp. is slightly less optimistic; it is expecting 60-62 million tonnes (which would be the second highest on record), and the International Fertilizer Association is expecting demand of 65 million tonnes, which would significantly exceed 2014’s record.
Are these forecasts reasonable? They seem to be. Potash still remains very affordable for farmers, as well as necessary, and farmers will need to apply potash to replenish potash that was lost due to recent record harvests as well as to meet growing demand for crops.
Currently, potash costs are 1.9% of crop revenue for farmers in China (which is less than the five-year average of about 2.5%), and in other key markets (such as Brazil and the U.S.) potash costs are only slightly above the five-year average, making it very affordable.
In addition to this, potash producer Mosaic estimates that inventories in key markets such as Brazil and the U.S. are low this year, which in turn could lead to some inventory building and increased demand.
What it means for Potash Corp.
The fact that Potash Corp. is the largest producer by capacity means that it is well suited to meet any increase in demand with increased production. Currently, Potash Corp. has an operating capacity of about 10.9 million tonnes. This year, Potash Corp. expects to produce nine million tonnes of potash or so, which means it still has plenty of capacity to use.
In 2016, Potash Corp.’s capacity will only grow. Its three million tonne Rocanville expansion is coming online in the second half of the year, which should add 1.5 million tonnes of total capacity in 2016. Potash Corp. will also add production at its New Brunswick operations, with total capacity for the entire organization reaching as high as 13 million tonnes in 2016.
This means Potash Corp. has plenty of room to ramp up production. Analysts at TD see Potash Corp.’s potash sales growing from nine million tonnes this year to 9.2 million tonnes next year, and if potash prices stay around the same levels, TD sees Potash Corp.’s earnings growing by 8% next year.
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Fool contributor Adam Mancini has no position in any stocks mentioned.