Markets & Finance

Marcial: Renewed Growth for Potash Corp.?


The stock may be undervalued based on its earnings outlook and the chances of the company benefiting from a rise in corn prices

Corn prices are on the rebound after being depressed earlier this year, and so are shares of fertilizer companies, such as Potash Corp. of Saskatchewan (POT), the world's largest potash producer. The recovery in corn prices is a welcome and timely relief for farmers whose income has dried up due to unexpected cold summer weather and diminished demand for food crops as the economy weakened.

It is equally a lifesaver for investors in fertilizer stocks, a formerly red-hot group which has diminished even as the Dow Jones industrial average has rallied close to the 10,000 psychological barrier.

Corn was selling at about $3.05 a bushel in September but has since come back, to $3.71 on Oct. 16. Consequently, shares of Potash have climbed from 84 in mid-July, a 52-week low, to 94 on Oct. 16. The stock traded as high as 241 in 2008.

The stock's prior collapse has generated a swirl of speculation that Potash may be ripe for a takeover by the likes of BHP Billiton (BHP), the giant Australian mineral exploration and production company, and Brazil's Vale (VALE), another large mining company that also produces potash, among other metals and commodities.

BHP potash expansion?

BHP, according to press reports, has accumulated about $18 billion in cash, to be used mainly for acquisitions. Last year the company made an unsuccessful bid to buy a Russian potash mine owned by Eurochem Mining and Chemical and did acquire Canada's Anglo Potash. These developments indicate to some analysts that BHP is indeed seeking to further expand its stake in the potash industry, and that Potash Corp. is its main target.

Some investors and analysts believe that if the stock of Potash remains depressed and continues to drag behind BHP and Vale, the chances get even higher that those two giants will make a move on the company.

So far, shares of BHP and Vale have outperformed those of Potash. Since their low of around 25.53 on Nov. 20, 2008, the ADRs of BHP have just about tripled, to 71.50 by Oct. 16. And Vale's ADRs, down to a 52-week low of 8.80 on Nov. 20, 2008, have more than tripled, to 26.14 on Oct. 16.

"This kind of a wide gap between the price of Potash and that of BHP/Vale makes Potash more vulnerable to a takeover," says Sam Kanes, analyst at Scotia Capital, a subsidiary of Bank of Nova Scotia. However, with or without a takeover, he is a bull on Potash. He rates Potash a buy solely on fundamental reasons, he says, and thinks the stock is undervalued based on its earnings outlook and the chances of the company benefiting from the spiraling rise in corn prices.

china fertilizer purchases likely

Kanes is also looking at the possibility that China, a significant buyer of potash, will sign an agreement soon with the company to resume purchases of the fertilizer. The expectation is Potash will start shipping the product to China by January. That too is behind the fresh bounce in its stock, and is improving the prospects for Potash's sales and earnings.

Apart from potash, which accounts for 43% of sales and 62% of gross profits, Potash Corp. also produces two other plant nutrients: nitrogen—the company is the world's second-largest producer—and phosphate, of which it is the No. 3 producer.

Kanes says that based on his earnings forecasts, his 12-month target for Potash is 130 a share. He expects the company to earn $3.50 a share in 2009, $7 in 2010, and $11 in 2011.

One big Potash investor, who preferred not to be identified because of his close relationship with Potash executives, figures that in a takeover, Potash is worth 150 to 175 a share. "It should be a no-brainer for the likes of BHP or Vale to see the merit in acquiring Potash," says this investment manager. It takes five years, he notes, to build a potash mine, "while Potash Corp. is out there probably ready to be taken out."

more fertilizing by farmers?

The spokesman for Potash couldn't be reached for comment. Potash hasn't indicated it is for sale or that it would welcome an offer.

Analyst John Chu of Research Capital in Montreal says "rumors continue to swirl" about an mergers and acquisition deal. Potash indicated "it sees consolidation taking place amongst the larger players, and that BHP could be an acquirer," wrote Chun in a recent note to clients. The fall in the price of Potash shares, he said, looks like an "opportune time to invest" in fertilizer companies.

"If China does settle by November and restocking [of fertilizer] takes place, we believe the strength typically seen in the fall [season] for agriculture and fertilizer stocks will be especially pronounced this year," especially for Potash, said Chu. He rates Potash a buy with a 12-month target of 113 a share.

When farmers start replanting, the fertilizer sector in particular will see the beginning of a recovery in their income. "We believe farmers will have to return to normal nutrient use beginning in 2010," says Richard O'Reilly, analyst at Standard & Poor's, who has upgraded his recommendation on Potash to buy from sell, based mainly on valuation. Farm activity will "drive potential volumes closer to those in recent years," says O'Reilly.

In sum, Potash is a win-win proposition based on improving fundamentals: the rising price of corn, new orders from China—and the possibility of a takeover by a larger rival. Savvy investors may be able to harvest some nice gains from a Potash revival.

Marcial writes the Inside Wall Street column for BusinessWeek. In 2008, FT Press published the book Gene Marcial's 7 Commandments of Stock Investing.

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