Potash Worth Feasting On by Motley Fool - March 20, 2008
I hate chasing a stock. Especially when the stock in question has enjoyed a spectacular run and trades at a relatively rich valuation. But sometimes, the growth story is so exciting that I bite the bullet. Canadian-based Potash Corp. (NYSE: POT) is a case in point. Shares of the world's largest producer of fertilizers have advanced some 215% in the last year, lifting the valuation to roughly 22 times consensus fiscal 2008 estimates of $7.38.
That would appear to be quite a steal if the company could continue to grow at its five-year historical annual rate of 94%. But with analysts expecting just 10% growth in the next five years, that's a hefty price tag in terms of growth potential.
Of course, you can't always bank on what analysts project. And thanks to Potash's commanding position in the expanding fertilizer market, along with its advantage of being a low-cost producer, I believe the company will continue to outperform.
According to the International Fertilizer Industry Association, global fertilizer demand grew 5% in 2007, and is expected to expand an average 3.5% over the next two years as increased grain consumption in emerging-market countries such as India and China, growing demand for biofuels, and rising crop prices spur farmers to plant more.
This is no temporary trend. The world's population is expected to grow from roughly 6.7 billion currently to 9.2 billion in 2050, meaning more people will have to eat. Rising incomes in many emerging-market countries are rapidly changing dietary habits in favor of eating more chicken and beef, which increases demand for grain fodder. In fact, inventories are at their lowest in 17 years, and with roughly 90% of farmland already utilized, farmers turn to fertilizers to enhance the quantity of production possible per acre.
Ahead of competitors CF Industries (NYSE: CF), Mosaic (NYSE: MOS), and Agrium (NYSE: AGU), Potash Corp. is a force in fertilizer as the largest potash player in the world, the second-largest producer of nitrogen, and the third in phosphates. Given that prices of all three fertilizer products are increasing rapidly, this certainly bodes well for the company's prospects. Its unique position in the potash market is what strikes me as its most alluring investment characteristic, and the segment that should propel much of the company's future growth.
Potash Corp. operations accounted for 17% of worldwide production of potash in 2007 and 22% of global capacity. It holds an estimated 75% of the world's excess capacity. Potash Corp. should be able to secure its position in the market, as opening a new mine can cost roughly $2 billion to $2.5 billion, and then take nearly five years to come fully online. That certainly seems like a considerable barrier to entry.
Additionally, potash supplies are particularly tight these days, naturally pushing prices up. Farmers are willing to pay premium prices for quality fertilizers since the additional crops they can yield provide lucrative returns. Consequently, contracts are resetting at much higher prices. This has already translated into improved margin expansion and boosted earnings growth for Potash Corp. and should further enhance financial performance if these trends persist.
In addition to its notable market share, Potash Corp.'s other competitive advantage is its low-cost production base. Take, for example, the company's nitrogen business. Close to 66% of Potash's ammonia production is located in Trinidad, which allows the company to secure low natural gas prices, which can constitute nearly 90% of the production cost. Further, the company's mines are located in low-cost areas, and management puts its production near end users to minimize transportation costs.
Potash's shares may appear richly valued. But I think there is a growth story here. The company is the global leader in a rapidly expanding industry, holds what could be termed a quasi-monopoly in the important potash market, and is also a flexible, low-cost producer. Potash is poised to continue benefiting from current bullish agricultural trends, and this kind of growth potential and market-share positioning doesn't come cheap. So, investors, load up your plates and enjoy the feast.