Cost Cuts Aren't Enough for Potash Corp.

After several weak months of potash pricing caused by the collapse of the Belarusian Potash marketing arrangement, Potash Corp. made a decision last month to cut costs in just about every corner of the company. Considering the apparent pricing advantage of Russian producer OAO Uralkali, will those cost cuts be enough to matter?

Potash is a Canadian-based fertilizer stock that controls a majority of the Canpotex marketing partnership. Both Mosaic and Agrium provide a smaller level of potash to what is commonly referred to as the Canadian potash 'cartel.' Besides potash, Potash Corp. mines other fertilizers including phosphates and nitrogen, but previously potash was the most important by far, providing gross margins approaching 60% and a majority of the gross profit generated by the company.

Cost-cutting plan
Potash reduced its workforce by approximately 18% from prior levels due partly to the previously mentioned dispute between Belarus and Russia that sent potash prices down. The goal of the cost cuts is to reduce the per-ton costs of potash by $15 to $20 in 2014 with a further 2016 targeted reduction of $20 to $30 per ton.

While those cuts are helpful and probably necessary, the bigger issue for the stock remains the ability to maintain propped up margins helped by the marketing agreement. The ability to reduce costs only suggests the margin is already too high. During the weak third quarter, potash still contributed $148 margins per ton for Potash. The number was down significantly from $269 per ton in the prior year period, but the margins still amounted to nearly 50% gross margins.

Mosaic generated a $133 gross profit per ton, or a 35% gross margin. Considering Agrium contributes less than 10% to Canpotex, its margins aren't meaningful to the discussion and will only have a minor impact on the stock.

The most important numbers come from OAO Uralkali, which wants potash prices down around $300 per ton so that it can increase sales to Asia. Signs already exist that the plan is working, with Russia obtaining 73% of the sales to China in Oct., up from only 26% back in May.

Phosphate cuts
The cuts to the phosphate production might help balance out the focus at Potash. A total of 350 employees were let go form the phosphate and nitrogen operations. The cuts will eliminate 215,000 tons of phosphate by 2015 and cut the average cost by $10 to $15 per ton.

Considering the substantially lower $83 per ton margins for phosphate and $128 per ton for nitrogen, these cuts might have a bigger impact on competitive position. Mosaic has a substantially larger phosphate division so it might need to address these cost cuts by Potash. Mosaic had 14% gross margins for a $71 gross profit per ton.

While Mosaic obtains roughly 75% of its revenue from the phosphate division, the total gross profits were roughly equal with potash. So even after the huge hit from the Belarusian dispute, Mosaic had potash gross profits of $184 million and phosphates of $193 million.

Bottom line
While potash remains a vital component to the agriculture industry, the opportunity in fertilizer stocks remains murky. Even with the substantial drop in potash prices and margins, the numbers are still significantly higher than other fertilizers. In a normally functioning market, the gross margins could take another hit. The cost cuts by Potash Corp are significant, but one major concern is whether it's a race to the bottom with Oralkali in Russia.

Some of the recent gains in shares of Potash and Mosaic appear technically driven and shouldn't be chased. Without cooperation in Russia, potash margins remain at unsustainable levels, and the top two importers of the fertilizer, China and India, are likely to continue pressing for lower prices and margins. 

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