This week’s turkey is the world’s largest fertiliser ingredients supplier, producing potash, phosphorus and nitrogen. Over the past two years its shares have surged eightfold on the back of changing diets in developing nations, expansion of biofuels, massive price hikes, financial speculation and the recent Midwest floods.
Yet this looks like another commodity bubble waiting to pop. First, even after baking in these near-perfect conditions, which are set to double Potash’s sales and triple its earnings this year, the company’s valuation still looks fanciful, trading on multiples of seven times revenues and more than 20 times earnings for 2008.
Turkey of the week: Potash Corp (NYSE:POT), rated a BUY by Merrill Lynch
Next, the prices of its three main products look over the top, driven as much by speculation as underlying demand. Potash prices had plodded along for more than two decades at less than $80/ton. Then suddenly they doubled between 2004 and 2006 to $200, and jumped to over $600 this year, with spot values of $750 being reported in Brazil. Indeed, overall fertiliser prices are rising faster than those of almost any other raw material used by farmers. In April, US farmers paid 65% more for fertiliser than they did a year ago, compared with rises of 43% for fuel, 30% for seeds and 3.8% for chemicals.
Third, fertiliser is not a new invention. It’s been around for centuries and there’s more than 100 years worth of reserves; no ‘peak oil’ problems here. The issue, especially with potash, dug from underground deposits, is that it is concentrated in a few countries, causing severe bottlenecks. Just 12 nations mine potash, and about 80% of reserves lie in Canada, Belarus or Russia. But if new fertiliser substitutes are developed, or better supply is introduced, prices would undoubtedly wilt.
Fourth, much of Potash’s explosive growth is down to the exceptional amount of new land being planted for biofuels. The US ethanol industry could this year consume almost a third of the country’s corn crop, up from 25% in 2007 and 5% in 2000. This parabolic rate of expansion in acreage simply cannot go on forever, and could be hit hard if biofuel subsidies are reduced. What’s more, as the effects of the global slowdown take root, then rampant consumption should also wane.
Finally, although Potash is undoubtedly performing well, the stock looks vulnerable to a sharp pull-back. I would rate the business – at most – on a 14 times 2008 earnings multiple, giving a fair value of about $160 a share, or 25% less than today. Second-quarter results are due out on 24 July.
Recommendation: SELL at $218.84
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments