A global food crisis is about to hit again. As shock waves from the credit crisis have spread to Asia, governments have been taking emergency measures to store up food. China has been the most aggressive, hoarding critical supplies of grain and stamping out exports of fertiliser.
That’s having a big ripple effect – the price of a bag of fertiliser in Nairobi has shot up nearly $50 in a few weeks, says Ariana Eunjung Cha in The Washington Post. As a result, many African farmers are leaving half the acres they own fallow as they head into planting season. But they are not alone in cutting back. With grain prices plummeting and banks cutting credit, farmers worldwide are reluctant to spend on extra equipment or fertiliser to boost their crops.
Little wonder the stockmarket has punished agricultural stocks. Take producers of potash – an essential ingredient in fertiliser. They once thrived as Brazilian farmers rushed to boost sugar cane crops and Americans became big buyers to support their ethanol craze. But fears about falling fertiliser demand have decimated share prices. Industry giant Potash Corp, for example, has dropped 60% from its peak. Meanwhile, Mosaic has slumped 80%, as have Potash One shares.
So why are purchasers at the port of Vancouver now paying a record $872.50 per tonne for potash? In short, because, unlike the other essential fertiliser nutrients, nitrogen and phosphate, potash is actually very scarce. Indeed, “potash is arguably the most exclusive product in mass mining”, says Mineweb’s Barry Sergeant. Only 12 countries produce it and about 85% of the market is controlled by just two cartels, the Canadian Canpotex syndicate and Belarussian Potash Company. Both are quick to cut supply when it suits.
What’s more, they have few rivals. “Potash is a hugely capital-intensive game requiring monster long-term capital investments,” says Sergeant. According to Potash Corp, it takes up to $2.8bn fully to commission a two-million-ton-a-year potash mine – a process that can take seven years. And that’s assuming you have the rail, road networks and ports systems in place to bring the potash to market.
Fertiliser demand could soon pick up. China is in the midst of a devastating drought that could cut wheat production by 13%, according to Merrill Lynch. Farmers can’t add fertiliser to rain-starved land – dusty winds blow it off dry top soil – but they will be forced to increase fertiliser use on less afflicted fields to boost harvests. “Since 1987, fertiliser demand in China grew on average 7.9% in drought years, more than double the 3.2% average in non-drought years,” according to Merrill Lynch.
Once the grain price recovers later this year, potash producers will really boom, says Chris Mayer in his Capital & Crisis newsletter. Global inventories are at their lowest level in 50 years. And takeover excitement is building in the sector, notes Barry Sergeant, with Agrium bidding for CF Industries, after CF Industries bid for Terra, and BHP Billiton “lurking in the background”. We look below at a potash giant that won’t stay cheap.
The best bet in the sector
Potash Corp of Saskatchewan (NYSE:POT) is “the Saudi Arabia of potash”, says Chris Mayer. The company’s huge, low-cost operations are based mainly in Canada. It also mines nitrogen and phospate, but potash is the firm’s main product. The company has plans to take production from ten million tons to 18 million tons over the next five years. At that level, it will be responsible for more than half the world’s new potash supply.
However, Potash Corp tanked last year due to fears about falling demand for fertiliser, and is now trading on a forward p/e of 5.85. In response, Potash Corp has moved to cut output by 20%. “But Potash has long made the calculus that what it can lose on volumes it can more than make up on prices”, Salman Partners analyst Raymond Goldie told Bloomberg. The company also benefits from solid cash flow. For the first nine months of last year, Potash generated in excess of $2bn in free cash flow after capital expenditure.
But it’s the long-term growth story that makes this stock interesting. Population growth and Asia’s developing appetite for meat – it takes seven pounds of grain to produce one pound of beef, while for pork the ratio is 4:1 – will require a constant supply of fertiliser as farmers struggle to boost crops to keep up with demand. Five years from now the company could earn $25bn in gross profit a year, says Chris Mayer, as that demand picks up. With today’s market capitalisation at only $22bn, this is one to buy and hold.