Equity research: The Mosaic Company (Part 3 of 5)
The Mosaic Company (MOS) and the global food story
The global fertilizer story is a compelling one over the long term due to two overarching themes:
- World grain and oilseed use to increase driven by population growth and “advancing” dietary habits in developing countries (further protein, meat et cetera, consumption).
- With limited land available, crop yields must increase to feed all these people. Crop yields improve with more fertilizer implementation and use.
The below two charts outline the long-term expected (and arguably needed) grain usage and yield improvement around the world:
The below comp set outlines other publicly-traded agriculture producers as well as valuation levels:
Main risks to the MOS story
Risk: Uralkali breaks up Belarusian Potash Company
On July 30, Russia’s Uralkali quit one of the two largest potash cartels, Belarusian Potash Company (BPC), as cooperation with BPC’s partner, Belaruskali, reached a “deadlock.” The market perceived this as a large competitive risk to potash pricing, as a breakup of the BPC means Uralkali could ship potash fertilizer to China at a lower price. So shares of POT, MOS, AGU, and others all traded down steeply with the expectation of lower prices, meaning much lower profitability for these big fertilizer companies. Canpotex and BPC historically were the behemoths in the fertilizer market (together controlling 70% of the potash export market) and negotiated large shipments to countries like India, China, and Brazil—typically in similar price ranges as some perceived the market to be a duopoly.
Some perceive Uralkali’s move as simply posturing, and the end result will not be a full-on BPC breakup. Although there might be a threat to shipments to China, India has already signed a 4 million tonne import deal. Much of the market reaction is an overreaction (which is typical for Mr. Market), as we do not know the full impact nor the end result of this BPC drama. Fertilizer stock prices are baking in a very drastic outcome. This news could also prompt a halt in planned potash capacity expansion, which should partially support fertilizer prices.
Russian and Ukrainian wheat slashed prices in 2011 to gain market share as wheat prices were at record highs; the associated drop in global wheat pricing lasted ~12 months then rebound to pre-2011 levels… Point being: we’ve see Russia do this before.
Future capacity expansions risks oversupply
Planned capacity expansions for potash and DAP (phosphate) could lead to lower fertilizer prices.
- Significant DAP capacity could come on stream from Saudi Arabia and Morocco over the coming two to four years. This capacity could lead the phosphate market into conditions of oversupply, reducing product prices and volume for Mosaic, and leading to a lower share price.
- Meaningful potash capacity could come on stream over the coming three-to-five-year period, placing pressure on Mosaic’s potash volumes and prices. A key event that has yet to be determined is whether BHP proceeds with construction of its large Jansen potash project in Canada.
- Both scheduled and unscheduled production curtailments have already begun in 2013. In early July, Potash Corp, for example, announced it will reduce potash production by 1 million tons through August. In addition, an extra 2.5 million tons of unexpected shutdowns will occur through December of this year for the company. If the biggest player in the market is taking more downtime than expected, then the likelihood of further green- or brown-field capacity expansions by Potash Corp or other players to be pushed back is fairly good. In addition, these production downtime announcements should support fertilizer prices.
- Even if plans for new capacity additions are not pushed back, the long-term supply/demand impact on the fertilizer is not out of whack. The near term could experience some fertilizer pricing volatility, as capacity does not come online perfectly vis-à-vis demand. However, as the below chart shows, demand for phosphate will grow comfortably into the additional supply coming online:
Idiosyncratic mishaps at MOS have historically threatened earnings results
MOS has had a history of various one-time items hitting the company (usually on the cost line) that surprises to the downside on quarterly earnings. This is one of the main reasons why MOS has typically traded at a 1x-to-2x multiple discount to its peers.
Over the past about six months, however, MOS has resolved a couple of these main issues that were typically behind the earnings misses. I go into more detail about these items in the Catalyst Overview section of this report, but specifically, they are the Esterhazy tolling agreement and the Fort Meade mine
The Market Realist Take
Potash prices have declined to their lowest since 2010 following the BPC breakup. Uralkali’s head of sales, Oleg Petrov, said he expects global potash prices to fall further this year but rebound in 2014 once supply contracts with China are set. He said, “The (global) price will not drop to $300, but there might be a correction from current levels this year because Belaruskali and other producers’ attempts to place volumes could put pressure on the prices.” Fertilizer companies’ share prices have taken a hit following the BPC breakup, so investors need to take note as to whether the fall in exports and declining prices will remain a long-term trend.
Browse this series on Market Realist: