The stock market has been in rough water over the last three weeks and stocks across many sectors including banking, energy, telecommunications and others have consolidated quite a bit. While I think that the consolidation in the markets is necessary and healthy, I also believe that a variety of companies now make even better value propositions than just a few weeks ago when optimism peaked. As a contrarian investor, I am still looking for companies that were unfairly punished because of some short-term, singular event but which have asymmetric return profiles as they are somehow misunderstood by the market.
One of my favorite contrarian bets at this point of time is Potash Corporation of Saskatchewan (POT). The company, like most other companies in the fertilizer sector, has been exposed to an extraordinary earthquake in 2013 which was precipitated by Uralkali's (OTC:URALL) announcement to break up the Belarusian potash cartel and Uralkali's intention to pursue a volume-over-price strategy. Since Uralkali is one of the biggest players in the potash industry, its announcement carried some weight: Potash prices and share prices of potash firms took a nosebleed dive in July 2013 erasing billions of dollars in market capitalization. Potash firms whose share prices are depicted in the chart below include: K+S (OTCQX:KPLUY), Mosaic (MOS) and Compass Minerals (CMP).
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A forceful decline in share price is always a good sign for a contrarian investor because it is likely that investors are selling indiscriminately without consideration of the underlying intrinsic value of the company. Similar chart patterns, which reflect a sudden change of heart by the shareholder base, can also be found for BlackBerry (BBRY) or, more recently, Best Buy (BBY). Once the emotional excitement subsides, investors usually come back to the table and conclude that news weren't as bad as they initially thought. Hefty share price declines oftentimes define the beginning of a slow and gradual recovery trend and it was of no real surprise that potash companies rebounded nicely in the second of half of 2013 and the beginning of 2014. Now, share prices of potash firms are correcting once again which I attribute to an overall profit-taking mentality in the marketplace. However, long-term investors can still find a decent bargain in Potash Corp. of Saskatchewan over the next two or three years and I have repeatedly argued that I expect shares of potash firms to climb back to pre-crisis levels (in the case of Potash Corp. this would imply a target price north of $38 per share).
Fourth quarter results
Potash prices have been declining throughout the second half of 2013 as fertilizer dealers acted strategically and put off purchases in hopes of further falling prices. Potash prices have declined from nearly US-$400/t in July 2013 to around US-$330/t at the end of 2013. Clearly, this was going to have a nasty impact on Potash Corp.'s results.
In the fourth quarter of 2013 Potash Corp. earned $0.26 per diluted share which compares against $0.48 in the year ago quarter (down 46%). Fourth quarter potash sales volumes, however, increased 13% sequentially and 34% y-o-y driven by higher North American demand. Given the weak pricing environment for potash, Potash Corp. reported lower realized average prices of US-$282/t for the fourth quarter 2013 (US-$332/t full-year).
Cost savings and share repurchases
While the macro environment remains challenging going into 2014, Potash Corp. takes the right actions to address those challenges and create value for shareholders. The fourth quarter of 2013 saw $60 million of severance-related costs in order to facilitate downsizing measures and streamline the company. In addition, the company repurchased 7.8 million shares worth nearly $250 million in the fourth quarter. For the full-year 2013 Potash Corp. repurchased 14.1 million shares worth approximately $444 million.
Market outlook positive
The most important thing when looking ahead is that Potash Corp. sees improving potash demand conditions in all geographic regions (see chart below). Rebounding potash prices driven by higher demand will be a key driver of Potash Corp.'s share price in 2014 and beyond.
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On January 30, 2014 Potash Corp. stated that:
In potash, the uncertainty that persisted over the past six months appears to be subsiding and we expect global demand to improve. We enter 2014 with improved market engagement and believe global shipments for the year could be in the range of 55-57 million tonnes (an increase of approximately 5 percent from 2013 levels), with those during the first half expected to be particularly robust. Although we believe conditions are supportive for record potash demand, achieving such levels will largely depend on consistent buyer engagement and renewed commitment in key developing agricultural economies to address nutrient-deficient soils.
Conclusion
Potash Corp. also operates nitrogen and phosphate segments, but the market will value the company based on its performance in its dominant potash business. The low pricing environment and negativity in the analyst community offer investors huge upside surprise potential. Expectations with regard to potash prices, sales and earnings are so low, that it won't be difficult to deliver meaningful surprises in the coming quarters. While I consider the return of Uralkali back into the cartel structure a low-probability event, it still has to be proven whether the volume-over-price strategy will pay off for Uralkali.
Potash Corp. investors, in my opinion, face relatively little downside risk. Pessimism in the market place with respect to future earnings is so high, that current share prices already reflect a high margin of safety. Potash Corp. presently pays investors $0.35 quarterly ($1.40 annually) which equates to a forward annual dividend yield of 4.47%. Investors get paid quite a decent dividend yield for just sitting back and waiting until the dust in the potash market settles. Contrarian long-term BUY with a 2014 price target of $38.
Disclosure: I am long POT, MOS, KPLUY, BBRY, BBY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)
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