On January 28, for the first time since its 1989 IPO, Potash Corporation of Saskatchewan Inc. (TSX:POT)(NYSE:POT) cut its dividend. The company is dropping its payout by roughly 34% to $0.25 a share. While reduced, this still results in a yield of roughly 6.4%.
The cut may represent troubles to come, however. On its most recent conference call, management said that “weaker fertilizer prices late in the year reduced earnings for the quarter, giving rise to a more cautious outlook for all three nutrients as we begin 2016.” Sales volumes in the fourth quarter fell 31% with the average realized potash price falling to $238 per metric tonne from $284 a year earlier.
While the macro backdrop is seemingly poor, reducing the dividend should provide excess cash to invest in other ventures. “We looked at it from a point of remaining flexible enough that we can contemplate other opportunities,” said Jochen Tilk, the company’s CEO. One of those opportunities may eventually create major long-term value for shareholders.
With shares down 57% in the past 12 months, a stock buyback could amplify shareholder returns if conditions rebound. Potash Corporation is no stranger to buybacks either. Management has instituted multiple programs over the last 10 years, cumulatively reducing the share count by over 20%.
The CEO specifically mentioned buybacks on the conference call, but they would only add value if business conditions improve long term. Today many argue that the company’s outlook is the worst it’s been in decades, and the recent dividend cut is but a precursor of financial pressures to come.
A rocky future
“The real story is how poor 2016 guidance is due to weak potash fundamentals, and a 34% dividend cut may not be deep enough,” says Joel Jackson, an analyst at Bank of Montreal.
Potash Corporation itself is forecasting 2016 earnings to be $0.90-1.20 per share, potentially the smallest profit in over a decade. With dividend payments totaling $1.00 a share, things don’t have to deteriorate much for it to be in danger again, especially with $800-900 million still needed for capital expenditures.
The biggest detractor stems from falling Chinese demand. This year China is expected to demand only 14 million tonnes of potash, down from an already depressed level of 16 million tonnes last year. With China being the biggest consumer of potash in the world by far, permanently slower growth there could upend the entire market for years to come.
That’s not the only issue. The biggest decline in sales volume for 2015 actually came in North America. Growing foreign imports are providing strong competition at cheaper prices, while three years of bumper crops have pressured most agricultural commodities, limiting farmers’ fertilizer budgets.
While you may be tempted into thinking the current dividend is safe after the recent cut, it’s likely that it will be lowered again. Potash Corporation continues to lose market share in a shrinking market that’s experiencing rapidly declining prices. The factors driving poor conditions, namely foreign competition and slowing Chinese demand, won’t fade anytime soon.
Perhaps after another cut or two, when shares get punished even more, things will get interesting. For now, it’s best to stick to the sidelines.