Tuesday, July 30, 2013

Potash Cartel Crumbling Down

For those who follow fertilizer stocks such as Potash Corp (POT), Mosasic (MOS) and Agrium (AGU), the stocks are taking a big dive today after Russian fertilizer company Uralkali decided to pull out a potash cartel (Belarus or BPC) ending a cartel era of the Potash market where it almost controls 70% of the market. The other major play is Canpotex which sells Potash produced by POT, MOS and AGU. With BPC and Canpotex losing Urallkali as a partner, the two cannot effectively contain demands by emerging countries such as India and China for lower prices. Canpotex has been trying to finalize deals with the Chinese after old contracts (at ~$450/mt) already expired and India is not even in discussing as they want deals below $400/mt. With prices just at $900/mt just four years ago, the potash industry is seeing excessive inventories as companies expanded to boost capacity only to see prices tumble to current ~$400/mt range. Urallkali warned that potash prices may reach $300/mt or even lower as it tries to undercut BPC and Canpotex in pricing and supply the necessary potash to China and India. Just a quick review of the economics shows how Urallkali has a huge advantage vs Canpotex producers (POT, MOS and AGU). Marginal cost of production for Urallkali  is slightly below $100/mt while Canpotex is around $100-$150/mt so the Russian company definitely use pricing as a secret weapon given it is a low cost producer. Plus transportation by rail is much easier for Urallkali  than transporting via ships for Canpotex producers. 

Reaction to the News:
POT and MOS are down more 20% so far today. AGU is down less at 8% because of its retail operations and much lower production of Potash. Given the news today shows a major shift in the Potash market, I would avoid POT and MOS for at least rest of the year and until late 2014 when current excessive potash inventories sold off at lower prices. POT and MOS has large exposure to the Potash so lower prices will materially impact their operating results and underlying earnings. On the other hand, I would look for opportunity to pick up AGU thanks to this news but may wait until later this year. AGU is still trading at lower multiples (9X) vs. POT(10X) and MOS (9.5X) and has much lower exposure to Potash. AGU may be a target of further activist campaign as Jana Partners may either build its 5% stake or others may come in which could be positive for the stock price. Unlike MOS or POT, AGU faces less multiple contraction risks given its diversification. 

Notes:
*mt = metric tonne
** I am not 100% on the stats but  I am sure there is at least 10 million metric tons of excessive potash (supply >demand) with demand around 45 million metric tons. I will check the numbers and update this post.

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