Was investors' punishment of potash stocks an emotional overreaction or a rational recalibration of expectations for the global fertilizer market?
Well, it's still unclear. Russia's Urakali suggested prices would fall to $300 (U.S.) per tonne from the current $400 as it apparently busts up Belarus Potash Co., its half of the global potash cartel. In sending most potash producers' shares down 20 per cent Tuesday, investors seemed to embrace that view, even as Urakali's competitors urged everyone not to be too hasty.
As the author of a February article that recommended Potash Corp. of Saskatchewan Inc. and Mosaic Co. as long-term investments at prices that are now 30 to 50 per cent above today's levels, I'm sympathetic to the latter view. I didn't buy then – I can't purchase every stock I say nice things about – but I made a token bet, purchasing 50 shares of each company during Tuesday's carnage.
There's a group of potash stocks I don't quite have the guts to buy, however, even though they could produce even better long-term returns if the current potash sentiment is too pessimistic. They're the potash juniors, small companies with claims or potential mines but without revenue or the capital to pull the stuff out of the ground. Most trade for less than a dollar on the TSX or Venture exchanges; nearly all have market capitalizations of less than $100-million (Canadian).
If potash prices do settle in at $300 (U.S.) for the long term, many of these companies' shares arguably didn't fall enough Tuesday – some are probably worthless. If the potash producers can avoid cutthroat price competition, however, and the long-term agricultural thesis – more people, more food – holds, these bargain-basement stocks could provide risk-loving investors with a multiple of their initial investment.
Let's start with three companies that weren't hit as hard Tuesday (perhaps proving the market reaction was rational) because they are developing what's called sulphate of potash (SOP), a niche variant from the muriate of potash (MOP) that's produced and sold by the big industry players.
IC Potash Corp., Potash Ridge Corp. and EPM Mining Ventures Inc. all operate in New Mexico and Utah (although IC Potash and Potash Ridge have their headquarters in Toronto.)
Analyst Kiril Mugerman of Industrial Alliance Securities says SOP is the "preferred" potassium fertilizer for high-value crops such as tropical fruits and vegetables, but lack of supply and its higher cost makes farmers choose MOP instead. He says the Urakali news could reduce SOP pricing from $600 a tonne to $500 a tonne, which should still be a "healthy profit margin" if the companies produce at an expected cost per tonne of $150 to $250.
He has "speculative buys" on both IC Potash and EPM Mining Ventures (he doesn't cover Potash Ridge), saying the two "remain strong investment opportunities, as the SOP market dynamics are completely different and not dependent on the global cartel that controls the MOP market."
The outlook is more challenging for the juniors that intended to compete with the big MOP producers. Analyst Spencer Churchill of Paradigm Capital notes the stocks that took the biggest hit Tuesday were the companies working on relatively high-cost Saskatchewan projects that counted on significant sales to China and India (top markets for the large producers).
Specifically: Vancover-based Encanto Potash Corp., down roughly 30 per cent to about 18 cents per share, and Alberta's Karnalyte Resources Inc., down almost 50 per cent to less than $3 per share. (Vancouver-based Western Potash Corp., which also holds interests in potash permits in Brazil, saw much less damage to its share price Tuesday.)
The investment thesis behind these shares, says Mr. Churchill, has been that China and India will grow tired of dealing with the two cartels, Belarus Potash Corp. and Canpotex, the Canadian marketing group, and turn to the newer entrants for supply. But if Urakali leaves its group and begins cutting prices, "there is little incentive for China/India to write a potentially multibillion [dollar] cheque to secure [outside] supply." Much lower potash prices make these junior companies' projects "uneconomic," he says.
Toronto-based Allana Potash Corp. and Verde Potash PLC, which has its head office in Brazil, have some locational advantages. Allana's Ethiopian project gives it a freight-cost advantage to China and India, and the company has $20-million in the bank, Mr. Churchill notes. "The company has two to three years of runway and can weather this storm."
Brazil imports 90 per cent of its potash, which gives Verde's project value. Unlike Allana, however, its project "is very high cost relative to existing producers, and has yet to be proven at scale." As with the Saskatchewan mines, much lower potash prices make these companies' projects "uneconomic."
Indeed, much lower prices may make investing in any potash company uneconomic. For those who see the current contretemps as a blip in the longer-term "ag" story, however, it's possible that even the smallest and riskiest of potash miners can make a portfolio grow, too.
David Milstead