A Wilted Fertilizer Stock Can Sprout Again By NAUREEN S. MALIK | MORE ARTICLES BY AUTHOR
The once high-flying shares of Potash Corp. have fallen far enough to be compelling again.
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SHARES OF POTASH CORP. OF SASKATCHEWAN (ticker: POT), a leading global fertilizer company, experienced a meteoric rise over the past two years before collapsing in recent months.
But this stock, which has fallen 71% since hitting an all-time high of more than $241 in June, is ready for a second act.
Unlike the Net stocks of the 1990s that rose and then fell dramatically because they lacked a convincing long-term business model, Potash Corp. is backed by powerful and sustainable fundamentals.
As the world's population continues to grow, rising middle classes in emerging markets like China and India are demanding more nutritious diets. The food crisis earlier this year pointed to how tight grain supplies are as inventories hover at historic lows.
At a Glance: Potash Corp. of Saskatchewan (POT)
Stock Price: $69.68 52-Wk High: $241.62 52-Wk Low: $60.38 Market Cap: $21.03 billion Est. 2009 EPS: $19.16 2009 P/E: 3.6x Est. Long-Term EPS Growth: * N/A Est. ('09/'08) EPS Growth: 56% Revenue (trailing 12 months): $8.5 billion Dividend Yield: 0.6% Chief Executive Officer: William J. Doyle Headquarters: Saskatoon, Saskatchewan, Canada
* Based on analyst estimates looking ahead three to five years. Sources: Thomson Reuters, Barron's OnlinePotash, nitrogen and phosphates are crop nutrients produced by Potash Corp. And all three fertilizers are increasingly important to farmers seeking to increase the yield and quality of soybeans, corn and other crops that they grow.
Certainly, tight credit and 45%-60% price declines in soybean, wheat and corn from their highs earlier this year have put a crimp in fertilizer spending, which is why the stock has come down so much.
Ultimately, though, farmers will need to replenish soil or risk lower crop yields. A subsequent crop shortage would boost crop prices, increase profits and spur demand for fertilizers.
The stock, which closed at $69.68 Tuesday, is trading less than four times 2009 a 2010 earnings estimates. (See Weekday Trader, "Fertilizer Stocks Could Start to Wilt," March 18, 2008.)
This may not be the bottom for the stock, but the dramatic pullback indicates there's more reward than risk at this level. (And who among us can find that perfect bottom to buy at?)
"You are seeing a complete divorce of fundamentals from prices," Evan Smith, co-manager of the U.S. Global Investors' Global Resources Fund. "It sounds a little trite, but you still have a lot of people that need to eat."
Potash Corp. posted its best quarter ever for the third quarter last Thursday, as record-high fertilizer prices offset lower volume sales. Even with more moderate expectations about both, the company should continue to post double-digit earnings growth over the next few years.
Analysts surveyed by Thomson Reuters expect Potash Corp to earn $12.29 in 2008, $19.16 in 2009 and $21.15 in 2010.
Results from annual negotiations with China by early 2009, some recovery in commodity prices, and the company's stock-buyback program could all act as catalysts for the stock.
Potash Corp., which emerged as a market leader in fertilizer by taking over smaller companies, could make further acquisitions in this environment thanks to the cash on its books.
Meanwhile, the company continues to see strong profits from timely offshore investments it has made in recent years in Arab Potash Co. of Jordan, SQM of Chile, Israel Chemicals and China's Sinofert. In an Oct. 24 note J.P. Morgan Securities analyst David Silver valued these investments at $15.25 per Potash Corp. share.
Ryan Ball, an equity analyst at McLean Budden, a Toronto-based money-management firm, says, "We think the stock is a buy down here," mainly because Potash Corp. is the world's largest producer of potash fertilizer.
Potash is a nutrient used to improve plant water retention (which helps increase yields and improve disease resistance), and enhance taste, color and texture.
About 51% of the company's gross profits come from potash with the rest roughly split between nitrogen and phosphates, according to Credit Suisse data.
The fundamentals for potash fertilizer are the strongest among the three nutrients in part because its reserves are "rare," Potash Corp. Chief Executive Officer William Doyle noted during the Oct. 23 conference call.
The nutrient is mined from underground deposits from seas that evaporated millions of years ago. The largest reserves are in Saskatchewan, Canada.
Doyle said that "it is the nutrient that has been most underapplied in developing nations."
The company controls about three-fourths of the available potash reserves, making Potash "the guy with his hand on the spigot," says Charlie Rentschler, a vice president with Wall Street Access, an NYSE member firm.
Being the swing producer of potash is important given low inventories of grain. The world's ratio of grain stocks-to-use is estimated to be 16.6% compared to a 30-year average of 25.3%, Doyle noted.
"Now it will take a record crop every year to keep pace" with demand, he said.
The inventories of potash the nutrient are also around record lows and the "product is close to being sold out by world suppliers," J.P. Morgan's Silver said. He expects potash price increases to average $849 per metric ton in 2009 from about $460 in 2008 and $168 in 2007.
Declining inventories in China plus the government's move to increase grain prices in 2009 "suggests a higher potash settlement" for the company, wrote CIBC World Markets analyst Jacob Bout on Oct. 24.
The company is expanding its annual production capacity from 10 million tons to 18 million tons over the next five years.
The prices of Potash Corp.'s other two nutrients are more volatile. Recently announced cuts in phosphate production by Mosaic (MOS) and Morocco's OCP "could have positive implications for phosphate rock prices," wrote RBC Capital Markets analyst Fai Lee on Oct 23. Nitrogen, in the form of ammonia, is produced from air and natural gas.
Jack Scoville, vice president of Price Futures Group, a Chicago brokerage firm, says that grain and soybean prices could soon start bottoming out.
"I don't think we will see highs of July," Scoville says. He thinks corn can go back to $5.50 but not $8, soybeans to $11-$12.50 but not $15 or $16.
One key overhang on the stock is an ongoing strike at various mines. The irony is that resulting production cuts have "helped solidify pricing during the third quarter," according to CEO Doyle. He expects to reach a resolution soon.
Still, the dramatic pullback in its valuation indicates that Potash Corp. stock is fertile ground for long-term investors willing to stomach the volatility.
• U.S. Global Investors held 261,500 shares of Potash Corp. at the end of the second quarter, based on StreetSight.net data.
• McLean Budden held 1,496,560 Potash Corp. shares, or a 0.5% stake, as of June 30, 2008, according to StreetSight.net.
• Wall Street Access Vice President Charlie Rentschler has a Buy rating and $90 price target on Potash Corp. shares. The firm or employees may hold securities of stocks covered in research notes.
• J.P. Morgan Securities analyst David Silver rates Potash Corp. at a Buy with a December 2009 price target of $100. J.P. Morgan seeks to do business with companies covered in its research.
• RBC Capital Markets analyst Fai Lee has an Outperform rating and a $175 price target.
• CIBC World Markets analyst Jacob Bout has a Sector Outperformer rating and 12-18 month price target of $200 on Potash Corp. shares. CIBC seeks to do business with companies under analyst
AEV Price at posting:
67.0¢ Sentiment: Buy Disclosure: Held
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