Yield-hungry investors are looking at Potash Corporation of Saskatchewan Inc. (TSX:POT)(NYSE:POT) and wondering if the fat dividend is sustainable.
Let’s take a look at the current situation to see if the name should be in your portfolio.
Market outlook
A quick look at global potash sales could easily lead one to believe that the industry is in good shape. Shipments in 2014 hit a record 61 million tonnes, and the 2015 number was expected to be pretty close to that amount.
However, the price of the commodity has been falling for the past six months.
Why?
The global potash market is controlled by a handful of producers who are embroiled in a worldwide battle for market share. That is putting pressure on prices in the spot market as well as on fixed-price supply contracts with major buyers such as India and China.
China’s 2015 price was US$315 per tonne. That could come down to US$300 per tonne or lower when all the haggling is done for the 2016 contract.
Cash flow concerns
In the third quarter Potash brought in operating cash flow of US$358 million and spent US$333 million on capital projects, so the business generated enough funds to keep the mines operating.
Potash reduced its production by 500,000 tonnes in the fourth quarter, which means investors should expect to see a hit to cash flow when the Q4 numbers come out.
Opportunities for consolidation
Tough times in commodity markets tend to produce merger and acquisition opportunities. Potash took a run at German competitor K+S AG in 2015, but the overtures were not well received, and Potash eventually abandoned the US$8.7 billion attempt. With the market in even worse shape now than it was six months ago, some pundits think Potash could make another bid for K+S. The long-term benefits are hotly debated, but the short-term impact would probably be negative for Potash’s shareholders.
Dividend risk
Potash now offers a yield of 9%. That looks pretty tempting, but investors should take a hard look at the numbers before jumping in for that reason. Operating cash flow didn’t cover the dividend in Q3 2015, and the Q4 gap will probably turn out to be even wider.
The company has sufficient access to cash, and a cut probably isn’t in the cards in the next quarter or two, but the trend isn’t a healthy one at the moment, and the rest of 2016 could be ugly.
If Potash tries to buy K+S and is successful, the dividend might be reduced.
Should you buy?
The short-term outlook isn’t great, but it’s often a good idea to be greedy when everyone else is fearful, especially when it comes to top companies in secular-growth sectors.
Potash is a low-cost producer in a market that is growing and will continue to do so. As population numbers climb, global demand for fertilizers will increase. This makes the stock an appealing buy-and-hold investment, but the dividend should be treated as a bonus in the near term.
Value investors might want to start nibbling. Income investors should be careful.
