January 04, 2010

Negativity on Potash Industry: Overblown?
Recent activity could be marking bottom.

With the recent Chinese potash supply deal signed with BPC (Belarrussian Potash Co.) coming in roughly 24% below the deal signed with India many analysts and investors are worried.  The Indian deal was signed almost 6 months ago, and just like the Chinese deal included shipping.  In the industry these deals are referred to as free-on-board price, and during the recent bull markets in the potash and shipping industries not all supply deals included shipping.  The recent activity regarding the equity issues we follow seem to be in-line with potential pricing pressure Canpotex Ltd. will have to deal with.  For those not familiar with Canpotex Ltd., it is the marketing arm of the three big North American potash producers- Potash Corp. (POT), Agrium (AGU) and Mosaic (MOS).

We think that this recent price decrease, once again the result of the North Americans’ weaker brethren in Eastern Europe marks a bottom, much like the prices of 12-18 months ago represented a high water mark.  We cannot think of a time since we have been covering potash that at least one customer was not paying their own freight, and now we finally have a situation where there are none.  We can only hope that the North American producers are now locking in shipping rates before they begin to rise, nothing is worse for a business than to be selling your product at a fixed price while variable costs rise and eat away at your profit margins.  It is a situation we will watch closely, but nevertheless one that all should be aware of.

We see the North American producers, which we have always regarded as being more sophisticated business men than their counterparts in Eastern Europe, making some smart moves right now.  Potash Corp. has managed their output in order to keep the supply/demand ratio intact (which we must admit has cost them while benefiting others to an extent) while Agrium is looking to further consolidate in the industry.  If Agrium can take over CF Industries (CF) rather than CF take over Terra Nitrogen we think this would be much better for fertilizer producers.  In short it brings further control of the fertilizer industry under the control of those running Canpotex Ltd.  The United States Government has already given preliminary approval to the proposed merger, so a major hurdle has been cleared (the Obama Administration stated early on that they would take antitrust law much more seriously than the previous administrations).

So we see the supply side clearing up over the next 6-12 months and we have to admit that business on the American farm has never been better.  This year continued the current streak of bumper profits for farmers and everything we hear from clients and those in the business indicate that they see better years ahead as the economy improves.  This is true for many reasons, but most importantly as economies improve worldwide, the citizens can once again resume improving their standard of living, which includes among other things eating hardier meals…lots of meat in other words!

We also know from reports we have read that China allowed their potash reserves to dwindle in recent years rather than pay top dollar at the market peak, brilliant market timing for them and great move, however now they are left with less than half a year’s potash requirements for their farmers.  China is one who will need to increase their reserves back to levels seen in previous years and this is one factor which will eat up a considerable amount of production.  To put it in perspective, if China were to decide to replace their reserves to the levels from the reports we have read, they would need to purchase nearly 25% of their total potash needs this year.  This would equate to roughly a 33% increase in China potash imports and would soak up the producers’ excess inventory over the five year average.

We doubt that China buys all their needed potash at once, but it is simply something to keep in mind, when you look at the numbers, the increase in producers’ ending inventories is in the neighborhood of what China did not purchase for last year’s needs.  Coincidence, perhaps, but intriguing nevertheless.

Brazil, China and India will probably look to increase yields in the years ahead to match the generational trend taking place in the emerging world, that of productivity.  Brazil has learned the hard way what happens when you do not use potash to replace nutrients taken out of the ground from repeated corn and soybean plantings, and American farmers with farms down in Brazil have reported that Government Agencies are now educating farmers on the importance of crop rotation and use of fertilizers.

We believe the pendulum has swung a bit too far to the bearish side with all of the negative reports being issued by analysts.  If investors can withstand a poor earnings report or two and buy on dips, we believe that profits could be realized in this industry once again.  Farmers in our neck of the woods expect to pay more for potash and fertilizer needs in the near future as the economy continues to improve, they are not pleased about it, but they recognize the competition they now have from foreign growers for this important crop nutrient.