2007 Cost Impacts at Potash Corp. (Part III)

This is part III of my analysis on Potash Corp. (POT) (see parts I and II).

The magic number to start with is 1049.2 million. This number represents the 2007 subtotal impact of volume/price/other of all three segments combined, on the total gross margin increase. From this number, 170.0 must now be subtracted as total cost to result in, the by now familiar, 879.2 gross margin increase. If you can understand the significance of this simple exercise, then consider yourself to be in the minority, as the overwhelming majority of people on this planet do not think in these terms about anything, as it is very unsettling for them to do so. The issue at stake is cost, and the simple, underlying, governing principle is that "it always costs money to earn money." The apparent innate need in mankind to deny the true impact of cost has led to the eventual and inevitable downfall of many. Therefore, the weight of the cost impacts should not be underestimated.

Starting this time with the Nitrogen segment, 66.6 million or 39% of the total cost was incurred here in order to contribute 220.5 or 25% of the total gross margin increase. Taking the Potash segment next, 64.6 or 38% of the total cost was incurred here in order to contribute 351.2 or 40% of the total gross margin increase. And lastly, the Phosphate segment incurred 38.8 or 23% of the total cost in order to contribute 307.5 or 35% of the total gross margin increase. A quick glance indicates that the Nitrogen segment was the least cost effective of the three segments, while the Phosphate segment was the most cost effective, and the Potash segment was somewhere in between the other two segments.

To fully understand the cost impact of 170.0 on the subtotal 1049.2, each number must get divided by the other in order to get both a percent ratio and the easier to understand dollar ratio. Dividing 170.0 by 1049.2 results in 16.20%, the ratio of cost to subtotal, and dividing 1049.2 dollars by 170.0 dollars results in 6.17 dollars. The ratio of one dollar to 6.17 dollars is also 16.20%, gotten by dividing one dollar by 6.17 dollars. Therefore, the dollar ratio and percent ratio are equal and interchangeable. However, these numbers are all about the subtotal, not the all important, total gross margin increase. To get the total numbers, the cost must first be subtracted from the subtotal because "it always costs money to earn money." This is the step that most people don't like and thereby ignore to their own peril, which can be devastating if the costs are a very large percentage of the subtotal.

The total, as we already know, is 879.2. Now you can divide both 170.0 and 879.2 by each other to get the percent ratio of 19.34%, and the dollar ratio of 5.17 dollars. Or you can take the short cut of subtracting one dollar from 6.17 dollars to get 5.17 dollars and then divide one dollar by that to get the 19.34%. This is an example of the sublime beauty and simplicity of the laws of mathematics, that govern everything that happens on our little planet, as well as,what happens in my little life.

In the year 2007, the money making machine at Potash Corp. managed to change every dollar of cost impact into 5.17 dollars of gross margin increases, a dollar for dollar increase of 517% in one year. Over the same period of time, the stock price "only" increased 201%. Unless the stock price was grossly overvalued at the end of 2006, it would seem like something very mysterious was holding this stock down all year long. Could it possibly have been the curse of.......That Damned Albatross!

Looking closer at each segment, I'll spare you the math and just state that the Nitrogen segment numbers were 30.20% or 3.31 dollars. The Potash segment numbers were 18.39% or 5.44 dollars, and the Phosphate segment numbers were 12.62% or 7.93 dollars. The combined Nitrogen and Phosphate segment's numbers were 19.96% or 5.01 dollars. And repeating myself again, the total numbers were 19.34% or 5.17 dollars.

So what does all this mean? It simply proves that the Nitrogen segment was the least cost effective of the three segments in 2007. This was because Nitrogen both comes from and uses Natural Gas to be processed. Therefore, this segment will always be negatively impacted by the rising cost of Natural Gas, as the company must buy it from some other company, hence cost. I'll look deeper into that in another article. Phosphates were the most cost effective, as they had both large price increases, as well as very low costs. I don't happen to think that this performance will be sustainable in 2008. I think that in 2007, Phosphate was a one year wonder, not likely to be repeated, but I still think that Phosphates and Nitrogen will still both be very strong, just not stronger than Potash, either alone or combined. These are of course only my opinions, and are not backed up by facts, at this time. Perhaps in another coming article. Management has said all along that Potash is the future, and I don't disagree with the management at Potash Corp. on anything. It's the investment community that I don't agree with.

It's worth noting that the Potash segment, although smaller and slower growing in 2007 than the combined Phosphate and Nitrogen segments, was still more cost effective, contributing 5.44 dollars for every dollar of cost than the other two combined at 5.01 dollars, for every dollar of cost, or all three segments combined at 5.17 dollars, for every dollar of cost. Obviously, it makes the most sense for management to focus on and invest in whatever they think will be the most cost effective over time. More than two decades ago, that choice was made, and that choice was, very wisely, Potash. The strategy has always been Potash first, backed up by very strong Nitrogen and Phosphate segments, with all investments carefully weighed and balanced between the calculated future risks and the expected future returns. Need I say anything more?

Part four, on the way. - Carl Martin at seeking alpha