Potash Corporation of Saskatchewan Inc. (TSX:POT)(NYSE:POT) has endured a difficult year, and investors are wondering if the selloff is overdone.
Let’s take a look at the current situation to see if the company deserves to be in your portfolio in 2016.
The fertilizer market stinks
Global demand for potash hit a record 61 million tonnes in 2014, and 2015 is expected to turn in similar results.
So why have Potash Corp.’s shares dropped 40% this year?
A number of events have hit the stock. The bad news started early in the year when the Saskatchewan government changed some tax rules, which had a negative effect on earnings for the year. The modification should have a lower impact in 2016.
The larger issue is weak potash prices. China and India managed to negotiate lower-priced supply contracts than initially expected, and spot prices have weakened through 2015.
The potash market is dominated by a handful of large producers who are stuck in a global battle for market share. This is driving down prices and hitting the bottom line of everyone in the group. At the moment, there isn’t much relief in sight.
As a response, Potash Corp. has decided to move forward the shutdown of an old facility and is reducing output at a number of its other mines. The move will reduce Q4 production by about 500,000 tonnes and hit fourth-quarter revenues.
Dividend sustainability
The slide in the stock has driven Potash Corp.’s dividend yield to 8%, and some pundits are concerned the distribution could be cut.
The company had to use cash on hand to cover a shortfall in the third quarter as operating cash flow wasn’t high enough to pay for the capital expenditures and the dividend.
Investors should expect another gap in Q4, and that will probably be covered using the company’s line of credit.
This situation is normal in the commodity space, but it can’t continue indefinitely. If fertilizer prices don’t improve by the second half of next year, the distribution could get trimmed.
Another issue for investors is the possibility of a new takeover bid for German competitor K+S AG. Potash Corp. abandoned a previous attempt, but another run is considered possible by some followers of the stock. If management decides to go that route, investors should expect the dividend to take a hit.
Is Potash Corp. a good buy?
The long-term prospects for the company look good, but the stock could remain under pressure through next year. Investors with a long-term perspective might want to start nibbling at current level in case the market begins to turn around, but Potash Corp. shouldn’t be bought purely for the yield.
