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The next pitfall for potash stocks? Lower grain prices

A potash mine owned by Uralkali, near Berezniki, Russia. Falling grain prices leave growers with less cash to buy fertilizers.


Bargain hunters looking to scoop up a deal on the distressed shares of potash producers should first take a look at the dismal forecast for corn, wheat and soybean prices.

Even as shares in companies such as Potash Corp. of Saskatchewan Inc., Agrium Inc. and Mosaic Co. begin to recover from last week's drop, the stocks remain under pressure from falling grain prices, which reduce farm incomes and leave growers with less cash to buy inputs for their crops.

Potash producers are already bracing for increased competition and lower prices as a result of the surprise decision by Russia's Uralkali to walk away from one of the industry's two dominant marketing groups, thus effectively breaking up the oligopoly that has long determined prices for the key crop nutrient.

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"Investors should steer clear of owning fertilizer shares, with a look toward continuing to reduce current exposure," Cowan and Co. analyst Charles Neivert said in a note this week.

"There are still more critical issues the market will need to address and downside risk remains meaningful despite the already steep share price declines. Basically, we do not see any positive catalysts coming into the market that could provide a meaningful lift to the shares."

Shares of Potash Corp., the world's largest producer, are down 18 per cent since Uralkali said on July 30 that it was exiting the Belarus Potash Co. (BPC) joint venture. Uralkali said it will now sell potash on its own rather than through BPC, and will ramp up production to increase global supply, which threatens to drive down prices.

Potash Corp. is the largest supplier to Canpotex, the world's second-largest global potash marketing group. Shares of Canpotex's other two members, Mosaic and Agrium, have also fallen, by 18 per cent and 4 per cent, respectively, since the Uralkali announcement. Agrium is the smallest player in Canpotex and the least exposed to potash, representing about 8 per cent of gross profit in 2012 and 4 per cent of sales.

Analysts have been revising their estimates on these and other potash producers over the past several days, and some are calling into question whether Canpotex can carry on as the lone global marketing group after the breakup of BPC.

Meantime, Canpotex's member companies are assuring investors the group will remain intact.

"I don't see Canpotex changing," Agrium chief executive Michael Wilson said in an interview on Thursday, adding the market has "overreacted" to the BPC breakup.

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"I don't think you should assume the price is going to drop to $250 or $300. … I think it will fall to whatever [is a] reasonable level, and I don't know what that is yet." Potash prices are currently about $400 (U.S.) per tonne.

He said Canpotex will adjust its prices based on supply and demand, as it has for decades.

"The fundamentals of ag[riculture] are still strong," Mr. Wilson told investors during the company's quarterly conference call. "I don't think anyone should pull the panic button."

Analysts say investors should look at grain prices to see where potash stock prices are heading. Robert Winslow, an analyst at National Bank Financial, points to a strong correlation between Agrium and Potash Corp. stocks and grain prices dating back to at least 2006. As grain prices fall, so do share prices for potash producers, and vice versa.

"You cannot fight the trend of grains," said Mr. Winslow. "Grains drive farmer income and farmer sentiment and they drive the amount farmers can afford to pay for their crop inputs. … Oligopolies can try their best to keep prices up, but in a falling grain price environment it's futile."

He says grain prices are likely to fall as a result of bumper corn and soybean crops. "If grain prices were to continue to fall … whether there is an oligopoly or not, those prices for fertilizer are going lower," said Mr. Winslow.

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Despite the issues around the industry, some analysts still see hope for investors. Nine of the 29 analysts following Potash Corp. call it a "buy", according to Bloomberg. Sixteen label it as a "hold" while only four deem it a "sell."

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