Thu, 12 Sep 2013
As the clash among Eastern European producers has caused a rift in the global potash market, the long-term outlook remains in question for investors, say Morningstar's Matt Coffina and Jeff Stafford.
Matt Coffina: For Morningstar StockInvestor, I am Matt Coffina. I'm joined today by Jeff Stafford, who is an equity analyst on our basic materials team, and we're going to talk about recent developments in the potash industry.
Jeff, thanks for joining me.
Jeff Stafford: Thanks for having me, Matt.
Coffina: In recent years, the potash industry is operated as what we consider a rational oligopoly. Can you explain what this means?
Stafford: The potash industry is very concentrated. The top five or six producers in this space control about 80% of production capacity. On top of this, the top four producers, PotashCorp, Uralkali, Belaruskali, and Mosaic, are part of two large marketing organizations that act in a cartellike fashion. What this means is these companies, during periods of slow demand, actually shut in production to better match demand with supply to help preserve prices. And that has led to an industry with potash prices well above marginal cost of production for several years now.
Coffina: Recently, there have been some signs that this market structure could be breaking down, in particular, a dispute between Russian miner Uralkali and Belarusian miner Belaruskali. What do you think is behind this dispute?
Stafford: The main reason behind this dispute is Belaruskali was going outside of Belarus Potash Company, the cartellike marketing organization, to sell potash to international players, and they legitimize this with a new law in Belarus. This upset the Russian producers and Uralkali and led to a breakdown in relations between the two companies, and ultimately led to Uralkali leaving BPC and choosing to market its potash on its own through its own trading company. And next year, Uralkali will operate at 100% of capacity and pursue a volume-before-price strategy, which runs opposite to what industry players had done in the past.
Coffina: This dispute has taken on some interesting twists and turns since it was first announced. For example, Uralkali's CEO was arrested in Belarus. Could you describe some of these events and what they might mean for an eventual reconciliation?
Stafford: This is a very interesting twist in the potash story recently. The Belarusians invited the CEO of Uralkali to Belarus to discuss the recent potash developments, and this was at the invitation of the prime minister of Belarus. And upon leaving Belarus, the CEO of Uralkali was detained at the airport and is, to our knowledge, still being held in Belarus.
What I think this means for the industry is that, I don't see a quick reconciliation between these two parties and I think the act of detaining the CEO of Uralkali even lowers the chances that we're going to see a quick reconciliation. And in our view, a quick reconciliation would be a positive for potash prices.
Coffina: What does all this mean for potash prices? I know you lowered your base-case forecast. Could you give us some sense of what assumptions are underlying that new forecast and what could go better or worse than you expect?
Stafford: We've lowered our long-term potash price forecast to $300 per metric ton at the typical plant gate in Saskatchewan, down from $375 per metric ton. We're assuming that there is some real pressure on potash prices both in the near term and the long term from Uralkali's new volume-before-price strategy. But we're not assuming that price will go all the way down to marginal cost of production for the industry. We're not sure yet what Canpotex, which is the Canadian cartel, what their new strategy will be in this environment. We don't expect them to run at full capacity right away. So there should be an opportunity to maintain some of that oligopoly pricing power, particularly in North America.
On the upside, I think, would be a quick reconciliation and a reformation of the BPC cartellike marketing organization. And in that case, we would expect our potash price forecast to go back to the $375 per metric ton number that we had before the Uralkali announcement.
On the downside, I think you could see more and more players adopt this new Uralkali volume-before-price strategy, and that would put even more pressure on potash prices by increasing supply far greater than demand. In that case, I think, we could see potash prices drop materially below $300 per metric ton.
Coffina: StockInvestor's Hare portfolio owns PotashCorp and Compass Minerals, two companies in this industry. Would you be interested in either of these companies at current levels? And are there any other names in the industry that stand out as potentially being good investments right now?
Stafford: We've lowered our fair value estimates for the two wide-moat players in the potash space that we cover: Potash Corporation of Saskatchewan and Compass Minerals. We think those companies are both marginally undervalued at the moment. But they also carry wide economic moats, thanks to their low position on the industry cost curve for both muriate of potash and sulfate of potash. We think that they look attractive, but we would also caution investors that these are, in the case of PotashCorp, this is a high-uncertainty company. And the impact of Uralkali's announcement is still flowing through the marketplace, so there could be even more uncertainty in the near term as we get more data on what Uralkali's ultimate strategy will be.
Coffina: Are there any other companies that you have on your radar screen?
Stafford: Some of the other potash companies that we cover are Mosaic, Intrepid, SQM, and K+S in terms of attractive valuation. Right now we don't see any of those companies--most of them [have Morningstar Ratings for stocks of 3, 2, or 1 stars]. We don't see really any compelling valuation stories with that other group.
Coffina: Thanks for joining me, Jeff. In conclusion, this is a difficult situation with a lot of geopolitical risks and a lot of uncertainty about what some of these international players in Eastern Europe are going to do. But PotashCorp and Compass Minerals, we think still have wide economic moats and are trading at a modest discount of fair value. For StockInvestor's Hare portfolio, I expect to hold these companies in the near term as we see this play out.
For Morningstar StockInvestor, I am Matt Coffina.