Nutrient fertilizer producer Potash Corp (click ticker for report: ) posted weak second quarter results Thursday morning. Revenue declined 11% year-over-year to $2.1 billion, worse than consensus estimates had anticipated. Earnings per share, adjusted for one-time items, declined 26% year-over-year to $0.73 per share, which was also worse than consensus expectations. Free cash flow remained terrific at $848 million, equal to 40% of revenue.
Image Source: POT 2Q 2013 Investor Slides
Potash’s issue during the second quarter was the material decline in potash (the mineral) gross margins. Prices declined significantly, falling 18% year-over-year to $356 per tonne as robust North American farmer demand (up 28% year-over-year) was more than offset by lower realized prices shipped via Canpotex. Price is paramount to Potash’s success, as CEO William Doyle mentioned on the conference call:
“We clearly believe price is more important than volume. We always believe that. We will continue to believe that. I think if you look at some of the places where we are up, little bit better in India in terms of total what we were awarded there, I think a lot of people realize around the world the value of what Canadian potash brings to the table.”
Because demand has been flat during the past several years, additional supply has put downward pressure on prices. Given the importance of potash as a fertilizer, we think long-term demand is healthy, but the short-term picture continues to look uncertain. India in particular has reduced farm subsidies, making it difficult for farmers to afford potash.
Not only is demand from India weak, but the Canpotex does not yet have a deal in place with China for second-half shipments. With the threat of BHP (click ticker for report: ) jumping into the potash market and Chinese economic fundamentals looking weak, China may have stronger negotiating power with the potash cartel.
Image Source: POT 2Q 2013 Investor Slides
Even though prices could be weak, we expect free cash flow will remain strong. Potash production already has strong margins, and Potash Corp has little incremental capital investment ahead, especially relative to peers. This gives the company robust financial flexibility, while it positions the firm to capitalize on any price movements.
Looking ahead, Potash Corp is confident that demand will be in-line with record-setting 2011 levels after experiencing some weakness in 2012. On a product basis, the firm anticipates 2013 potash gross margin at $1.8-$2.1 billion, with $1.1 billion realized in the first half. Nitrogen is anticipated to post new records, as gross margins totaled $547 million during the first half of 2013, despite the fall in prices. Phosphate, on the other hand, hasn’t been able to absorb lower prices with a superior cost structure, so the firm isn’t predicting a blockbuster second half.
As for earnings, management predicts third-quarter earnings of $0.45-$0.60—well below the consensus of $0.74 per share. Full-year earnings are expected to be $2.45-$2.70 per share, also considerably lower than the consensus estimate of $2.88 per share. Potash Corp’s guidance reflects a great deal of uncertainty in the second half of 2013.
Valuentum’s Take
Though potash is one of the better commodity businesses to be in—high margins, strong barriers to entry, and fairly rational behavior from participants—Potash Corp has experienced some minor headwinds as China and India demand lower prices. Without question, the company can thrive with prices in the mid-to-high $300 range, but it takes price expansion to help the firm achieve greater levels of profitability.
All things considered, Potash Corp’s strong cash-generating profile has us a bit intrigued. With price weakness persisting, shares now yield 3.8%. We’re would take a very close look at adding them to the portfolio of our Dividend Growth Newsletter if the yield climbs above 4%.
Chemicals – Agricultural: AGU, CF, CMP, IPI, MON, MOS, POT, SMG, TNH