I bought Sept-13, $32 Strike Call Options on PotashCorp today. Potash was down as much as 23.5% to $29.00 per share earlier, but has bounced back modestly to about $30.5 per share. The news that sent the potash sector reeling is serious stuff for sure. However, there are mitigating factors that suggest stocks like PotashCorp could be oversold. First the news.
There are, (or perhaps I should say “were”) two potash cartels that controlled up to 70% of the global potash market. One of them, the Russian/Belarus cartel known as BPC has broken apart. As a result, a top-5 potash producer, operating at about 10 million metric tonnes per year has threatened to flood the market, i.e. produce at 100% capacity, at a price of $300 per metric tonne, “mt”. That compares to current spot prices near $400/mt.
Again, on the surface this is a huge development in the sector, and one which was not anticipated. However, here are what I believe to be some mitigating factors…
1) The news almost certainly has some grandstanding component, why price product at $300/mt if the going price is $400/mt? The company, Uralkali, making this threat was looking to demonstrate its market clout. It has succeeded, but will the company follow through with its threat?
2) Uralkali plans to increase annual production by about 3 million metric tonnes. But, how quickly, if at all, can the company accomplish this goal? Yes, 3 million tonnes would be a large number, about 5% of the global market, but not a number that couldn’t be offset by global industry production cuts. Will potash prices fall on this news? Definitely. Will prices fall all the way to $300/mt? Probably not. And, if a few, small spot transactions occur at $300/mt, that would not be the end of the world.
3) Uralkali’s stock is down 20% on this news. Uralkali has an obligation to its stakeholders to preserve and grow shareholder value. The negative reaction by shareholders signals that the company’s bold plans might have to be scaled back.
4) Many companies near production, or ramping up production, will be forced to delay or cancel projects. Most notably, BHP’s massive Jansen project is much less likely to proceed, a clear benefit supporting longer-term prices.
5) Instead of a full $100/mt hit to industry margins, the true impact might be closer to $25/mt. Assuming that global prices settle in around $350/mt, due to the mitigating factors listed above, and assuming that most potash producers could cut $25/mt in operating costs if their backs are against the wall, then the overall margin impact would be $25/mt for a company like PotashCorp.
Remember, PotashCorp and Mosaic are wildly profitable at $400/mt pricing. Therefore, they have not been operating especially lean like other natural resource companies in for example the gold, silver, uranium and coal sectors.