Fertilizer Stocks Acting Like Fertilizer
(Featured in our Newsletter, Bond Funds and Fertilizer. This week's newsletter includes sections on inflation/dollar, bond funds and the stock market. For email notice of new articles and Paul's stock market activity, sign up with your email address on our home page.)
Potash is the common name for various mined and manufactured salts that contain potassium in water-soluble form. The name, from "pot ash", refers to plant ashes soaked in water in a pot, the primary means of manufacturing potash before the industrial era. The word "Potassium" is derived from potash. Worldwide today, potash is produced at amounts exceeding 30 million tonnes per year. It's main use is in fertilizers. For more, visit Wikipedia.
Last week, news that Russia's Uralkali would be pulling out of the potash pricing cartel sent shares of Mosaic (MOS) and Potash (POT) plunging almost 30% in pre-market trading. Since Tuesday's early tumble, share prices have firmed up. The price of another company that sells potash, Agrium (AGU), fell about 5%.
Paul couldn't resist buying more shares of MOS and POT in Tuesday's premarket shit-storm.
The Boston Herald noted:
"On Tuesday the fertilizer hit the fan. Share prices of nutrient companies were demolished as investors reacted to news that a big Russian fertilizer company [Uralkali] would stop cooperating in a pricing cartel. The move is likely to slash prices for the fertilizer potash. Investors worried that it will slash profits for potash companies, too...
Potash is a major fertilizer, used by farmers worldwide. It has been selling for almost $400 per ton. Some analysts believe the price could fall below $300 now." (Stocks of fertilizer companies hammered)
An end to the powerful potash cartel would start a price war and hurt the earnings of the potash producing companies. In reaction, the six largest publicly traded potash companies lost more than $13 billion in market cap.
The Mosaic Co. and Potash Corp. of Saskatchewan Inc. were hit particularly hard, hurting the results of our virtual portfolios. Market Shadows' Virtual Value Portfolio holds MOS, AGU and POT. Market Shadows' Virtual Put Selling Portfolio had sold one put on MOS and one put on Agrium Inc. (AGU). We're not closing these positions.
Michael Babad of The Globe and Mail questioned whether Uralkali's plan to break up the cartel is a “high-stakes game of chicken,” or an industry changer. He wrote,
"To recap, Uralkali and Belaruskali had together been one of the world’s two potash cartels, the other being North America’s Canpotex.
"Traditionally, one had followed the other in major pricing deals.
"But yesterday, the Russian cartel, BPC, collapsed as Uralkali pulled out, the suggestion being it wants to spur demand by cutting prices for the key ingredient in fertilizer. There had also been complaints that its partner, a Belarusian state-owned firm, had been operating outside their agreement.
"Uralkali, backed up by analysts, forecast that potash prices could plunge by up to about $100 (U.S.) a ton. Its decision won’t only affect its own prices, but also those of the Canpotex group, made up of Potash Corp. of Saskatchewan, The Mosaic Co. and Agrium Inc...
"'Although we believe Uralkali has been frustrated with Belaruskali and Canpotex playing on the margins of an oligopolistic industry, we believe Canpotex has been equally frustrated with BPC producers,' analyst Joel Jackson of BMO Nesbitt Burns said today." (Potash shares crushed: Is Russian cartel dead, or is breakup a ‘high-stakes’ bluff?)
Would this move really benefit Uralkali?
Uralkali does not produce nearly enough potash to meet worldwide demand. Cutting prices, and profit margins, to gain market share may not be in its best interests. Uralkali would probably be selling more, but earning the same, or less, than it currently is.
A concession by the other cartel members to cede some additional share to the Russians is a likely outcome. The other cartel members might agree on a price point not too far below the previous price point. EPS would be hurt somewhat, but the shares prices of POT, MOS and AGU probably overreacted to the downside. Good-quality companies rarely deserve to be marked down by 25% - 30% on any specific news story, short of fraud.
Barron’s commented on the potash situation.
"TURMOIL IN THE GLOBAL POTASH patch last week was bad news for the cartel of companies mining the stuff, but good news for farmers around the world. They’ll pay less for fertilizer, of which potash is a principal component...
"The market’s headlong exit followed news July 30 of a pricing agreement bust-up between a large Russian producer, Uralkali (URKA.Russia), and Belarus’s Belaruskali. With the Russians said to be intent on raising volume, some believe potash prices could drop 25% to $300 per metric ton by year end. There are fears it could fall further.
"That would eat into Potash earnings...
"Keith Goddard, CEO of Capital Advisors, a shareholder who didn’t sell on the news, advises not to look for an immediate rebound as the potash world sorts out this big change. However, Potash is a low-cost producer, and can earn $2 per share with $300 potash, he adds. That’s what happened in 2010, when the stock was over $30 most of the year...
"More importantly, the long-term Potash investment thesis still holds: Diets are improving around the world and moving toward protein, particularly in India and China. Combine that with lots of underutilized farm acreage and lower fertilizer prices, and the demand should continue to grow nicely..." (Barrons)
Research outfit Morningstar had rated both MOS and POT with four stars (out of five) before the news. The long-term fair values left room to adjust earnings downwards. We expect analyst downgrades, but higher share prices, after last week's dramatic sell-offs. Both companies have been raising dividends. At $29, POT yields 4.8%. At $40 MOS pays 2.5%.
The key to investing in a company is having confidence in its value. If we didn't already hold shares of MOS, POT and AGU in our virtual portfolios, or hadn't already sold puts, we would do so now.
Disclosure: Paul is Long MOS, Long POT, Long AGU
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