Time For Wall Street to Get Back on the POT

It's pretty clear that the stock price of Potash Corp of Saskatchewan (POT) is suffering from a sector rotation out of commodity-based stocks, as their Q2 earnings and forward guidance is 1 of the best reports I have ever seen. I would like to share my current observations on POT and why I feel it is still a good long-term investment.

The TTM P/E for POT now stands at 30 (rounded), and their projected P/E for 2008 is only 15.

To compute the Forward 12-Month P/E, start with the 2008 guidance of $13, then subtract Q1+Q2 to get $8.44 for Q3+Q4. Using an overly conservative assumption that POT experiences zero growth from Q4 to 1Q2009 (so, we get $4.22 each of the next 3 quarters), and sticking with the old estimate of $5 for 2Q2009, we get $17.66 over the next 12 months. Using this conservative method, this results in a Forward 12-Month PE of 11 for a company which is tripling its YOY profits - seems undervalued.

As noted, the unjustly low valuation is due to the recent sector rotation (much into the Financials), plus the assumption that POT's growth rate will decline rapidly as commodity prices decline. Let's discuss these 2 items:

Sector rotations are transient events. Wall Street follows the money and eventually returns to wherever the profits are growing most quickly. There are very little profits in the Financial sector now - in fact, we see mostly losses and write-downs. It is likely to continue getting worse for the Financials, as there is no end in sight for the housing problems which precipitated the global Financial problems. The dropping price of Energy, which triggered a rally in Financials earlier this week, benefits Financials less than any other sector - actually, falling Energy costs benefit mining companies by reducing input costs. We are continuing to see problems with credit ratings for various Financial institutions (recall the fear that the mono-line bond insurers may not be credit worthy - this issue is arising again) and further write-downs. The Financials no longer have access to money-making schemes such as subprime mortgages, highly-levered CDOs, SIVs, etc., and they will be more closely watched and regulated in the future. So, the rotation into the Financial sector appears to be short-lived (and broke down today).

As for the decline in commodity prices which is partly underway, it is not going to affect food (and the inputs to its production, such as fertilizers) as severely as other more speculative or less vital commodities. Food is the most basic need of humanity, and demand for food is growing rapidly as the masses of previously under-developed countries are rising out of poverty and starvation. Even if corn prices decline, the benefits of fertilizers far outweigh their costs to the extent that any intelligent farmer will continue to use them as long as the business case justifies their use. Given that a $100/ton increase in fertilizer cost only adds 3 cents to the cost per bushel (per Bill Doyle, CEO of POT), the cost of fertilizer has much room to grow still. Doyle noted that supply is unable to keep up with demand, and he refers to "allocations" to each country as if he is doling out a limited supply to desperately needy countries.

Face it, we are in the midst of a fundamental tectonic shift where companies supplying the surging global middle class with vital needs (i.e. fertilizer, food, energy) have become the most profitable, and this is not changing anytime soon.

As for Potash Corp of Saskatchewan, this is not just another Agri company - this particular company is so well-managed, that I would choose investing in them over any other Agri company. Note that they forecasted the current potash demand increase 4 years ago and positioned themselves accordingly for expansion, thus they have the most excess potash capacity in the world and essentially control the market. Their CEO noted on the conference call that they managed their costs well and hedged their natural gas expenses - very smart move. They waited patiently after their European counterparts in Belarus (who are currently having sinkhole problems) raised potash prices before slowly following suit, as they are trying to grow in an orderly manner rather than creating a bubble. They are extremely focused on maintaining long-term growth rather than trying to suck out as much money as possible during the current Agri boom (I believe the CEO once stated he prefers to drink from a steady fountain rather than from a "firehose").

Finally, I wouldn't be surprised to see them increase their tiny dividend on a regular basis to demonstrate their steady growth.

There is no sure thing, but long term, the pros seem to outweigh the cons here.

Disclosure: Author holds a long position in POT

Comments

[will]

100% agree. potash is king, should be trading over 250+ right now, and one of these days the big boys will wake up and figure out that their money should be flowing into Potash, not banks that continue to lose money. It's amazing how stupid some of these analysts and funds are. This stock is a powerhouse. It's that simple. They better get in now before this crosses 250 next week.

[hook]

none of this is new news, hence the falloff in Potash's stock. Blowout earnings were widely anticipated by bulls (who bought ahead of the report) and bears (who didn't short ahead of the report, which would have provided the necessary short covering fuel to push it higher after earnings.)

[CDW]

I also 100% agree with this article.
And let's face it: what does it matter if POT looses even 10-15% within the next few days or weeks?
Absolutely nothing since in the long run the steady worldwide demand will guarantee the price of this share to rise to 300$ or above.

[DAD08]

Title of this article says it all.
Well said.

[investor88]

POT is a definitely a fundamentally good stock. It is a matter of getting in at a good entry point to ride the next wave up, will be watching technical picture closely. This article has provided useful fundmental information on POT for investors and short term traders.

[najdorf]

POT is obviously a great company and a great stock, but projecting enormously out-of-historical-tren... earnings to continue into the future is a risky game. No one does this anymore, but Benjamin Graham would have investors look at ten years worth of earnings - now we're buying based on what we think will happen next quarter. Why do you think oil companies were trading at such low multiples even before oil prices started moderating a bit? People realize that oil prices are volatile and don't assume that present earnings will continue. Why do you think the tech crash happened? It wasn't because the underlying business failed at companies like MSFT and ORCL, it was because people realized that the projections of future earnings had become absurd and panic ensued.

Here's another way to look at POT: What do you know about it that other investors don't know? This is a fairly simple company that has recieved an enormous amount of publicity and is held by many well-known mutual funds. Everyone projects nice profits going forward. There are no problems on anyone's radar. So if the company is worth more, why isn't it trading for more? If any bad news comes out (decline in pricing, decline in output, new finds by competitors, scientific discoveries that reduce fertilizer needs, etc.), what's that going to do to a stock that's riding such a wave of momentum? Owning POT at this point is kind of like owning AAPL except that POT can't invent a new potassium.

As to the sector rotation to financials: of course some of it is silly. The people who have been piling in to C as losses continue and management shows no signs of having a clue what to do are just speculating. But there are banks with enormously beaten down prices who are turning profits again, and some are great long-term investments - WFC, BAC, etc. A financial crisis doesn't mean banks are never again good investments (take a look at what banks did after every past financial crisis), and due to the forward-looking nature of the market banks become good investments BEFORE news actually gets better and problems cease. Only rarely does a whole sector stay good or stay bad for more than 5 years.

[podiddly]

Over the past several months I've read some strange and convaluted wisdoms about POT. I've regularly deferred to the arguments against the stock, by investing with extreme caution, stupidly missing opportunities by hesitation and wondering what causes the aggrevating volatility. It moves aggressively daily and also periodically, as you all know. This, while fundamentals and quarterly reports do nothing but improve. After a couple of years now, I think Potash of Sask. is frequently caught up in "noise", where "noise" is defined by incredibly erroneous opinons by TV media, bloggers, (CNBC's Erin on "The Call" actually called it "poop"); --where analyst"s "noise" continuously lumps potash with oil and hard metal commodities, allowing fund allocations to sweep it higgly-piggly into a "sector" that totally disregards its fundamentals. Also, as a Canadian stock, I notice that the electronic presentations (e-Trade, Schwab and others) often fail to update screen information (esp. current PE ratio, earnings, etc.) -- for weeks. Sometimes I think investors, and especially traders have too much of a hard time accepting good news. This stock is surrounded by postive news, most of it irrevocable and substantive. Fertilizer-compound demand, is world-wide, growing exponentially and predictably in every crop producting country on this planet. This demand will continue unabated while the "noise makers" continue to confuse its simplicity with every gloom and doom or "too good to be true" story imaginable. The stock may struggle crazily in the financial environment, but the need to feed the world will continue. So I remain long-term long in Ags.

[Think-About-It]

Has anyone estimated how much Potash this company has? I realize it would be a wild guess but for long-term investors don't you need to make a guess as to the point at which a company selling a limited resouce begins to run into production shortages?

Is anyone concerned that genetically altered seeds will offset some of the demand for Potash in the (probably distant) future?

[cyerman]

If Billy Doyle were such a hot POT manager why doesn't he sweeten the POT by putting some of this mega growth loot back in the POT - the POT called shareholder dividends?

The current minuscule dividend in light of all all this prosperity does not provide a dividend protection backstop if the stock were to go south in a serious way or a reason to buy POT based on growing substantial dividends. And it places the entire investment rationale on POT's capital appreciation based on EPS^ and similar POT financial measures. Come on Doyle, broaden the stocks appeal and loosen up on the purse strings. Failure to do so just opens the stock up to more speculation, manipulation and sector rotation because there is no dividend protected bottom no matter how, er, juicy the earnings may prove out. (Yes, yes I have heard about the financials and their fancy and funny money dividends not protecting their stocks from the actions of their fantastically talented and poorly regulated managers. Hopefully there are no CDO equilavents on the horizon for fertilizer. One big pile of it courtesy the banks, hedge funds and private capital folks is quite enough, thank you.)

Hey, Mr. POT CEO: Begin a 30 year record of increased dividends to your owners beginning 4Q08 starting from some substantial perspective - say 3% or better.