Potash mania bites the dust

Should a fertilizer company be Canada's stock market darling?

Photo courtesy of Potash Corp.

Photo courtesy of Potash Corp.

For a simple fertilizer company, Potash Corp. has found itself the subject of some lofty comparisons over the last year. “The Google of fertilizer” was how one financial blogger described it. Financial analysts dubbed Saskatchewan the “Saudi Arabia of potash” for its abundant reserves of the coveted, pinkish mineral, an essential ingredient in chemical fertilizers. And as the suits on Bay Street suddenly discovered their inner Old Mcdonalds, potash was hailed as the “new oil” and “pink gold.” But lately, another analogy has been making the rounds, and it’s not nearly as flattering. “A technical and quantitative analysis shows the trend for Potash Corp. as being very similar to that of Nortel,” wrote Mark Deriet, an analyst at Cormark Securities in a recent column. Nortel, he continued — as if anybody really wanted to be reminded — was the “former stock darling during the tech boom . . . that ended in the tech wreck.”

There’s no question the past few years have been a wild ride for Potash Corp. and its investors, not to mention everyone else saddled with a rising grocery bill. Potash has quickly become one of the hottest commodities amid fears the world’s agricultural land can’t produce enough crops to feed a growing, hungry planet. And as the world’s largest producer, investors couldn’t get enough of Potash Corp. shares. By the time the stock hit $244 in June, it had soared a whopping 1,600 per cent in just four years. What’s more, its market value of $63 billion easily made it the largest company in the country — ahead of titans like the Royal Bank, Manulife Financial, and Research in Motion.

But lately, storm clouds have begun to gather. In recent weeks, Potash Corp., along with other fertilizer and agriculture companies, shed a quarter of their value before rebounding late last week. For some, the dramatic rise of the company’s shares and euphoria for all things agricultural is reminiscent of the mania that surrounded Internet stocks during the late 1990s, when tech-euphoria briefly made Nortel Canada’s largest company by far. Last week, Citigroup’s chief equity strategist, Tobias Levkovich, warned a “dot-corn” bubble has formed. “Excess excitement in the farming sector seems reminiscent of days past,” Levkovich wrote in a note. “The refrain of ‘everyone has to eat,’ while catchy, can also lead to sentiment-based investing and not more rational, fact-driven constructs.” To put it bluntly, investors who stampeded into agricultural stocks seem to have left their brains behind.

While potash retains a loyal legion of believers who argue the stock is seriously underpriced given the food crisis, the fact is potash, like almost every agricultural commodity, has a long history of booms and busts. The question now is whether Potash Corp. will continue one of the greatest bull runs in Canadian history, or wither on the vine like so many stock market darlings before it?

What’s made the Potash Corp. story so compelling is its apparent simplicity. Not only is the world’s population growing, so too is its appetite. Hundreds of millions of people have been lifted out of poverty in countries like China, India and South America. Thanks to their fatter wallets many have developed a taste for meat — a fact Potash Corp. promotes heavily. In its 2006 annual report, the company said China’s meat consumption “more than tripled” over the past 20 years. By the 2007 annual report, the term being used was “almost quadrupled.” (The company didn’t make anyone available to comment for this story.) Whatever the multiple, it takes seven grams of grain to produce one gram of meat.

At the same time governments have pushed for the use of biofuels made from corn and other food crops, to lessen the world’s reliance on oil. Many analysts believe surging demand for biofuels has put enormous added pressure on food supplies. Compounding matters, the amount of arable land is dwindling due to urban sprawl. Add it all up, potash proponents say, and the only way to squeeze more crops from less farmland is to use fertilizer, which boosts yields and helps plants grow faster.
No one has preached the gospel of fertilizer with more fervour than Potash Corp.‘s CEO Bill Doyle. “The bottom line is that the world needs more potash,” he told analysts in May, “and this is likely to continue for the foreseeable future.” When Doyle took the helm in 1999, potash prices had been stuck in neutral for years, at around $100 per ton. Doyle insisted that would soon change, and that Potash Corp. would be perfectly positioned for the rebound. While the company produces three key types of fertilizer — nitrogen, phosphate and potash — the latter is the most sought-after. Though 12 countries produce potash, Potash Corp.‘s Saskatchewan mines account for 22 per cent of the global market, and the province contains 50 per cent of the world’s reserves.

When Doyle’s prophesy became reality and demand for fertilizer started to increase, Canpotex, the consortium that markets Canadian potash internationally, was able to escalate prices to customers. In April, China caved to Canpotex’s demands that it pay $400 more per ton than the year before. Last month the price hit $1,000 per ton.

The result has been a windfall for Potash Corp., as well as for Doyle. In its most recent quarter, the company earned $905 million, up threefold from the year before, on sales of $2.62 billion. Meanwhile, according to company filings, Doyle has stock and options with a paper value of $620 million. Now Potash Corp. workers are angling for a bigger piece of the good times — in August, the company was hit by a bitter strike at three of its mines, which shows few signs of letting up.

With Potash Corp. tearing up the markets, several companies have rushed to get in on the action. For instance, in April, Denver-based Intrepid Potash went public in one of the strongest IPOs in the U.S. this year. Meanwhile, Vancouver-based Western Potash, which hit markets in May, quickly saw its value surge to $170 million, even though Western’s only assets are some exploration rights in Saskatchewan and the company has yet to generate a penny in sales. And when a shell company called Timer Explorations bought two exploration permits and switched its name to Potash North in May, its shares jumped 16-fold. If the key to a successful IPO during the tech boom was to have dot-com in your name, these days the magic word is potash.

Yet, despite the euphoria surrounding the sector, not everyone is sold. Critics take issue with some of the assumptions that fuelled the potash boom. For one thing, they say, it’s wrong to compare the mineral to crude oil, as some analysts have done. The steep run-up in oil prices was driven by the belief that the world’s supply of oil had peaked. Potash is often said to be scarce. But as David Wolf, an economist at Merrill Lynch pointed out in an April report, there is more than 300 years worth of potash buried underground waiting to be dug up. The reason the supply has been so restricted in recent decades is because the mineral was such a dud that companies saw no reason to boost their production. Wolf also noted that the market capitalization of the three largest North American potash producers was “bigger than the value of all of the potash ever sold in the history of the world.”

Rampant population growth doesn’t necessarily guarantee higherfertilizer prices either. Potash Corp. frequently cite UN projections that the world’s population will grow at a phenomenal rate in the future, from 6.7 billion people last year to 9.2 billion in 2050. That’s a lot of mouths to feed.

Yet the world’s population is 2.7 times greater than it was in 1950, and during that period, the price of potash, adjusted for inflation, actually fell by half, according to historical data from the U.S. Geological Survey. Part of the reason for this is that new agricultural technologies have enabled farmers to squeeze more out of their fields. At the same time, agricultural commodities as a whole have been laggards, despite the headlines about soaring food prices. Over the last two years the price of corn has tripled. But after factoring for inflation, corn still only costs a third of what it did in the mid-1970s, according to “Some folks in my profession will say, with some justification, that the outlook for commodities is bad, and that it always has been,” says Al Mussell, a senior research associate at the George Morris Centre, an agribusiness think tank in Guelph, Ont.

So is the outlook for agriculture bright or gloomy? It’s that very disagreement that has contributed to the constant boom/bust cycle underlying all commodity businesses, and potash is no exception. In America’s early days it was one of that country’s most important exports. (The very first patent ever issued in the U.S. was to an inventor who conceived of “a process for producing potassium sulfate from a potash source.”) But it wasn’t until the early 20th century that the first real potash bubble formed. At the time, most of the world’s supply came from Europe, and in the lead-up to the First World War, supplies were cut off. This sent prices soaring. In today’s dollars, a ton of potash fetched as much as $10,000, up from $1,000 a decade earlier. With prices so frothy, it wasn’t long before speculators plunged into the market and new discoveries began to make the news. In September 1916, the New York Times trumpeted an “enormous” potash find in Cuba. But barely one month later, the jig was up. “Cuba’s potash bubble, from which a number of persons expected to make millions, appears to be pricked,” the paper reported. As it turned out, samples taken from the site were fixed. “Someone must have salted them.”

Potash prices have never come close to reclaiming those lofty levels. But in the 1950s Saskatchewan seemed to be on the cusp of a potash boom. Huge discoveries were made a decade earlier, and the NDP government of the day offered hefty subsidies to kick-start the industry. At least 30 companies piled in, and the resulting glut caused prices to crater. The province seized control of the industry, and it wasn’t until 1989 that Potash Corp. was finally spun off as a public company.

Today potash production is tightly controlled by a small group of players, giving them lots of pricing power. Potash Corp. has plans to spend $6 billion to boost its operating capacity by 7.1 million tonnes by 2015, according to a report by RBC Capital Markets analyst Fai Lee. Even so, he suggests, global potash supplies will remain tight.

But for how long? Well-financed mining giants have started to take notice of the potash boom. Last month, Rio Tinto said it planned to develop potash mines in Canada and Argentina starting in 2012 and vowed to grab 10 per cent of the global market. Then last week, BHP Billiton, which recently acquired Calgary-based Anglo Potash, said it may plow “billions upon billions of dollars” into potash mining.

The prospect of intense competition could partly explain why fertilizer company shares declined in recent weeks. There are also concerns potash prices could fall. When the “sticker shock” fully hits farmers next year, says Mark Gully, an analyst at Soleil Securities, they may cut back on their use of fertilizer. Other analysts have also suggested warm weather and a good growing season in North America this year could reduce the need for chemical fertilizers.

But above all, there’s a feeling among some that the potash market simply got too hot, too fast. “The valuations were stretched,” says Gulley, who maintains a “hold” recommendation on the stock. “These stocks were trading above the replacement costs for their assets and that’s always a red flag.”

Potash Corp.‘s staunchest supporters are having none of it. Last month, as the stock tumbled, Lee at RBC raised his target price for the company to $375 a share, nearly double where it was last week. To put that in perspective, if the company’s shares reach that level, Potash Corp. would be more valuable than Royal Bank and TD Bank combined.

With the debate over the potash market raging on, perhaps it’s best to consider the words of Louis Ware, the Chicago-based formerpresident of International Minerals and Chemical Corp. According to a newspaper report, Ware told a luncheon in Regina that “the growing world population, the heavy withdrawals of soil minerals and advanced methods of farming all point toward an ever-increasing demand for potash.”

He gave that speech in 1957. With the subsequent collapse of Saskatchewan’s potash market, it took nearly half a century for potash prices to get much above where they were back then. Potash Corp. investors are hoping that this time things will be different.

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