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A bumper year for crops, a rocky patch for Potash shares

The Potash Corp. logo at the entrance of the company's office tower in downtown Saskatoon.

Liam Richards/liam richards/The Globe and Mail

Despite its commanding market share, cartel-like pricing and some of the lowest production costs in the world, Potash Corp. of Saskatchewan Inc. has disappointed investors over the past year, as farmers pushed back against high fertilizer prices and delayed enriching their fields with nitrogen, phosphorus, and potassium.

The company's share price has tumbled 23 per cent over the past 12 months, to a point where the vast majority of analysts consider equity in the world's largest potash producer to be undervalued. That is likely true, based on long-term trends. But investors tempted to buy in for short-term profits should brace for turbulence.

Among the factors feeding volatility: India and China are taking a tough stand on contract negotiations for potash this year, and in North America, inventories of potash are higher than normal.

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The best single indicator for Potash Corp. investors to watch is the price of corn . Since going public in 1989, the company's share price has closely followed the ups and downs of the corn market, even more so than the price of potash itself. In fact, corn prices have proved a leading indicator for potash prices (see chart).

The corn indicator is looking weak at the moment, as prices for many grains have dropped as much as 40 per cent from their 52-week highs, due in part to bumper crops in Eastern Europe, Russia and Australia. On Thursday, the U.S. Agriculture Department reported that both corn and soybean inventories are higher than expected.

Traditionally, when demand is soft, Potash Corp. curtails production to maintain prices, much as Saudi Arabia takes the lead among members of the Organization of the Petroleum Exporting Countries to support oil prices.

Over the past two months, Potash Corp. has announced the temporary closure of three mines in Saskatchewan that represent about 10 per cent of its overall production. The Street is hoping that the shutdowns won't exceed more than eight weeks and will balance production and demand. More details are expected on Jan. 26, when the company is scheduled to report fourth-quarter performance and offer guidance for the year.

But a small minority of analysts are raising red flags, including Jacob Bout, of CIBC World Markets Inc., who says growth in demand for potash will fall short of the historical 3.6 per cent mark this year, in the face of weaker buying in both the U.S. and China.

Robert Winslow, of National Bank Financial Inc., forecasts that Potash Corp.'s earnings per share will decline by 25 per cent and sales will drop 15 per cent this year, noting that grain prices have fallen about 15 per cent off their 2011 highs and global grain inventories have risen about 10 per cent over the last six months.

"While the potash oligopoly can try to keep prices artificially high in a falling grain price environment, farmers are savvy buyers of crop inputs and their potash demand can be sufficiently elastic to eventually bring potash prices more in line with other [agricultural]commodities," Mr. Winslow wrote in a report last week.

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Potash had the third-largest price increase last year among the 32 commodities ranked by the Scotiabank Commodity Price Index, rising 32 per cent, as high grain prices early in the year encouraged farmers to use more fertilizer.

"We're experiencing a lull right now, especially in November and December," Stephen Dowdle, president of sales at Potash Corp., admitted in a web discussion last month. But he cited several factors that he said should help performance this year, including the fact that fertilizer costs for corn relative to revenue are lower today than the 10-year average and that farmers have recently reaped record income thanks to high crop prices.

"We're expecting that demand is going to be quite robust in the first quarter," he said.

For investors who can stomach the short-term ups and downs of the agriculture market, it's hard to argue against the potential of Potash Corp. over the long term. The company produces the three primary crop nutrients – potash, phosphate and nitrogen – that help improve crop yields at a time when the amount of farmland is declining around the world.

"There will be 2.2 billion new mouths to feed in the next 40 years. That's part of this growth story," said Bill Johnson, Potash Corp.'s senior director of public affairs. "People who invest in agriculture take a look at those long-term trends."

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