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Potash Corp./Saskatchewan (USA) (POT), BHP Billiton Limited (ADR) (BHP), Intrepid Potash, Inc. (IPI): Should You Avoid All Potash Producers?

Published on August 13, 2013 at 10:16 am by The Motley Fool in News
Potash Corp./Saskatchewan (USA) (NYSE:POT)Uralkali, one of the biggest and most cost efficient potash producers in the world, has just announced a change in its marketing strategy from price-over-volume to volume maximization. Since Uralkali’s marginal production costs are just below $100 per tonne and current potash prices are around $400 per tonne (a few years ago the price was at $900), the price of this commodity might keep on plummeting going forward. The Russian producer has already declared that it plans to operate at 100% capacity by year-end. What should you do if you hold other potash producers in your portfolio?

Following the Russian trend

Potash Corp./Saskatchewan (USA) (NYSE:POT), the world’s biggest producer of fertilizers, has the largest incentive to follow Uralkali’s strategy and go for volumes at the expense of price stability. The main reason is that a relevant amount of the company’s capacity additions are expected to come online over the next two years. Even when North American demand for Potash Corp./Saskatchewan (USA) (NYSE:POT) is expected to grow by 25% year-over-year and international demand should also grow strongly, I believe that it is highly unlikely the company will be able to operate at full capacity, particularly as the company’s new projects ramp up during the next two years.

As a result of higher operating rates, Potash Corp./Saskatchewan (USA) (NYSE:POT)’s average cost per tonne should drop towards the $105 level (close to Uralkali’s cost per tonne). This should make the company a viable competitor in the international landscape even as prices come significantly closer to marginal production costs. Potash Corp./Saskatchewan (USA) (NYSE:POT)’s shares suffered strongly from Uralkali’s recent decision, and they are down by 22% year-to-date. I expect Potash’s EBITDA to go down to $3.3 billion by 2014 so the company would be currently trading at an 8.6 times 2014 EV/EBITDA multiple. I consider the multiple to be too high even when Potash pays an attractive 4.8% cash distribution yield.
Another relevant factor to take into account when thinking of selling Potash Corp./Saskatchewan (USA) (NYSE:POT) is that a potential acquisition by a strong miner such as BHP Billiton Limited (ADR) (NYSE:BHP) is further away now than ever before. BHP Billiton Limited (ADR) (NYSE:BHP), which is developing Jansen, the largest potash mine in the world, might even be thinking of suspending its heavy CapEx investment in the mine. The project represents a $10 billion CapEx effort, which is still in approval stage. I am sure that, if the Jansen’s economics continue to weaken, BHP Billiton Limited (ADR) (NYSE:BHP) could delay approval. The miner has already taken such kind of decisions at the iron ore Outer Harbour project.
I would be a buyer of Potash Corp./Saskatchewan (USA) (NYSE:POT) at 5 times EV/EBITDA. I think the market has not yet fully considered the effects of future commodity price instability and the reduced probabilities of M&A going forward. Nevertheless, Potash will remain on business thanks to the company’s cost advantages and, at the right price, it should be considered a buy.

Selling weaker players

Intrepid Potash, Inc. (NYSE:IPI) is a considerably smaller player despite being the largest producer of the commodity within the US. Against what many analysts think, I do not believe the company is isolated from the the world-wide price war which is about to start playing out. If Intrepid Potash, Inc. (NYSE:IPI) were to keep prices high, I think we shall witness an increase of potash imports from abroad. Besides, I do not think a ramp up in production from the HB Solar project will help to materially offset falling prices.
As a matter of fact, I think EBITDA could go down as much as 30% year-over-year by 2014. If my estimates are correct, Intrepid Potash, Inc. (NYSE:IPI) would now be trading at 8.1 times 2014 EV/EBITDA, which I think is overly optimistic. Plus, the company does not offer any cash distribution yield. Being a smaller higher-cost producer should damage Intrepid Potash, Inc. (NYSE:IPI)’s market position now more than ever before. I would sell Intrepid Potash, Inc. (NYSE:IPI) despite the 30% year-to-date fall in the company’s shares.

Foolish conclusion

As professor Greenwald from Columbia University says, if you operate in a market without strong barriers to entry (such as aluminum or potash), you need to be extremely efficient. Potash of Saskatchewan and Uralkali are extremely efficient and, therefore, destined to survive. Other companies, such as Intrepid, could find themselves in a serious situation if a full-scale price war unravels. Sell all potash producers until the commodity’s price stabilize somewhat. Then, buy only the most cost-efficient players.

The article Should You Avoid All Potash Producers? originally appeared on Fool.com and is written by Federico Zaldua.

Federico Zaldua has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Federico is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.

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