Potash of Saskatchewan set for surge

Industry output will be lower than expected as rival Vale abandons plans for a huge mine in Argentina.

By StreetAuthority Mar 21, 2013 1:29PM
USA, Utah, sprinklers watering farm grass copyright John Wang, Photodisc Red, Getty ImagesBy David Sterman  
                                                     
Wall Street analysts tend to provide an updated look at the companies they follow every month or two, ignoring short-term issues and trends on a week-to-week basis. The good thing is you can use this slow reaction to your benefit. When major news hits the wires -- and analysts fail to even discuss it -- you have an opportunity to seize the initiative before the crowd arrives.
 
This notion was brought home on March 11 when Brazil's mining company Vale (VALE) announced it would abandon plans to pursue a $5.9 billion mining project in Argentina that was set to produce potash, a key fertilizer raw material. That mine had been intended to produce more than 4 million tons of potash each year, but now rival producers can breathe a sigh of relief. After all, smaller industry output is always a positive for pricing.

The reduction in industry output is likely to lead to higher pricing and profit forecasts for Potash of Saskatchewan (POT), aiding industry supply-and-demand trends that were already strengthening. Global demand for the fertilizer element cooled in 2012 as major buyers decided to whittle down inventories by roughly 4 million tons, according to Potash of Saskatchewan. Yet with inventories now at manageable levels, the company expects to ship 55 million tons of the agricultural product this year, or almost 4 million more tons than 2012. "Activity remains robust in North and South America with demand picking up in SE Asia," note analysts at Merrill Lynch.

We'll have to wait until analysts get around to adjusting their pricing and supply forecasts now that Vale is keeping that extra expected supply off the market. But even before that change, analysts already spot a looming upturn for Potash's key metrics. Goldman Sachs, for example, says that demand for all three of Potash's fertilizer products -- potash, potassium and nitrogen -- are set to rebound in 2013 from 2012 levels. The "rebound in operating rates in 2013 should drive a solid earnings recovery," Goldman's analysts say.

Now that much of the company's capital spending programs are nearing completion, the company is on the cusp of paying a lot more attention to dividends and buybacks. The dividend was recently boosted 33%, after rising more than 100% in 2011 and 2012. As free cash flow rises from here, more dividend hikes are expected to be announced in the next few years. Analysts at Goldman Sachs expect free cash flow to exceed $1.6 billion this year, $2.5 billion in 2014 and approach $3.5 billion by 2015.

That kind of prodigious free cash flow may also fuel share buyback programs. Potash managed to reduce the share count from 973 million in 2007 to 877 million in 2011, but didn't buy back any more shares in 2012. Now, with the reduced capital spending and expected commensurate surge in free cash flow, more buybacks may be in the offing.

Risks to Consider: Firming potash prices might induce Brazil's Vale to restart development plans for its stalled Argentinean mine, which might keep a lid on pricing.

Action to Take: The dividend growth and share buyback that analysts expect underpins Credit Suisse's "buy" rating and $50 price target on the stock. "POT is well positioned to potentially return a significant amount of capital to shareholders over the next 3 years," the analysts note.

By the time analysts digest news of Vale's mining changes, estimates for Potash may move even higher. If you want to be ahead of the crowd, now is the time to get into this stock.

David Sterman does not personally hold positions in any securities mentioned in this article.

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