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Will Potash Corporation of Saskatchewan Inc. Rebound in 2016?

Potash Corporation of Saskatchewan Inc. (TSX:POT)(NYSE:POT) fell 40% in 2015, and investors are wondering if the stock is now oversold.

Let’s see how things are shaping up for 2016.

Potash market

Global potash shipments hit a record 61 million tonnes in 2014, and the 2015 report should indicate demand was pretty much in line with that number.

With strong global sales you might think the market is in good shape, but potash prices dropped significantly through the back half of 2015.

Why?

The wholesale potash market is dominated by a handful of global companies that are fighting a bitter battle for market share. The situation could continue for some time and spot prices for the fertilizer are not expected to recover in a meaningful way in the near term.

China and India are large buyers of potash, and the two countries negotiate supply contracts on an annual basis. Last year’s prices came in lower than expected, and investors should brace for similar or even weaker deals when the 2016 agreements are finally announced.

Cash flow outlook

Potash generated Q3 2015 operating cash flow of US$358 million and spent US$333 million on capital projects, so the company brought in more than enough cash to cover the costs of keeping the mines running.

In response to the tough market conditions, management decided to cut production by 500,000 tonnes in December of 2015. That is going to have an impact on cash flow for the quarter, and investors might see some ugly numbers when the year-end earnings statement comes out.

Growth ambitions

Last year, Potash made a US$8.7 billion bid for German competitor K+S AG. The overtures were not well received and Potash eventually abandoned the effort. Shareholders should be relieved that the deal didn’t go through, but some pundits speculate the story might not be over.

If Potash decided to take another run at K+S, investors should brace for some dividend pain.

Dividend safety

The rout in the stock price has driven Potash’s dividend yield to 8.5%. That looks pretty attractive, but investors should be careful buying the stock for its distribution.

Operating cash flow in Q3 2015 wasn’t adequate to cover the dividend payment, and Potash had to use savings to cover the gap. Another shortfall should be expected when the Q4 numbers come out.

Potash has ample credit line capacity to cover the difference, and the payout is probably safe if market conditions don’t deteriorate much further, but a renewed bid for K+S would change that scenario.

Potash would have to dilute shareholders through an equity issue or load up the balance sheet with debt to pay for the acquisition. If that happens before fertilizer prices recover, investors could see a dividend reduction.

Should you buy?

This year could be another rough year, and there probably isn’t a rush to buy the stock.

Having said that, Potash is a low-cost producer and most of its large capital expenditures are behind it. The long-term outlook for the fertilizer industry is very good, so Potash deserves to be on the radar of buy-and-hold investors.

I wouldn’t buy it purely for the dividend, but the stock looks attractive for its growth potential over the next 20 years, and contrarian investors might want to consider adding the name on further weakness.

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Fool contributor Andrew Walker owns shares of Potash Corporation.

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