Is Fertilizer Starting to Stink?

If you were Rip Van Winkle (or in a coma) and had looked at the stock price of Potash Corp of Saskatchewan (NYSE:POT) before you fell asleep on January 1 of this year, and then stretched your legs and checked the papers Wednesday, you wouldn't think there was much to this stock. Not much growth, no real action, nothing to see here. But of course, that wouldn't be the whole story, because while you were sleeping, you missed a hell of a ride.

Back in March, I wrote about the fertilizer market with its skyrocketing potash prices and crazy-high P/E ratios - with a nod to some pretty heavy volatility. Here's a little snapshot of the numbers from back then:

Agrium
Potash
Mosaic

Market Cap ($B)
10.3
50.52
45.62

P/E (ttm)
20.14
47.05
48.31

EPS (ttm)
3.24
3.403
2.13




Here's what those numbers look like today:

Agrium
Potash
Mosaic

Market Cap ($B)
10.9
43.1
35.5

P/E (ttm)
10.07
21.97
17.10

EPS (ttm)
6.86
6.44
4.67




What happened?

As predicted, Potash Corp has reported some tremendous profits. The second quarter alone saw its earnings go up 220% - $905.1 million vs. $285.7 million the year before. As we suspected back in March, this was because they were able to lock in high prices, while there was increased demand due to larger crop plantings.

Globally, the fertilizer market remains concentrated and tight; in other words, a market ripe for rising prices. The largest potash-producing countries are Canada, Russia, Belarus and Germany. China has some of its own resources, but may face a shortage of up to 25% of its potash needs for this year and is looking to lock in contracts before any further price increases occur. Both China and Russia have implemented export tariffs to try and keep much-needed fertilizer products at home for domestic use.

Since January 1, Potash Corp.'s stock ran for almost double, from $120.24 on January 17 to $239.50 on June 17 - a price it was unable to sustain, and at a P/E ratio way ahead of most boom-boom tech stocks. Competitor Mosaic (NYSE:MOS) also doubled its stock price - going from $80.02 on January 18 to $161.08 on June 17.

No coincidence. Both stocks were running as hot knockoff agricultural commodity plays. But P/E ratios have come down by half all over the commodities markets, and the potash business has been no exception.

But there's more going on here than just the revaluation we saw in other commodity equity markets like coal, especially with regard to what happened in August. We tend not to spend a lot of time worrying about Canadian labor disputes down here in the U.S., but in this case, we do so to our peril.

In early August, close to 500 United Steelworkers union members walked off the job at three Potash Corp. mines after contract negotiations broke down. The workers had been without a contract since April. As of Monday, there weren't any talks scheduled between the union and the company. Potash Corp. has plans to increase capacity at their mines by 76% by 2012, and is still expecting to go forward with those expansion plans. Of course, increasing capacity without actual miners to turn that into capacity utilization ...

As of now, Potash has managed to start up one of the mines, at least in a limited fashion. While the strike has affected deliveries of the mineral to Potash Corp.'s industrial customers, farming season demand has yet to hit - look for headlines to scream of a potash shortage, and spot prices to rise, if the strike continues on into October. (That all could be good news for Mosaic, of course, which is the key competitor in terms of potash production.)

Many analysts are looking for a Potash comeback. Not a hard call, looking at the volatility of the stock, but it's difficult to say how much of the current drop is really about the event - the strike - and how much is a real reassessment of value of these old-economy stalwarts to a more stately P/E - say, one under 20, more in line with the historical norm for natural resources extractors.

Business Week/Standard & Poor's suggests that Potash Corp. is a strong buy, believing that high earnings per share will continue into 2009: higher potash prices, increasing fertilizer demand due to population growth, and increasing crop plantings. Morgan Stanley takes things a bit further, stating that this latest stock price slump of "Ag Names" is "unfounded."

My call? I'm not so sure. These companies are intrinsically tied to agricultural commodities, and with the recent slump in commodity prices, they could not hope to escape the bloodbath. Yes, prices will probably stay high, demand will remain strong and earnings will be great. But ultimately, how much of that is priced in, with P/Es back at historical norms?

It's like Arch Coal all over again.