7/25/08

Waiting for a Lower Price Before Buying POT

Potash of Saskatchewan (POT) is one of the world's largest fertilizer companies. It produces three plant nutrients, nitrogen, phosphate, and potash. The firm reported very solid earnings recently. Gross profit tripled year over year on a 94% jump in revenue. This came on significant price increases on nitrogen (up 57%), phosphate (up 135%), and potash (up 162%). POT expects the good times to continue, and has raised its guidance for the year to between $12 and $13 a share. The consensus among analysts, as of writing, is around $11.70 a share.

Here are some of the pros for investing in POT:

1. At about $200 a share (as of writing) Potash is trading around 17 times its full year earnings estimated by analysts, which is below the company's forecast.

2. The company is a cash machine. Free cash flow accounted for over 20% of sales in the last two quarters.

3. POT has been buying back shares. The company stated it intends to buy 5% this year.

4. The world's food stocks and arable land are at historically low levels while demand is high.

5. There is plenty of room for growth, as farmers in markets like Brazil and China have underused fertilizer in the past.

6. There are significant barriers to entry into the nitrogen, phosphorus, and potash markets.

7. The stock can easily double in the next couple of years as long as fertilizer prices continue to rise.

8. Management is knowledgeable, responsible, and shareholder friendly. The CEO has three decades of experience in the industry.

If you are interested in agriculture businesses in general, and would like a more diversified approach across a number of industries, you may want to look at the Market Vectors Agribusiness ETF (MOO). POT is currently its second largest holding while agriculture chemicals stocks account for almost half of its holdings.


Despite POT's potentially bright future, I'm waiting for a lower entry point. The reason is that there is a host of unpredictable risks:

1. In the near term, there is a threat of a strike at a few of the company's potash mines (they account for almost one third of the firm's potash production). A labor strike, depending on its duration, may hurt profits. The share price may fall too.

2. While POT's private competitors, like Agrium (AGU), Mosaic (MOS), and Yara International (YARIY) have an interest in not overly increasing supply, government owned competitors have less incentive. They may overproduce, lowering prices.

3. Fertilizer pricing is volatile. While prices have gone up recently, the trend may reverse. Factors affecting pricing include the weather, agriculture commodity prices, and natural gas prices.

4. Government policies may also affect pricing. For instance, the US, in its recent negotiations with India has signaled that it might cut farm subsidies. As another example, if the price of oil continues to fall, the US may be less favorable toward biofuels. The Environmental Protection Agency is set to decide whether to cap corn for fuel use at 9 billion gallons for the foreseeable future (it was widely expected that the cap would rise to 15 billion gallons). This could drive corn prices lower, which in turn would hurt fertilizer demand.

5. While demand for food is historically high, slowing economic growth and rising inflation could cut demand for meat in places like China. This can drive down grain prices, and thus demand for fertilizer.

6. There are already signs of weakness. China's phosphate fertilizer demand dropped around 10% (year over year) in the last two quarters. Its potassium fertilizer demand fell about 15% (year over year) over the same period.

7. Rising sulfur (an important ingredient in phosphate fertilizer) costs can contract margins.

8. Water inflow, which potash mines commonly face, can ruin mines. This can seriously hurt profits.

9. Nitrogen and phosphate prices are not expected to rise very much in the future. Nitrogen and phosphate accounted for around two thirds of sales and just over half of POT's gross profits in 2007.

10. If the US dollar weakens against the Canadian dollar, POT's earnings can be hurt.


The risks don't necessarily outweigh the potential returns. Nevertheless, as they are numerous and unpredictable, I would prefer a lower price at which to buy shares. I'll be a buyer at around 14.5 to 15 times analyst projected full year earnings. That's around $170 to $175 a share. I may miss the boat on this one, but that's ok.