Fabrice Taylor is a chartered financial analyst.
At roughly 30 times this year's earnings, Potash Corp. of Saskatchewan Inc. shares aren't going up because they're cheap. They're rising - 15 points in the past 10 days - because investors are pricing in the possibility of a takeover, most likely by an international resource giant such as BHP Billiton, Rio Tinto or some such.
That makes sense. Potash demand is depressed - down at least 50 per cent this year - and so are prices. Inevitably, however, both have to rise. The stuff is crucial to plant nutrition, and the more you take out of the soil by raising crops, the more you have to replace it. As for speculation on who the buyer might be, these multinationals are snapping up anything involved in extractive industry and they can get big money.
It would be a sad day for Canada, of course, and especially so in this case. Potash is a world leader, with roughly a quarter of the market, dwarfing its biggest rivals. It has enormous, high-quality reserves and low costs in a stable country. More tragically, I would argue, is that Potash may have blown its chance all on its own.
Flashback to three years ago, when everything was coming together for potash prices. The ethanol bubble was swelling nicely (ethanol is made with corn which needs a lot of fertilizer), global demand was starting to grow at a faster than average rate and a major mine, Uralkali's Mine 1 in Russia flooded, creating a massive sinkhole and immediately cutting off about 3 per cent of global supply. That might not sound like a lot but remember that in commodities the last unit of supply has a huge influence on prices.
So 2007 was shaping up to be a great year price wise. And it was. As Potash said in that year's annual report: "In the past - yesterday - we were able to report that some factors of this global development affected our business favourably, but never did the drivers of our business line up as we believed they could. Never, that is, until today."
The company would earn $3.40 per share (U.S.), or 72 per cent more than the year before, and almost two thirds of the increase in earnings was because of higher potash production and prices (the company also sells nitrogen and phosphate, but potash is its key product).
The following year was even better, despite the onset of the financial crisis. Potash earned $11 per share on the back of dramatically higher prices for everything it produces, but especially potash. This year won't be so kind. Potash just cut earnings estimates, pegging them between $3.25 and $3.75.
Now, here's the question: Potash is the Saudi Arabia of the industry, the low-cost swing producer. Would it have better served its shareholders had it tempered prices by increasing production in even if that meant earning less? It certainly had the capacity to do so.
There are many reasons, including big crops, for plummeting demand. Might one be that buyers were taking huge writedowns on their potash inventories which they paid $1,000 per tonne for? They have less money and less inclination to buy more today because of what it cost them?
Those high prices did more than cut demand. They attracted a lot of capital to the sector. There are eight advanced greenfield projects under way and about 20 early stage greenfield projects (greenfield meaning from scratch), according to CIBC World Markets. And that's not counting expansion plans at existing facilities. That means more competition down the road.
The Chinese, the biggest buyers, are reportedly looking to build their own potash mine in Saskatchewan. Greenfield takes five to seven years, but in the meantime they have the upper hand in price negotiations and they're not wasting it.
To restate the question: did Potash get greedy in the short-term? CEO William Doyle's stock options were worth $730-million at their peak and he's no spring chicken. Was he thinking about distant horizons? Would any of us?
As Warren Buffett says, be greedy in the long-term, not the short-term. I'm not sure that Potash was or wasn't. It's worth asking though. I'm sure it's a potential takeover candidate. I'm also sure that the economics would be better if it had been long-term greedy, were such a thing possible.
© The Globe and Mail
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