POT - Potash Corporation

[petec]

BHP's general phil;osophy, as I understand it, is always to own the low cost asset and produce flat out.  No restricting volume to control price.  And in the long term that's the sensible strategy IMHO.  That is what they planned to do with Potash Corp, I think.

[Phaceliacapital]

Yeah that's how I understood it too.

[SharperDingaan]

The cartel only exists because each producer is gaming - & the most profitable option is to stay with the cartel versus break from it. Today, for some members, it is more profitable to break from it. If you think the cartel will hold, with no changes, POT is a buy. If you think the cartel is going to significantly change, POT is a sell. If you are on the fence, most would reduce their risk by selling their common & replace with call options.

 

SD

 

[fareastwarriors]

http://online.wsj.com/article/SB10001424127887323455104579016904256791702.html?mod=WSJ_business_whatsNews#articleTabs%3Darticle

 

Potash Miners Pressured on Prices

 

Indian Buyers Demand Discounts for Fertilizer Ingredient

 

...

We will certainly like to negotiate lower prices," said P.S. Gahlaut, managing director of Indian Potash Corp., a big buyer. "We have asked for a 12% discount."

...

Given a seasonal lull in buying in a sector with little spot-market trading, analysts say it is too early to get a meaningful gauge on the effect on pricing. Still, Sri Lankan buyers recently bought 26,000 metric tons of potash at around $404 per ton, 22% lower than the price paid in March, according to BMO Capital Markets in Toronto.

[no_free_lunch]

BHP's general phil;osophy, as I understand it, is always to own the low cost asset and produce flat out.  No restricting volume to control price.

 

That is just talk from BHP.  In reality they are going to maximize profit as best they can.

 

I found this on their production, so we already know that this isn't how they operate.

 

The miner said its production reflected curtailments in its iron ore, manganese and coking coal divisions in line with weaker demand.

http://www.smh.com.au/business/bhp-production-falls-as-economy-slows-20090422-aefb.html#ixzz2cQ2jZaN5

[bmichaud]

From FT this morning:

 

BHP Billiton commits $2.6bn to Canada’s Jansen potash project

 

http://www.ft.com/intl/cms/s/0/2484c226-0967-11e3-8b32-00144feabdc0.html#axzz2cVmY732q

[fareastwarriors]

http://online.wsj.com/article/SB10001424127887323608504579022951450640842.html?mod=WSJ_business_whatsNews

 

Belaruskali Chastises Russian Potash Partner

 

 

...

 

"We have received an invitation from China in September to negotiate a new contract," Mr. Kiriyenko said. In January, China, which is the world's largest potash consumer, agreed to buy up to one million tons from BPC in the first half of 2013 for $400 a ton.

 

...

 

On July 30, Uralkali announced it was pulling out of the Belarussian marketing group, saying it would pursue a volume-over-price strategy in place of the long-standing reduced production-higher price approach all the world's main producers had used. The decision sent potash stock prices stumbling as Uralkali predicted a 25% drop in price for the fertilizer to $300 a ton this year.

 

...

[fareastwarriors]

From FT this morning:

 

BHP Billiton commits $2.6bn to Canada’s Jansen potash project

 

http://www.ft.com/intl/cms/s/0/2484c226-0967-11e3-8b32-00144feabdc0.html#axzz2cVmY732q

 

 

http://blogs.wsj.com/canadarealtime/2013/08/20/bhps-jansen-investment-could-spell-more-bad-news-for-potash-sector/?mod=WSJ_LatestHeadlines

 

BHP’s Jansen Investment Could Spell More Bad News for Potash Sector

[alertmeipp]

Jansen cost per tonnes is well north of $300, this and the cartel news can't be both bad news.

[fareastwarriors]

http://www.bloomberg.com/news/2013-08-25/bhp-to-pursue-canada-potash-venture-on-strong-return-expectation.html

 

BHP to Pursue Potash Venture on Strong Return Expectation

[fareastwarriors]

http://www.bloomberg.com/news/2013-08-26/uralkali-ceo-detained-in-belarus-on-charge-of-abuse-of-office.html

 

Uralkali CEO Detained After Holding Potash Talks in Belarus

[mikazo]

"Potash Corp. earnings tumble as prices drop"

 

http://www.cbc.ca/news/business/potash-corp-earnings-tumble-as-prices-drop-1.2223647

 

Shares down 3.5% today, P/E 11.85, div. yield 4.6%

 

Might start looking into this more.

[nestorius]

This is an interesting one, I am short. Summary of my views below.

 

---

 

Focusing on the medium term supply and demand, my views on the progression (informed by looking at regional demand elasticity over the last 10 years and the incentive prices for new capacity additions) should prices recover to the $400 China CFR range are as follows:

 

    S   D   Util
2010    68  50  74% 
2011    72  52  73% 
2012    76  53  70% 
2013    79  54  69% 
2014    84  55  65% 
2015    90  56  62% 
2016    99  57  58% 
2017    107     58  55% 
2018    110     60  54% 
2019    111     61  55% 
2020    114     62  55%

 

That is clearly a wholly unsustainable situation, and has been building up over the last 3-4 years. For the incumbents who have professed to defend high prices, this would imply that their "market share" would gradually be eroded, both in relative and most importantly in absolute terms. It's the classic overshoot of commodity businesses (we see it in steel, iron ore, North American nat gas, etc.), and if prices stay at the $400 mark then there is real incentive to add capacity. Look at pricing before the supercycle ramped up in the $200s.

 

The guys with substantial unused capacity (like URKA, and POT) would be forced to cut production levels while essentially providing further fuel to the fire that enables decent greenfield economics and encourages new entrants. This is why URKA has committed to the strategy... and why POT will eventually be forced to go along with this. Prices going to $300 would likely let K+S limp along with no cash margin, so Canpotex/URKA would take it down to $250 in that case. So in my view, a more realistic scenario is as follows, assuming China CFR $250/t:

 

    S   D   Util
2010    68  50  74% 
2011    72  52  73% 
2012    76  53  70% 
2013    79  54  68% 
2014    76  58  77% 
2015    80  60  75% 
2016    85  62  73% 
2017    87  64  73% 
2018    88  66  74% 
2019    88  68  77% 
2020    90  70  78% 

 

This is pretty close to the new reality that URKA put forward, although I do think the demand estimate for 2013 at 58mt is pretty aggressive. My supply forecast involves total shutdown of all K+S (including Legacy), plus no new greenfields from Vale, BHP, Western Potash, Prospect Global, Verde, Acron, Encanto, IC, MagIndustries, etc. If prices remain high all of that stuff can get financed. If POT wants to ever use its excess capacity (which is ~7mt/yr starting 2015), it will need to push through a major reallocation of Canpotex, potentially breaking it up and further roiling market stability.

 

Short term K prices are less significant given low liquidity but we are hearing $320 cfr China done by URKA and Brazil spot prices around $340-355 which are roughly congruent to historical spreads. I would see a long delay on H1 2014 China contract which is just going to increase uncertainty around pricing and add to buyers' negotiating leverage.

 

The bull case on Chinese and Indian demand has been talked about for years but has never materialized. Why? India's absurd support for domestic N production, and China... well, China is its own animal. One analyst we spoke to, who does farm trips a few times a year in China, believes Chinese farmers are inelastic with respect to price; farmers don't see potash as a necessary input; consumers don't value the texture and shelf life benefits of K application; farmers don't have money to buy K, there is no agribusiness of scale like Brazil (K in Brazil is huge due to crop mix as well). Over the LT this will certainly change but it's a multi-year story. Many people put the NA NPK mix on China/India and that makes no sense due to relative weighting of wheat, rice, cotton. Roughly similar story in India but the application rates are so out of whack due to the N subsidy that to be fair, K demand will rebound a bit if that ever changes (beyond current election cycle which favors food / consumers over farmers).

 

For K valuation we completely ignore replacement cost. Not a factor, that money is spent. Look at FCF and EBITDA. Most of the street uses a historical K EV/EBITDA approach at 8-11x (i.e. not fundamental valuation -- times were different), plugging their ears to the reality that K is a commodity just like NP, iron ore, copper... ignorant of the fact that at that time with better market structure growth projects were very high ROIC (20%+) and today that just isn't in the picture, no reason it should be above 5-7x typical N, P or mining ranges if your ROIC=WACC for growth going forward (i.e. 1x EV/IC).

 

Note I don't discuss the resolution of the cartel. I think it's a red herring that moves the market but not intrinsic value, URKA is really serious about V over P and if there is a resolution there is no way that Russia is going to let Belarus win in substance. The economics of V over P are real for URKA, they can take real share in China, Brazil and get their costs/t down while crushing high cost guys. This is a industry-wide issue (as demonstrated above in the S&D forecast) and has been in the background for a few years now with market share fights and discounting, greenfields incentivized to ramp up their exploration and construction. This is not something that can be resolved by Putin forcing URKA/BK to be friends again.

 

For short targets the higher cost guys have more downside, particularly K+S, but everyone is going to take a hit. POT has a little optionality on breaking up Canpotex and pumping volume out... if it makes sense for URKA to crush the market, it makes even more sense for POT and the longer they wait the more pain they ensure with underutilized assets. Target price mid 20s on lower multiples / DCF@11% / EVA especially considering their equity investments will get impaired at lower K prices.

[ItsAValueTrap]

nestorius, great post and I have similar views.

 

Potash clearly isn't running at full capacity and their expansion projects are about to come online.  The industry has a huge wave of supply coming online.  This will not end well.

 

I'm surprised that the implied volatility on POT options is still low.  I don't like chasing stocks and try to exercise price discipline so I don't have a short position in POT though.

 

*I suck at predicting commodity prices.  I used to be long POT and long natural gas through MCF (and long cotton and gold, which were positions that worked out).  This is the main reason why I will be watching this from the sidelines.

[nestorius]

*I suck at predicting commodity prices.  I used to be long POT and long natural gas through MCF (and long cotton and gold, which were positions that worked out).  This is the main reason why I will be watching this from the sidelines.

 

Conceptually I agree about predicting commodity prices. I hate it. To be fair, part of the short thesis is for hedging purposes.

 

But I don't think the thesis on potash depends on commodity prices going down, but rather the change in market structure and the ability for potash firms to redeploy capital accretively. If Canpotex defends high prices (as they have done in the past), their capacity expansion will be unused, not generating earnings, and their market share and earnings will shrink over time as greenfields come on and run full out taking advantage of those who defend prices. If Canpotex crushes the market at low prices, then capacity expansions are far less valuable and the company is undeserving of historical multiples that analysts use to value the company. I've modelled both cases and come to mid $20s in either. If the second case looks more likely I'll shift some to K+S once I get up to speed on it.

[ItsAValueTrap]

Hmm I guess I am anticipating a potashpocalypse that's worse than your outlook.

 

I don't see how the potash market can possibly absorb so much supply.

[nestorius]

FYI, short thesis on POT released on VIC today (the delayed timing) that is substantially in line with my views.

[ItsAValueTrap]

Weird... the implied volatility on the puts is in the low 20s.

 

http://quote.morningstar.com/Option/Options.aspx?ticker=pot

 

I guess some people are expecting the dividend to drop.

[Guest notorious546]

qv investors recently initiated a position in POT.

"the

Canadian equity strategy initiated a small position in

Potash Corporation of Saskatchewan. It is among the

lowest cost producers of potash, and has at least 50

years in reserves of mines that are expensive and

difficult to replicate. PotashCorp holds comfortable

leverage ratios and pays a dividend that yields in excess

of eight percent. Its valuation is at a level not seen since

the start of the commodities boom, but it now generates

three times more free cash flow."

QV_Update_-_151211.pdf