What inventory levels tell us
Inventory levels reflect current industry supply and demand balance and safety stock. Inventory levels rising is often a negative sign, as it suggests industry demand is cooling. While manufacturers can adjust to the weaker demand by cutting production, they often lag. But when inventory reaches a certain level, it will usually fall as cyclical demand returns or the pace of production cuts begins to outpace falling demand.
Potash inventory rises in July
On July 31, phosphate inventory in the United States had stood at 677,000 short tons, and it remains near the common peak level seen for the past eight years. A stable inventory level means that production has been matching inventory withdrawal (demand) for the past few months. While higher crop prices have supported demand for phosphate earlier this year, the weakness in the rupee and an unfavorable subsidy program in India were negative.
New capacity increases from China, Ma’aden (a Saudi Arabian mining company), and OCP (Office Chérifien des Phosphates—a national Moroccan phosphate company) are expected to outpace demand in the near term, according to Mosaic Co. (MOS)’s third quarter calendar 2013 earnings presentation. That means inventory levels could rise higher if competition among these firms intensifies. This move would have a negative implication for phosphate producers.
A flat inventory level is better than a rising inventory level, because it suggests production is meeting demand. With the cost of production falling this year due to lower phosphate rock prices, companies should enjoy higher earnings in the future as the more expensive inventories that were produced at higher phosphate rock prices are expensed today and replaced with cheaper costs moving forward. But given the larger increase we’re expecting in supply to demand, we might see higher inventory levels. That would be a negative for fertilizer stocks like Potash Corp. (POT) and Mosaic Co. (MOS) in particular, as well as Agrium Inc. (AGU) and CF Industries Inc. (CF). This negative outlook also applies to the Market Vectors Agribusiness ETF (MOO).
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