1 Industry to Avoid as 2014 Begins
Potash is a critical part of the global fertilizer market, and the industry faces falling prices and excess supply. In 2013 copper and iron ore prices have fallen steeply. Now more miners would like to turn to potash as a way to escape traditional markets where slowing Chinese industrialization is reducing demand.
BHP Billiton (NYSE: BHP) approved $2.6 billion of work on its Jansen potash project, even though it has a negative present value at current market rates. With prices forecasted to be around $330 per tonne in 2014, the potash industry is facing a big drop from the $390 per tonne it saw in the majority of 2013.
Get ready for falling profits
PotashCorp's (NYSE: POT) decision to lay off 1,045 workers and take a minimum $70 million severance charge should not come a surprise. In the first three quarters of 2012 the company brought in $6.29 billion in revenue and $1.93 earnings per share (EPS). In the first three quarters of 2013 its revenue fell to $5.76 billion and its EPS fell to $1.79.
The company is aiming for lower costs in the midst of the current downturn. By continuing its Rocanville expansion, reducing production at its Cory facility, and stopping production altogether in Penobsquis, New Brunswick, PotashCorp hopes to achieve cost savings of $15-$20 per tonne in 2014.
Regardless, the company's EPS is expected to fall from $2.13 in 2013 to $2.06 in 2014 thanks to challenging prices. A 3.41% fall in profits may sound quite small, but Wall Street thrives on growth. Any notion of shrinking profits can send a stock falling like a rock. Until prices come back and more of the industry's production is taken offline, it is best to put PotashCorp on the side-burner.
Some players in the potash market are only slightly exposed to falling prices. Agrium (NYSE: AGU) runs a big retail arm, and its wholesale potash operations in Q3 2013 were only 3.2% of its total sales. The market could still get spooked by falling margins from Agrium's planned 14-week potash outage in 2014, but the company is promising permanently lower costs in 2015 and beyond. Agrium is taking some short-term pain for long-term gain. While traders may punish the stock for decreased potash output in 2014, its long-term growth plans still stand strong.
The bigger downside
Get ready for more potash mining operations to be idled or shut down. The market will freak out over one-time charges and falling profits, but lower prices help existing miners by discouraging new entrants. If the prices don't stay low enough, big miners like BHP Billiton will increase supply by shoving billions of new capex into the industry. BHP Billiton boasts profit margins around 16.8% and a return on investment (ROI) 11.1%, pumping out the profits necessary to afford the multi-billion dollar price tag for greenfield development.
Vale's (NYSE: VALE) current potash operations are very small. In Q3 2013 potash produced a minuscule 0.49% of total operating revenues. The company recently got out of a $6 billion potash project in Argentina and suspended a $3 billion potash project in Canada. If potash prices rebound in the coming years these projects could be restarted. As it stands the Brazilian government is putting pressure on Vale to secure more potash supplies for Brazil's domestic agriculture sector.
BHP Billiton and Vale are cutting back on capex, but what they really want is a stable market not dependent on China's slowing growth. Potash demand is dependent on the world's food consumption. Seeing as conservative estimates forecast a growing world population until 2055, big miners are ready to gain a bigger share of the potash market once the prices are permitting.
The good news
As prices fall and more mines are idled, existing potash players like PotashCorp and Agrium will probably see their stock prices dinged. The positive side is that falling potash profits have not been brought on by gross mismanagement or heavy debt loads. The industry needs to rationalize production. Depressed prices decrease competition from big miners like BHP Billiton and Vale. As valuations come down and 2014 earnings bottom out PotashCorp and Agrium will be worth a second look.
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The article 1 Industry to Avoid as 2014 Begins originally appeared on Fool.com.Joshua Bondy has no position in any stocks mentioned. The Motley Fool owns shares of Companhia Vale Ads and PotashCorp. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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