Potash Corp. Confirms Challenges Are Unlikely to Abate

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While Mosaic (NYSE:MOS) is more optimistic on the potash demand recovery in 2014, we think Potash Corp. of Saskatchewan’s (NYSE:POT) view of near-term potash market recovery is more realistic. Now that the China contract has settled at a lower price and buyers in other regions are re-emerging, we think potash prices have found a bottom. However, there are still obstacles for full recovery, including continued uncertainty regarding India demand, lower grain prices, and medium-term potash oversupply. Additionally, lower grain prices will remain a first-half 2014 headwind.

After adjusting the headline earnings per share for $60 million or 5 cents per share of onetime severance charges, Potash Corp. of Saskatchewan, the world’s largest fertilizer producer by market value, reported fourth-quarter 2013 adjusted earnings per share of 31 cents, slightly below consensus estimates of 32 cents. With the company’s full-year guidance, issued after the Chinese contracts are settled, the investors also got a reality check as to just how much a potash price level this low ($305 for first-half 2014 contracts) will impact earnings power.

Although the potash market remains challenged, as is evident from the quarterly results and 2014 guidance, there are still positives to take out for the coming year. POT’s potash operation costs are expected to drop as the company shifts production to lower-cost mines. Additionally, nitrogen volumes are trending well as the Geismar expansion ramps and gas curtailments at Trinidad are reduced.

Potash starts to flow with Chinese contracts

Canpotex, the offshore marketing agent for three of Saskatchewan’s largest potash producers, recently announced that it had signed a first-half 2014 seaborne import contract with Sinofert to supply 700,000 metric tons of potash. Although Canpotex did not specify the price per ton of the contract, it said that the contract was priced at “current and competitive market levels.” This would mean a price consistent with the contract signed by Uralkali (OTCMKTS:URALL) recently, at $305 per metric ton CFR, with a $20 per metric ton discount. This compares with 1 million metric tons of potash that Canpotex sold to Sinofert in first-half 2013 at a ticket price of $400 per metric ton.

For all three Canpotex stakeholders — POT, MOS, and Agrium (MOS) — the contract is largely a neutral event. The timing and pricing of the contract is largely consistent with investor expectations following Uralkali’s contract. “It’s a definitive price point that people can look at and use as some sort of floor price,” said Peter Prattas, a Toronto-based analyst at Cantor Fitzgerald LP. “Buyers have been waiting for something like this as a catalyst so they can start buying again.”

The contract size of 700,000 metric tons represents a modest headwind to first-half volume expectations given the decline from 2013. However, the tonnage is also below the 1 million metric ton minimum in the recent one-year MOU signed by Canpotex and Sinofert, likely ensuring another import contract in the second half of 2014 in contrast to second half of last year, when China did not sign a seaborne import contract.

India contract: next big catalyst

The next big catalyst for POT will be a contract with India. Although the China contract has set the potential price floor, uncertainty remains around the timing and pricing of the Indian contract. MOS expects Canpotex to sign the India contract by the end of April. Despite most analysts and investors focusing on the pricing implication, it is important to stress here that the volume number has much broader implications. The more optimistic analysts and companies including MOS are expecting a material rebound in year-over-year Indian volumes. However, any implied volume number below 4 million tons would make achieving industry volumes above 56 million tons quite difficult, particularly as recent contracts with China were signed at flat year-over-year levels.

Conclusion

One thing is clear from the quarterly results of all fertilizer companies: that the potash soap opera post-BPC breakup is far from over. There is limited visibility to a more meaningful recovery in emerging market demand, with POT lowering its industry shipment range to 55 million-57 million tons from 55 million-58 million tons. POT acknowledges that it could take the better part of five years before demand absorbs its expansion capacity that would drive a sustained uptick in industry utilization. However, POT balances a cautious potash market backdrop with a strong near-term commitment to return cash to shareholders.

POT has completed about one-third of its 43 million share buyback program, and management has indicated its desire to accelerate buybacks in first-half 2014 now that some level of normalcy has returned to fertilizer demand.The company has a high dividend yield of 4.2 percent. We believe that the performance of POT shares will be essentially range-bound until the market is convinced of sufficient growth in global potash demand to require greater capacity utilization and support higher prices.

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