POT - Potash Corporation

[myvalueedge]

Packer - I am certain the smaller, regional players may provide more upside like Intrepid Potash.  POT is attractive imo for the 20% global capacity, higher gross margins, tail end of $8B CAPEX to expand potash capacity, exposure to phosphate and nitrogen markets.  Shipping costs play a part, but I am not certain what the margin hit is to the various destinations.

 

I believe POT supplies over 30% of the potash to the North American market and can garner a slight premium from prices overseas.

[no_free_lunch]

I still the think the break-up of the cartel is noise.  BHP is about to make it's decision on jansen, I think these are just scare tactics.  Why would Uralkali tell the market that prices are going down otherwise?  These articles make it sound like the russian oligopoly was this disciplined force in holding prices up but I think they were always shipping close to capacity.

 

I think mosaic is as good a play.  They benefit as much as potash corp from the sask government.  Ultimately the sask government will, I suspect, just do what is best for the province.  Mosaic's mines are in the province so are potash corp's, I don't think we need made a distinction.

 

The huge wild card is still jansen.  I just don't see how there is room for all these expansions by the current players and then another 8M+ tons from BHP.  For that reason I would probably invest via options.

[alertmeipp]

I think POT is better if one think the recent event is just noise. Nice dividend and strong buyback program. If they execute on the the buyback and the potash price doesn't collapse, things will be nice.

 

 

[no_free_lunch]

Packer, within North America the shipping costs between the domestic producers are going to be similar.  Given the higher margins I don't think they are significant enough to play a major factor.  Shipping to China, they can't compete with uralkali which it sounds like (from one of the articles above) can ship by rail.  I am not sure who has the upper hand to brazil.

[moore_capital54]

I still the think the break-up of the cartel is noise.  BHP is about to make it's decision on jansen, I think these are just scare tactics.  Why would Uralkali tell the market that prices are going down otherwise?  These articles make it sound like the russian oligopoly was this disciplined force in holding prices up but I think they were always shipping close to capacity.

 

I think mosaic is as good a play.  They benefit as much as potash corp from the sask government.  Ultimately the sask government will, I suspect, just do what is best for the province.  Mosaic's mines are in the province so are potash corp's, I don't think we need made a distinction.

 

The huge wild card is still jansen.  I just don't see how there is room for all these expansions by the current players and then another 8M+ tons from BHP.  For that reason I would probably invest via options.

 

Agreed we bought some POT this week! Cheers.

[SharperDingaan]

We do not have a position in POT, as we expect a further material decline in the price over the coming months.

 

We think the Uralkali announcement is real, & that the intent is to ultimately reset the market share of cartel members via a new cartel 18-24 months out. The cartel cannot function unless it can restrict supply, & to do so - it needs the new capacity resolved via a market solution.

 

If we are correct, we expect rapid & ruthless price cutting to force the industry down to the lowest sustainable marginal cost. Mines either get replaced or cancelled, the industry takes $ multi-billion write-downs, & dividends get cut. Senior managements get replaced, & customers (China) stock-pile.

 

New managements, & the cartel gets reinstated - with the market share as at time of reinstatement. Higher profitability funds industry consolidation, sets the cartel partners, & locks up the outstanding deposits. Business as normal, & all the supply overhang issues answered.

 

Obviously .... this is not good news for a current POT investor. The big questions are ....

(1) How probable is the scenario (...70%+)

(2) How uncertain are the steps (...15%+)

 

Don't be shy!

 

 

[no_free_lunch]

Sharper, I agree with you that this is the most likely scenario.  I thought they were just posturing but your view is they are going to let things play out with a longer term game in mind.  It's entirely possible but then again the russians have always seemed more  short-sighted than that. 

 

I hadn't thought of market shares changing but it is a good point.

 

I am not sure of probabilities but I do believe that BHP will go through with things.  This will be destructive if it happens.  I saw a quote from the BHP CEO just a few days ago that they are committed to the future demands from china, they listed a few products and potash was on the list.

 

I have heard speculation that BHP's goal in all of this is to drive this industry consolidation with them being the ones to consolidate.  They weren't allowed to buy potashcorp before, but what about when it is on the ropes? 

 

It is difficult to see how you can continue to sell a product that costs $100 per ton (even less for uralkali) at $400-$1000 per ton.  Basic economics says this will result in increased supply and a crash in prices.  Which is where we are at today.

 

I do see the possibility that BHP doesn't go through with Jansen, that there is crop failure, who knows and that there is a sudden spike in the potash producers.  That is why I might be tempted to buy some options.  However, the premium is quite high so I am not let willing to take the bait.

[no_free_lunch]

One thing I forgot.  The only place where consolidation can really happen is with the canadian producers.  Most of the other producers are in countries where they are they are the only producer, the government is going to block the takeover.  However in Canada, there are 3 producers correct (agrium, mosaic, potashcorp).  I think mosaic is an american company and potashcorp is listed on the nyse.  So while in the past the government has blocked a sale here, it isn't guaranteed to always go that way.  If BHP was willing to make certain commitments they could probably make an acquisition.  I am thinking though, that given it's american status maybe mosaic would be an easier takeover.

[LC]

Had a small position in POT that I sold for a loss. Shouldn't really have purchased it in the first place but I was going through a Malthusian period :D

 

Essentially the fundamental investment thesis changed, and I have no idea whether it is a temporary issue or permanent.

[SharperDingaan]

We assigned the high probability as we see it as being both in the Russian (Supply), BHP (Supply) & Chinese interest (Demand). Jensen needs a long term take-or-pay contract, this is how China typically establishes its long term commodity supply (pulp, coal, etc.), & it means a increase in total supply - & therefore a reduction in the cartels current price of potash.

 

The cartel price will be highest if they can shut some mines, but we just do not see it happening voluntarily. It will be most efficient (time & capital destruction) to get there by letting the market decide, & we suspect that mosaic will be a casualty. Even if you are profitable at the new equilibrium price, if you are not earning the average industry ROE - you will be a target.

 

We don't see the cartel re-establishing until the consolidation is over, & we think it will be tolerated only so long as it raises the price of potash enough to achieve a sustainable long-term ROE (Canadian, Australian, Chinese government agreement). Acting now, versus after a global recovery, ensures that the ROE will be as low as possible (Chinese requirement).

 

Boards don't make mistakes; they pay their CEOs to take the dive. We think that the sooner the mine write-offs (for later amortization savings), & CEO replacements, flush through the system, the more comfortable everybody will be - hence there is internal bias to the long term stability of the market solution.

 

Timing is best guess. While there will be a strong bias to re-establish the cartel as soon as possible, the reality is that it is going to take some time to work its way through. It is unlikely that POT will be able to maintain the $2B buyback - & the dividend - & the coming write-downs - if the market solution prevails; so the near-term outlook has to be bearish.

 

The smart thing would be to minimize damage by rescinding the buyback, & cutting the dividend - as soon as there is evidence that the market solution is where the industry is going. If it occurs, even if after a delay, another 35-40% drop is not unreasonable.

 

SD

 

 

 

[mcliu]

Given that reserves are finite, it seems odd that Uralkali's planning to sell at a lower price to increase volume.

[no_free_lunch]

Sharper,

 

Why now?  2 or 3 years ago jansen was on the table, uralkali was going to double their output, potash was going up to 17 or 18M, mosaic upgrading, agrium upgrading, new mine in brazil, expansions in brazil, chinese mine in Saskatchewan, brazilian mine in saskatchewan, etc.  All of this was out on the table at least 2 years ago, I think it was 3.  The market didn't really react.

 

Now, you have uralkali saying that they will go from 11M to 15M output, price be damned and prices tank? 2 years ago they said they were going to 20M so what didn't we already know? 

 

I mean, if prices can be maintained in the face of all of that why is now the time for them to crash?  Not that i disagree that the prices are un-maintainable but it just seems that the market is inefficient.  It seems that prices of the equities should have gone down gradually over the past couple of years as it became clear that these upgrades were going to happen.  Is it just that BHP is about to announce on jansen?

[no_free_lunch]

mcliu,

 

Reserves are finite but massive.  I read that many of the canadian mines were built in the 60's so it is not really an issue of using up the reserves.  It is all about the output.  There is no reason the various companies couldn't double the world output, there are plenty of reserves.  It is just a question of playing this game between bringing on production without forcing down prices.  This isn't like oil where it is a huge struggle just to maintain existing production.  There is no hubberts peak for potash.  Not in the next 30, 40 years anyways.

 

The main thing for uralkali is to maintain the relatively high prices.  Better to sell 15M tons at $300 if that means scaring off the new mines than to sell 11M at  $400 for a few years and then $150 after that when the competitors mess up the market.

[alertmeipp]

So say Uralkali's maximize their output to 13millions (from 10millions last).

 

Global sales is 51 millions 2012 so they are only supplying ~25% of the market even they maximize their output (and remember they have no infrastructure in NA).

 

so net net an increase of 3 millions in 51 millions market...  i don't see that alone will tank the price by 33% if the rest of the big boys don't play along. Does Uralkali really need to lower the price by 33% to sell 3 millions more in a 50millions+ and growing market.

[no_free_lunch]

so net net an increase of 3 millions in 51 millions market...  i don't see that alone will tank the price by 33%

 

That's what I don't get either.  What I am trying to say is that it's not really that big news in and of itself but the analysts have used this point to focus on the serious issue of mine expansions which they have been ignoring.  So potash is in trouble just not because of uralkali's announcement.

[mcliu]

mcliu,

 

Reserves are finite but massive.  I read that many of the canadian mines were built in the 60's so it is not really an issue of using up the reserves.  It is all about the output.  There is no reason the various companies couldn't double the world output, there are plenty of reserves.  It is just a question of playing this game between bringing on production without forcing down prices.  This isn't like oil where it is a huge struggle just to maintain existing production.  There is no hubberts peak for potash.  Not in the next 30, 40 years anyways.

 

The main thing for uralkali is to maintain the relatively high prices.  Better to sell 15M tons at $300 if that means scaring off the new mines than to sell 11M at  $400 for a few years and then $150 after that when the competitors mess up the market.

 

Yes at current production levels, the reserves will probably last 300 years, but demand for fertilizer continues to increase (especially if prices drop rapidly). As the developing world develops, 20 or 30 years out, production levels may be much higher to meet demand, and by then, those reserves may not seem so long-lasting. But then again, anything can happen in 20/30 years.

 

http://www.napotash.com/images/potash/RBV_Line-Graph_large.jpg

[SharperDingaan]

Agreed this is nothing new - but ignoring it does not make it go away. Analyst output is primarily marketing, & there is no % in selling a downer over an extended period - especially when the market itself is not great, & the analyst will only be there 1-3 years at most.

 

Everyone with an existing/new mine needs to sell profitably or take a write-down. To sell more product you must lower price, & every producer has a profit incentive to reduce price - if they can make enough margin on their additional volume to more than offset the lost margin on their existing volume. A small producer doing this can be tolerated (uralkali) because their additional volume is not likely to be large. Not so with a big producer (BHP). BHP can either keep the incremental Jansan output off the market & take a write-down, or they can break ranks in return for a long term take-or-pay contract.

 

Cartel members could agree to reduce price to the BHP price to sell additional volume, & split the change less the output from Jansan amongst themselves, but it will be 9 for me (BHP) & 1 for everyone else. Or cartel members could go lower than the BHP price, split the additional volume over themselves, & offset some of the margin loss with FOH efficiencies. Suddenly it is a managed race to the bottom, & the 1st one to break ranks gets rewarded with a large take-or-pay contact at a premium price.

 

For a cartel in a falling price environment - the highest cost mine has to produce at maximum capacity, & cartel members have to absorb that mines incremental production by selling less. The cartel solution is to immediately reduce price  below that mines lowest marginal cost & put it out of business - & split that mines share over the cartel members. If that one mine is one company, it has incentive to break ranks & sell as much as it can - before it gets put out of business.

 

None of this is good for a POT shareholder. The obvious solution for POT is to cite market uncertainty & discontinue the buyback; agree to a deep price cut for potash, & take the bath (write-off & dividend cut) earlier vs later. This is the uncertainty in our forecast (primarily the timing).

 

An additional 30-40% off for industry restructuring, asset write-downs, reduced profitability, & a dividend cut is not unreasonable

 

SD

 

[Uccmal]

With seeming suddenness the world is awash in Potash.  How can that be, when as recently as May 20, 2012 we were running out.  Has anyone who is alive now, ever seen a commodity run out?

 

I am racking my brain to think of one, but we seem to have enough fertilizer, oil, gas, iron, silica, lithium, uranium, sugar, corn, methanol, ethanol, copper, palladium, platinum, gold, silver, at the moment.  It will take some time to rectify before we go into shortage mode again - like years probably. 

 

The trick with commodities is to buy when the price is lower than lowest, and the world is awash in supply, and we are never going to run out. 

 

Sharper, I think you are right to wait - probably a few years.  The dividend will get cut, the buyback program will get suspended.  No one will want to have anything to do with potash, and Pot's stock will be a fraction of the value it is now.

 

Of I were looking at commodities in general I would pay attention to the work of Jim Rogers.  He is something of an exert on cycles. 

 

[alertmeipp]

the fact that the reserve is 300 years does not mean the product has to be sold cheap.

 

re: Jansen, you guys have the economics of the project? Citi estimated the NPV for the project is negative 2.2 billions with $300 potash price.

[no_free_lunch]

Sharper, as far as assigning probabilities to a price collapse, I think the biggest risk is that BHP doesn't build jansen.  Their are estimates from citigroup that jansen isn't even profitable at $300 per ton.  Why would they then built it if the price will go even lower?  Even if they consolidate and buy a potash producer after jansen construction starts they are still left with huge excess capacity for at least the next decade.  Why do that when they could buy mosaic or potash?  I saw a commentary that they could buy mosaic for roughly what it would cost to build jansen and have higher output plus revenue on day one.  Mosaic is at 10-11M and already expanding to 15M tons so that is significant volume.  They also have a phosphate business that they could sell.  Given that it's american based they might have fewer complexities with government approval (although that is just a guess).

 

I put the probability that a potash producer, be it potash corp or mosaic, gets taken out by BHP and that jansen doesn't happen at about 40%.  Not to say they won't announce jansen just that it would be shelved indefinitely.  I view it as somewhat of a put on the equity prices in the intermediate term, another 20-30% and BHP would be foolish not to take them out, if they are still interested in this space.

[no_free_lunch]

alertmeipp,

 

You haven't really addressed my point.  It has to be sold cheap, so that it doesn't get sold cheaper later.

 

EDIT: And thanks for beating me to the punch on the citi BHP analysis. :)

[alertmeipp]

alertmeipp,

 

You haven't really addressed my point.  It has to be sold cheap, so that it doesn't get sold cheaper later.

 

EDIT: And thanks for beating me to the punch on the citi BHP analysis. :)

 

I hear you. Do I hear natural gas producers? :)

 

The key is the others don't play along with Uralkali.

[schin]

The main thing for uralkali is to maintain the relatively high prices.  Better to sell 15M tons at $300 if that means scaring off the new mines than to sell 11M at  $400 for a few years and then $150 after that when the competitors mess up the market.

 

I really don't understand the economics when they don't make any extra profits selling to China:

 

11M * $450MT = $4,500 (i'm not carrying out the decimal places)

15M * $300MT = $4,500 (after 25% price drop)

 

One, it's not easy to just ram up 4M capacity, there's overhead and friction on getting that extra capacity online. Two, on Jansen, it takes 7 years, to get a mine operational.  What are they scared of? It doesn't happen over night. Three, $150 wouldn't happen if they stayed in the cartel -- how much capacity could come on to justify the $150MT price tag. 

 

I'm still waiting for $1/gallon gas with all the oil in Alaska and oil sands in Canada. All the stuff that was going to give OPEC a run for them money. Yeah right.

[no_free_lunch]

Schin,

 

The way I look at it is that it is not just jansen.  Jansen could really, really throw things out of whack but it is also the additional capacity from the existing producers.  Look at potash corp, mosaic, agrium, the german one (name eludes me), ural kali, and more.  Look at their expected production increases.  At some point it could really topple the pricing mechanism if just one of them steps out of line and uralkali needs that to not happen.  There are also the chinese and brazilian companies that want to open mines and whose government is motivated to help them.  I think the increase to production will be real. We are not talking $1 gas, we are talking about increasing production another 20%.  Even if it does take a few years, the equity could be repriced a head of the prices being adjusted.  That is the bear case, in my mind.

 

In the short-term though, there is a real chance, I think, that BHP doesn't act crazy and just buys an existing producer and supports prices by restricting volume.  This is I guess the bull case.  You still have issues with the brazilian and chinese mines but in the short-term the equity could see a spike.  For this reason, I am considering options on mosaic or potashcorp.  But it scares me to actually own the equity.

[schin]

Schin,

 

The way I look at it is that it is not just jansen.  Jansen could really, really throw things out of whack but it is also the additional capacity from the existing producers.  Look at potash corp, mosaic, agrium, the german one (name eludes me), ural kali, and more.  Look at their expected production increases.  At some point it could really topple the pricing mechanism if just one of them steps out of line and uralkali needs that to not happen.  There are also the chinese and brazilian companies that want to open mines and whose government is motivated to help them.  I think the increase to production will be real. We are not talking $1 gas, we are talking about increasing production another 20%.  Even if it does take a few years, the equity could be repriced a head of the prices being adjusted.  That is the bear case, in my mind.

 

In the short-term though, there is a real chance, I think, that BHP doesn't act crazy and just buys an existing producer and supports prices by restricting volume.  This is I guess the bull case.  You still have issues with the brazilian and chinese mines but in the short-term the equity could see a spike.  For this reason, I am considering options on mosaic or potashcorp.  But it scares me to actually own the equity.

Yea, it just amazes me that anyone will take a 20% increase in production and negate that benefit with a 25% decrease in price.  It's kinda like going full circle.

 

Yeah, everyone is afraid of other other producers rocking the boat, but that defeats the whole point for an oligopoly/cartel. They make more money in tandem than as a broken arrow.

 

I mean.. if Urakali could take the whole market and only take a 25% hit in prices, it's definitely worth it. But, bring supply online is really not as easy as people think.